A New Chapter in the 9.5 Scandal

Blog Post
Aug. 31, 2009

On Monday, a federal court in Virginia unsealed a whistleblower lawsuit filed by Jon Oberg, the U.S. Department of Education researcher who uncovered the 9.5 student loan scandal, against 10 student loan companies that participated in the scheme. The lawsuit, which Oberg filed in 2007 under the federal False Claims Act, seeks the return to the federal government of $1 billion in excess student loan subsidies these lenders improperly obtained.

The roots of the 9.5 student loan case go back to the 1980s when Congress guaranteed non-profit lenders, which use tax-exempt bonds to finance their loans, a minimum rate of return of 9.5 percent on federal student loans made with these bonds. As interest rates on all other student loans fell in the 1990s, policymakers became concerned that these nonprofit student loan providers were making a killing. So in 1993, Congress rescinded that policy, but grandfathered in loans made from the old bonds, believing that the volume of 9.5 loans would decline as they were paid off and the bonds retired.

Instead, beginning in 2002, a small group of lenders devised a strategy to aggressively grow the volume of loans that they claimed were eligible for the 9.5 guarantee. This was a goldmine for lenders in the existing low interest rate environment (at the time, the borrower interest rate on regular loans hovered around 3.5 percent.) They accomplished this scheme by transferring loans that qualified for the 9.5 subsidy payment to other financing vehicles and recycling the proceeds into new loans that they claimed were then eligible for the subsidy. The lenders repeated this process over and over again.

As a researcher in the Education Department's Institute for Education Sciences, Oberg discovered the scheme in 2003 while reviewing internal agency spreadsheets that showed that the total volume of outstanding 9.5 loans was growing rather than shrinking. He brought his concerns to his superiors at the Department but they brushed them off. His supervisor, Grover Whitehurst, ordered him to stop pursuing the issue, and instead to focus solely on his responsibilities as a research administrator in the final 18 months before his scheduled retirement.

But Oberg had also reported his findings to the Department's Inspector General, which launched its own investigation into the 9.5 scandal. His work paid off in September 2006 when the Inspector General declared the lenders' loan and bond manipulations to be illegal. In January 2007, Education Secretary Margaret Spelling concurred with the Inspector General's opinion and barred the student loan company Nelnet and other lenders that refused to submit to independent audits from receiving any further 9.5 payments. But she did not require the lenders to return the overpayments they had already received.

Unhappy with this resolution, Oberg (who first revealed himself to be the whistleblower on the 9.5 scandal at an event hosted by the Education Policy program here at the New America Foundation in 2006) decided to file his own false claims lawsuit on behalf of the government, his lawyers stated. The lawsuit has been under government seal for the last two years, as the U.S. Justice Department weighed whether or not to join it. The federal district court lifted the seal last week after DOJ decided against joining the lawsuit. By law, Oberg has to right to continue to pursue recovery on behalf of the United States, with the Justice Department retaining the right to intervene at a later time.

Among the main targets in the case is Nelnet, which was created in 1998 when Nebraska's nonprofit student loan agency converted to for-profit status. The most active participant in the scheme, Nelnet increased the amount of loans for which it sought the 9.5 percent rate from $393 million in 2001 to more than $3.3 billion in 2004. The lawsuit estimates that Nelnet made approximately $407 million in unlawful 9.5 claims.

Other student loan companies named in the suit are the following:

Here is a link to the news release that his lawyers distributed yesterday. To read some of our recent coverage of the 9.5 scandal, read here, here, here, and here.

Tomorrow we will provide further analysis of this important lawsuit. Stay tuned.