A Missed Opportunity to Make Private Loans Safer?

Senate Democratic leaders are coming dangerously close to allowing a golden opportunity to rein in predatory private student loan practices pass them by.

The Senate is expected to complete work over the next week on its version of a financial regulatory overhaul bill that would create a new federal watchdog agency in charge of regulating all forms of consumer credit, including private student loans. The aim of the Consumer Financial Protection Bureau would be to protect consumers from the types of unscrupulous lending practices that led to the near collapse of the financial markets not so long ago.

The legislation holds out the promise that private loans would for the first time be regulated by a single entity, rather than the patchwork of federal agencies that have done little to curb even the worst private lending abuses in the past.

Unfortunately, the Senate bill, as currently written, falls far short of that goal. As our colleagues at the Project on Student Debt have pointed out, the measure includes “worrisome gaps” that would hamper the bureau’s ability to provide meaningful oversight over the private loan market and to ensure that students are not being led to take on high-cost private loans unnecessarily.

Here are three major changes that we would urge the Senate to make to the legislation to ensure that the consumer protection bureau lives up to its promise:

• Make absolutely clear that Sallie Mae, the largest provider of private student loans in the country, falls under the consumer protection bureau’s jurisdiction.

As we recently wrote, the bill appears to inadvertantly allow Sallie Mae, which made over $5 billion in private loans in 2008-09, to escape from the bureau’s oversight. Under the bill, this new agency would not have any supervisory or enforcement authority over banks with less than $10 billion in assets. Instead, these banks would remain under the jurisdiction of the existing bank regulatory agencies, such as the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation. The legislation’s authors included this provision to limit the regulatory burden that the measure would place on smaller banks and credit unions.

So what does this have to do with Sallie Mae? The student loan giant would apparently fall under this exemption because it is currently financing private student loans through a bank it owns in Utah (appropriately called the “Sallie Mae Bank”) whose total assets fall well below the threshold.

Allowing the nation’s top private student loan provider to potentially slip through the cracks is completely unacceptable — as it would perpetuate a disjointed regulatory system, which time and time again has failed to safeguard students from predatory lenders. That’s why we believe that it is critically important for the bill’s authors to address this oversight.

Sen. Richard Durbin (D-IL) has drafted an amendment to the bill that would do just that. Under the amendment, the consumer protection bureau would be given full enforcement authority over private loans made by banks with more than $1 billion in assets. We would urge the Senate to adopt this amendment.

• Give the bureau the power to oversee the sub-prime private loans that for-profit colleges are making directly to their students.

In 2008, Sallie Mae quit offering sub-prime private loans to students at for-profit colleges because astronomical delinquency and default rates had helped throw its stock into a nosedive. To get around this roadblock, the most profitable proprietary schools began to make private loans directly to their most financially needy students themselves.

The schools are making these high-risk loans even though they know full well that many of the low-income and working-class students they are offering these loans to won’t be able to repay them. Corinthian Colleges, for example, has told investors that it expects nearly 60 percent of the $150 million in “insitutional” loans it is making to students this year to end up in default. For the schools, these losses are more than offset by the federal financial aid dollars these students bring in. But for the students, defaulting on these loans could lead to a spiral of debt that could literally ruin their lives.

Meanwhile, serious allegations have been raised that some for-profit college school chains have signed up students for these loans without their permission, or at least without revealing the actual terms and conditions of the loans.

Last fall, the House of Representatives recognized these dangers and agreed to put all private loans, including those made by proprietary schools, under the jurisdiction of the consumer protection agency in its version of the legislation. The Senate should do the same.

• Require lenders to get colleges’ permission before providing private loans to their students

The House version of the Wall Street reform bill includes a provision that would require colleges to certify a student’s need for private loans before that individual could receive them. The plan aims to give college financial aid administrators the opportunity to counsel students about their financial aid options so that they do not take on unnecessary private loan debt. This is important because, according to the most recent U.S. Department of Education data available, nearly two-thirds of undergraduates who borrowed private loans in the 2007-08 academic year did so even though they hadn’t exhausted their eligibility for lower-cost federal student loans first. One quarter of these private loan borrowers did not take out any federal loans at all.

The Senate bill does not include the provision. So far Sen. Chris Dodd (D-CT), who as the chairman of the Senate Banking Committee drafted the bill, has resisted pleas from college lobbyists, consumer advocates, students groups to include it. Instead, as we recently reported, he continues to support a toothless alternative measure he helped push through Congress in 2008 that requires students seeking private loans to “self-certify” that they are aware of their federal student loan options.

As Inside Higher Ed reported today, an unusual coalition of consumer advocates and student loan industry lobbyists (groups that were on opposing sides during the recent battle over student loan reform) have joined together to persuade Senate leaders to adopt the House provision. “”Requiring school certification that confirms students’ attendance and loan eligibility — as is currently required on all federal student loans — discourages unnecessary borrowing which could lead to delinquency and default during repayment,” the groups wrote in a letter to Senate leaders on Friday that was spearheaded by the National Association of Student Financial Aid Administrators. “It also gives financial aid administrators an additional opportunity to counsel students about less expensive forms of financial aid and ensures that students do not inadvertently disqualify themselves for less costly aid. Simply put, school certification will help ensure that private loan borrowers maximize their ability to borrow federal loans and only turn to private loans after exhausting federal loan eligibility.”

We wholeheartedly agree and hope that Senator Dodd reconsiders his position now that the lenders are also on board.

As we said at the start, Senate Democratic leaders have an amazing opportunity to make private loan borrowing safer. Let’s hope they don’t blow it.