Exceptional Waste

If you want a glaring example of the types of favors and give-aways that the government provides the student loan industry at the expense of taxpayers, look no further than the "Exceptional Performers" program.

Under that program, the U.S Education Department reimburses lenders that participate in the Federal Family Education Loan (FFEL) program 99 percent of the value of loans that go into default -- 2 percentage points more than than it provides other lenders -- if the lender simply complies with "due diligence" rules that Congress and the agency require of banks collecting loans. These rules mostly dictate how often lenders must contact, by telephone and by mail, borrowers who have become delinquent on their loans to try to get them back in good standing.

While Congress created the program in 1992 as part of a broader effort to drive down the student loan default rate, not a single lender earned the designation until late 2003. But soon thereafter, the Education Department's Federal Student Aid Office -- led by ex-student-loan industry officials -- opened the floodgates. Today, there are 18 exceptional performers responsible for 90 percent of all outstanding FFEL loans, according to a recent report by the Government Accountability Office (GAO).

It's difficult to imagine what a company would have to do to be ineligible for the program. The Education Department considers the student loan giant Sallie Mae to be an exceptional performer, even though not long ago the company admitted to billing incorrectly more than 800,000 student loan borrowers over a number of years. More spectacular is that Nelnet also holds the exceptional performer designation, even though the Education Secretary Spellings found that the company had broken the law when it overcharged the government hundreds of millions of dollars for subsidy payments on loans that it held.

Congress had the best of intentions when it created the program. In 1992, student loan default rates were at an all-time high of 22 percent, as compared to about 5 percent today. In addition, a Congressional investigation into student-loan practices in the early 1990s had found that many lenders, guarantee agencies, and servicers were failing to adequately inform borrowers about late payments before classifying them as defaulters.

The investigation, which was led by Sen. Sam Nunn, the Georgia Democrat, concluded that lenders needed a greater incentive to practice due diligence in preventing borrowers from defaulting on their loans. In creating the exceptional performers program, lawmakers hoped they'd be able to drive down the default rate and therefore reduce the government's costs in reimbursing lenders for uncollected loans.

It's not clear why the Education Department didn't name any exceptional performers for the program's first 12 years. What is clear, however, is that by the time lenders started flooding into the program, it was no longer needed.

First, by 2003, the default rate on student loans had already plunged to record-low levels. In the 1990s, the government had used a variety of tools, including barring trade schools and colleges with high default rates from participating in the federal loan programs, to get federal student loan liability levels under control.

Second, technological advances over the years "such as more sophisticated software and autodialers automated many aspects of required due diligence activities" making them much less difficult to carry out, according to the GAO. In other words, lenders can easily comply with the Education Department's regulations without any added incentive.

GAO says that the Exceptional Provider program, which it estimates will cost taxpayers about $1 billion over the next five years, hasn't benefited the government. In fact, the amount that the government pays on default claims to lenders has not dropped, but instead increased from 1.8 percent to 1.9 percent of the volume of outstanding loans. Meanwhile, the number of default claims has grown from 2.8 to 3.7 percent of loans over that period.

And lenders acknowledged in interviews with the GAO, that they did not improve their practices to win the designation. Guarantee agency officials interviewed said that they didn't see any difference in regulatory compliance between lenders who had and had not been designated exceptional performers.

The sole beneficiaries of the program have been the lenders. Not only have they they received significant monetary benefits, but they've also been able to boast in their marketing material that they are considered to be an exceptional perfomer by the federal government.

In its report, the GAO calls for ending the program. "Providing an extra 2 percent reimbursement rate for default claims serviced by exceptional performers is not in the fiscal interest of the federal government because lenders are being paid a premium to perform due dligence activities that are already required of all lenders."

Luckily, Congressional leaders agree, and plan to kill it the program as part of the budget reconciliation legislation they hope to finalize in the coming days. Action won't come a moment too soon.