Congressional Democrats Embrace "Students, Not Banks" Strategy

This week, House Congressional Democrats will attempt to pass a 50 percent cut in subsidized undergraduate Stafford student loan interest rates by raiding excess taxpayer subsidies to big banks like Sallie Mae. The interest rate cut from a 6.8 percent annual rate to 3.4 percent will be phased in over five years, apply only to new student loans, and require $5.85 billion in offsets.

To pay for their plan, House Congressional Democrats plan to:

(1) Reduce the government guarantee to lenders against default from 97 to 95 percent of principal borrowed. This is a modest reduction given that: (a) President Bush proposed the same level in his FY 2006 budget, and (b) the Small Business Administration guarantees loans at as little as 50 percent of principal borrowed and those loans default at a much higher rate.

(2) Eliminate the "exceptional performer" designation that entitles lenders who comply with regulations an extra two percentage points in the government default guarantee. Again, a modest offset given that the government currently designates lenders as exceptional for: (a) the activity of servicers, and (b) doing what they are supposed to do anyway under existing law and regulations.

Currently, Sallie Mae and Nelnet are the two biggest exceptional performer designees. They certainly have been exceptional. Not long ago, Sallie admitted to billing incorrectly more than one million student loan borrowers over 10 of the last 12 years. And Nelnet has ripped off taxpayers nearly $1.2 billion dollars through its 9.5 percent loan reverse-money laundering scheme. Again, currently taxpayers reward these top two lenders with a near risk-free guarantee against default.

(3) Reduce the Federal Family Education Loan guarantor collection fee on defaulted laons from 23 to 16 percent over the next four years. The 16 percent level is what the government pays for Direct Loan collections. Again, it's a modest offset. President Bush proposed the same in his FY 2006 budget.

(4) Pay attention, because people are getting this incorrect, increase the lender paid origination fee on all student loans, not just consolidated student loans, to 1 percent. This offset was passed by the Republican-led House of Representatives last year, but dropped in conference.

(5) Our favorite, because we recommended it (and to the partisans out there, Higher Ed Watch advises both Democratic and Republican Capitol Hill aides as well as Bush Administration staff), a targeted cut in the subsidy to large student loan providers -- thus creating what is called "a differential subsidy." The House Democrats will move to reduce by 10 basis points -- that's one-tenth of one percentage point -- the "special allowance payment" (i.e. subsidy) to lenders who in rank order hold the top 90 percent of student loan volume. In other words, small banks would be exempt from the Congressional Democrats' proposed subsidy cut.

Of note, because the student loan industry is dominated by Sallie Mae and a small number of others, only 32 lenders are impacted by the Congressional Democrats' proposed taxpayer subsidy cut. (Click here for a list of lenders ranked by volume.) We recommended targeting just the top three holders or only the for-profit holders since in the former case, these folks realize big economies of scale, and in both they give back very little in borrower benefits. But either way, a differential subsidy makes a lot of sense.

The bottom line

As we predicted here, Congressional Democrats want to deliver. They've trimmed the costs of their interest rate cut proposal and consequently trimmed their need for offsets. Although we still expect a fight, they've minimized the opposition's argument.

Stay tuned to Higher Ed Watch for more on the expected Congressional Republican opposition, the misleading facts on which we expect it to be based, and what the Senate and Bush Administration can do to achieve a constructive, bipartisan, and more comprehensive policy that is good for students, parents, and taxpayers alike.