A Well-Deserved Award

Too many times of late, we have seen mainstream journalists fall for the spin of lenders, who in the wake of the credit crunch have had a vested interest in raising panic levels about the availability of student loans.

That’s why it’s such a pleasure for us to see good, critical, and insightful reporting on the loan industry receive the recognition it deserves. Case in point: Paul Basken, a senior reporter at The Chronicle of Higher Education, has received a National Press Club award for a revealing piece he wrote last May showing how the revolving door between the Bush Administration and the student loan industry brought great rewards to Sallie Mae and put financially needy students in harm’s way. [Disclosure: the author of this post used to work for the Chronicle.]

We wrote about Basken’s article last year. But at a time when the student loan scandals of yore are fading fast from memory, we felt that it was important to remind our readers of just what he found. The conflict of interest that he uncovered still exists and needs to be dealt with.

Going to Bat for Sallie Mae

The Chronicle article revealed that Matteo Fontana, a high-ranking official in the Department of Education’s Federal Student Aid office, made “a controversial and high stakes legal ruling” in December 2004 that greatly benefited Sallie Mae, his former employer, the day before the company officially broke its ties with the federal government and became a private corporation. In fact, Fontana’s action essentially removed the last obstacle to the company’s long-sought transformation. [Yes, this is the same Matteo Fontana who was at the center of a Higher Ed Watch investigation that found that he held 10,500 shares of insider stock from Student Loan Xpress. Nearly 15 months later, Fontana remains on paid administrative leave pending the outcome of a Department investigation.]

In his ruling, Fontana rejected an opinion offered by the Department’s Inspector General (IG) two years earlier that a lucrative arrangement that exists between Sallie Mae and USA Funds, the country’s largest guarantee agency, violated the law and needed to be severed in order to protect borrowers.

Sallie Mae’s relationship with USA Funds dates back to 2000 when the loan giant purchased the guarantor’s parent company, USA Group, which had been one of its largest competitors.

On its face, the sale didn’t give Sallie Mae control of USA Funds. Under federal law, for-profit lenders, such as Sallie Mae, are not allowed to own nonprofit entities such as guarantee agencies. That prohibition makes sense because the Higher Education Act puts guarantors in charge of overseeing loan providers — making sure, for instance, that lenders do everything required to keep borrowers who are delinquent on their loans from defaulting.

Sallie Mae, however, found a creative way around the restriction. While the loan company’s purchase didn’t include USA Funds, it did gain control of USA Group Guarantee Services, a for-profit subsidiary that provided administrative services to help the guarantor carry out its functions. The deal also required USA Funds to contract its loan guarantee services to Sallie Mae.

USA Funds is now a shell of its former self. Sallie Mae employees carry out most of the agency’s operations. Meanwhile, the guarantor pays Sallie Mae about $250 million a year for staffing and other purposes, according to the Chronicle.

Raising Red Flags

In 2002, the Department’s IG raised a giant red flag. Sallie Mae’s relationship with USA Funds, the IG’s office wrote, presents “a conflict of interest” that needs to be cured. Because Sallie Mae effectively controls the guarantor, the IG pointed out, there is no independent agency ensuring that the loan giant is doing all it can to ensure borrowers don’t fall behind on their payments. By working hand-in-hand, the two entities actually have a perverse incentive to let borrowers fall behind so that the USA Funds can collect the generous subsidies the government provides guarantors for keeping delinquent borrowers out of default.

What makes the story especially outrageous is that the Federal Student Aid office initially agreed with the IG’s assessment. In March 2004, Fontana sent a letter to USA Funds saying the “conflict of interest” needed to be eliminated. But on the eve of the day Sallie Mae was finally to become a fully private for-profit company, he had a change of heart.

In the follow-up letter he sent that December, Fontana wrote that the Department “had reconsidered its prior position.” He said the conflict of interest did not exist because the Sallie Mae (SLM) subsidiaries that helped manage USA Funds had separate tax identification numbers from other parts of the company. “It is apparent from SLM’s website that SLM regards these subsidiaries as separate corporate entities,” he wrote. Great detective work there.

Basken’s piece showed how Sallie Mae’s friends at the Department went to bat for the corporation, despite having concerns that students could be hurt. Hopefully next year, when the Department’s leadership changes, the agency will revisit this dubious decision and, as a change of pace, put the interests of students first.

Congratulations on the award, Paul. Keep up the good work.