Friends in High Places Deliver Big for Sallie Mae Behind the Scenes

The Chronicle of Higher Education published an explosive piece on Monday providing greater detail of how the revolving door between the Bush Administration and the student loan industry has put financially needy students in harms way. (Disclosure: Higher Ed Watch staff used to work for The Chronicle.)

The article reveals, for the first time, that Matteo Fontana, an Education Department official who had worked at the student-loan giant Sallie Mae for 11 year before joining the agency, made a controversial and high stakes legal ruling in December 2004 that greatly benefited his former employer the day before the company officially broke its ties with the federal government and became a private corporation. [Mr. Fontana is currently on administrative leave from the Department because of his ownership of stock in another student loan company, which was first revealed by Higher Ed Watch.]

In his December 2004 ruling, Mr. Fontana rejected an opinion offered by Department's Inspector General two years earlier that a lucrative arrangement that exists between Sallie Mae and USA Funds, the country's largest student loan 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 Sallie Mae 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, like Sallie Mae, are not allowed to own nonprofit entities like 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 they are required to do to keep borrowers who are delinquent on their loans from defaulting.

However, Sallie Mae 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. Employees of Sallie Mae now perform the majority of operations at USA Funds, which has only 75 employees of its own, the Chronicle reports. Meanwhile the guarantor pays Sallie Mae $250 million a year for staffing and other payments.

In 2002, the Inspector General's Office raised a giant red flag. Sallie Mae's effective control over USAF presents "a conflict of interest" that needs to be "cured."

How does this conflict put students at risk? The Chronicle article explains:

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<em>As a provider of federal guaranteed student loans, Sallie Mae is required to maintain contact with borrowers for the first 60 days after a payment is overdue. USA Funds, in its role as an independent guarantor in the student loan system, can collect extra money from the federal government to assist a lender with that job if the borrower's payment becomes more than 60 days overdue.</em>
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<em>The federal government requires the lender and the guarantor to be separate entities, so that the two don't have an incentive to collect the federal subsidy by letting borrowers fall further behind on the payments.</em>

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<em>In the case of Sallie Mae, the potential benefit of letting students accumulate extra late fees and penalties is even larger because Sallie Mae also owns a series of debt-collection subsidiaries that perform work both for USA Funds and the federal government.</em>
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Got that? Because of its relationship with USA Funds, Sallie Mae wins when borrowers are delinquent on their loans. And because it owns a group of collection agencies, Sallie Mae wins when borrowers' loans go into default. And because the loan company effectively controls the entity in charge of monitoring its default prevention activities, no one is looking out to protect borrowers from abuse.

As Elizabeth Warren, a professor of bankruptcy law at Harvard Law School told 60 Minutes last year, "Sallie Mae makes money if you pay back on time. And Sallie Mae makes money if you don't pay back on time."

Outrageous, yes. But that's not how officials in the Education Department's Federal Student Aid (FSA) office saw it. Well actually, it's more complicated than that.

In fact, Mr. Fontana actually agreed with the Inspector General's Office before he disagreed. In March 2004, he sent a letter to USA Funds saying that "FSA concurs with the OIG's recommendation" to eliminate the conflict of interest.

But on the eve of the big day when Sallie Mae was finally to become a fully private for-profit company, Mr. Fontana had a change of heart.

In the follow-up letter he sent that December, Mr. Fontana wrote that the Department "had reconsidered its prior position." He said that the conflict of interest didn't exist because the Sallie Mae subsidiaries that helped manage USA Funds had separate tax identification numbers from the company's subsidiaries that did not.

It's nice to have friends in high places. Too bad financially-needy students didn't have any at the Department's Federal Student Aid office.