A $25 Billion Bet on Market Share and Private Loans

Do Sallie Maes buyers know what they are getting into? What do they think justifies such a high premium for the stock? Do they think the market was wrong about recently diminishing prospects and correspondingly lower stock prices for Sallie Mae?

The buyers seem to have been influenced by analyses that conclude Sallie Mae is so dominant as a provider of both federal guaranteed student loans and private student loans it's a sure thing. But those analyses are based on two assumptions: that Congress will keep responding favorably to Sallie Maes lobbying and campaign contributions, and that higher education institutions will continue to be cozy with the student loan industry.

Congress is almost certain to cut lender subsidies significantly in the federal guaranteed program. But it is increasing likely, given the recent scandals involving private loans, that Congress will start to enact more significant reforms in that area as well. It is especially in the delivery of private loans that Sallie Mae buyers should be nervous.

Given the recent revelations of predatory lending, kickbacks, payola and other deceptive practices in the for-profit student loan business, Congress will have to look at whether it wants to continue all of its subsidies and benefits to the private loan side of the industry. These subsidies are mostly indirect, but they are significant for private loans. For example: tax deductibility of student loan interest; non-dischargeability of student loans in bankruptcy; strong collection tools; and combined securitization with federal guaranteed loans. Apparently the federal government even allows loan default collections to pay off a private lender before reimbursing federal taxpayers, when defaulters hold both private and federally guaranteed loans.

If Congress scores these and other subsidies for their value to the industry, it will find they are substantial. Congress will surely ask if there is a better way to go about aiding students, instead of rewarding for-profit lenders who push extraordinarily expensive private student loans with deceptive tactics. Private loan provider Loan to Learn, for example, offers private loans with up front fees equal to as much as 10 percent of principal borrowed and annual interest rates in excess of 16 percent.

The most obvious Congressional reaction might be to move the private loan subsidies that are on the tax side of the budget to the spending side in the form of increased federal grants to students, so students would not have to borrow as much. Both President Bush and Senator Kennedy have proposed budget process changes to allow subsidies in the guaranteed loan program to be moved over to grantstax expenditures could be next. (Disclosure: Higher Ed Watch staff used to work for Kennedy.)

Another Congressional reaction might be to ask if it would be more appropriate to subsidize private loans in the same way that it subsidies other private activities worthy of public support. It could limit private loan subsidies to entities that qualify as tax-exempt organizations eligible for tax-exempt private activity bonds.

The other big unknown for the buyers of Sallie Mae is whether higher education institutions will look as favorably on for-profit lenders in the future as they have in the past. Some organizations of higher education officials have been badly burned by their close association with the big for-profit lenders, and others will surely want to keep their distance. It would not be surprising if many higher education leaders were to end their relationships with for-profit lenders like Sallie Mae, Nelnet, Student Loan Xpress, Education Finance Partners, among others. Lobbying alliances between higher education groups and the for-profit lenders, like the Coalition for Better Student Loans (which, not surprisingly, has no students in it) may be more of a liability than an asset for the image of higher education.

Buyers beware.