Student loan scandal

October 14, 2004

REMEMBER THE OLD saying about people who think they are wits are usually only half right? Well, if members of Congress think they've fully resolved the $6 billion student loan scandal, their brain cells have earned a similarly dubious title: lonely. Taxpayers are still going to get gouged by some private lenders. Why can't Washington stop this rip-off dead in its tracks?

Here's the problem. Under the Federal Family Education Loan Program, the government guarantees lenders a certain minimum rate of return on student loans. In the banking business, this is called lender yield. The lenders - banks or other financial institutions - issue tax-exempt bonds to make the loans. Before Oct. 1, 1993, the lender yield was 9.5 percent - meaning that the federal government made up the difference between 9.5 percent and whatever interest rate the borrowers paid.

Fair enough, right? After all, 9.5 percent was about the going rate 11 years ago. Well, you may have noticed that current interest rates on student loans are about 6 points lower than 9.5 percent. But thanks to a loophole in the law, the lenders are not only able to maintain these highly profitable returns, they've been expanding them. Lenders found a way to essentially clone the pre-1993 bonds. Like magic, the government is helping finance more than $17 billion in outrageously expensive loans - about $6 billion more than was invested a decade earlier.

It's all perfectly legal, of course. It's just costly.

On Saturday, the Senate unanimously approved a House-passed bill that is supposed to fix the situation, but unfortunately, the timid politicians didn't go far enough. They've chosen to ban new 9.5 percent loans (that's good), but they left in a costly loophole (that's bad). Lenders can recycle the payments, interest and other income from existing loans to make new loans carrying the 9.5 percent guarantee as long as the underlying bond doesn't expire. So how much extra will this cost? Nobody knows for sure, but it's likely to be measured in the hundreds of millions of dollars since many of these bonds will survive past 2020.

With congressional action falling short, it's now up to the U.S. Department of Education to make a regulatory fix. According to advocates, Education Secretary Rod Paige can simply rule them illegal. We urge him to do so. Mr. Paige had said that Congress needed to act first, and it has. The administration has already promised that all savings from the program will be plowed back into the nation's classrooms. Why not squeeze out a few hundred million more? The schools could use the money.

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