Guest Blogger: Prohibited Inducements in the College Loan Industry
by John Weaver, Editor-At-Large
Last month, Margaret Spellings, the Secretary of Education, released a “Dear Colleague” letter on the topic of college loans. In it, she asks colleges and universities to protect the borrower’s choice of lenders and base lists of preferred or recommended lenders solely on the best interests of the borrowers. This has been necessitated by a college loan scandal that hit news wires earlier this year, in which a number of school financial aid officers accepted gifts or favors from college loan providers in return for preferential business treatment.
She also references pending changes to 20 C.F.R. 682 et al. that will take effect on July 1, 2008. In theory, these new regulations – in conjunction with pending legislation like H.R. 890 and the S. 486 – will curtail the practices of some lenders and schools regarding prohibited inducements. Where the current code and regulations state generally that lenders and guarantors may not offer inducements to schools to secure loans, the pending code and regulations specifically state actions that are prohibited or that will be considered prohibited inducements. Additionally, H.R. 890 requires that every school participating in federal student loan programs have a code of conduct that prohibits school employees from engaging in activities with lenders and guarantors that constitute a conflict of interest or the appearance of a conflict of interest. This attempts to make law many of the requests Spellings has made in her “Dear Colleague” letter from last month.
The greater question, though, is how needed are these changes?
As some have noted, the recent scandals are an exception in the industry. Most lenders, schools, and guarantors act within the established law, and the wide diversity in lending programs created by the current federal program gives borrowers greater choice.
However, Congress has acted recently like closing or attempting to close loopholes in the prohibition against inducements in the college loan industry is not sufficient to genuinely help kids seeking a college education. Earlier this month, Congress passed a bill increasing federal financial aid to college students by $20.2 billion, the largest increase since World War II. Under this bill, the maximum Pell grant – which go exclusively to low-income students – increases from $4,050 to $5,400 over five years. Student loan interest rates will be phased down to 3.4% from 6.8%.
Critics say the legislation will be a blow to the student loan industry, shrinking the market. Providers will decrease their student loans, or scale back borrower benefits. One loan provider, Nelnet, has already announced that it will lay off 400 employees because of the recent changes in the market and its $2 million settlement to the state of New York for making improper arrangements with college alumni associations to promote its loans. In response, supporters of the bill point to the recent $25 billion acquisition of Sallie Mae as an indication that the student loan industry is fine, particularly since the government guarantees all federal student loans, ensuring a profit.
Indeed, Michael Kinsley has argued that the math for the federal government’s involvement in the student loan industry is all wrong:
[T]he government itself borrows the odd nickel to finance the national debt. This borrowing, obviously, is guaranteed by the government. For that reason, it carries an interest rate of only 3 or 4 percent. If the government can borrow money at 3 or 4 percent, why should it pay 7 or 8 percent for the privilege of guaranteeing loans to someone else? Wouldn’t it make more sense for the government to lend the money itself?”
Were the government to lend the money itself, many of the current problems with inducements and conflicts of interest would be nullified. The pending regulations and code, as well as Spellings’ “Dear Colleague” letter, would be obsolete.