The New York Times Misses the Story

Last week, The New York Times brought national attention to the struggles of thousands of newly-minted teachers in Kentucky who were left in the lurch when a popular loan forgiveness program designed to encourage students to become educators ran out of money. The Times certainly deserves credit for putting the spotlight on these teachers who have been left heavily indebted with student loans that they took out in good faith -- with the promise that they would have help paying them off in exchange for their public service.

But unfortunately, the Times didn't tell the whole story and instead left its readers in the dark about the real reasons for the loan forgiveness program's collapse. We fear that this omission could lead policymakers and the public to learn the wrong lessons from this debacle.

Ever since the Kentucky Higher Education Student Loan Corporation (KHESLC), the state's nonprofit student loan agency, pulled the plug on its "Best in Class" student loan forgiveness program, agency officials have tried to shift the blame on to the federal government. They have argued that the Democratic-controlled Congress effectively killed the program in 2007, when it approved the College Cost Reduction and Access Act, which cut lender subsidies to pay for increased spending on student aid.

The Times appears to have accepted this line of argument without question. In two articles it ran last week (here and here), the newspaper placed the blame for the program's demise squarely on the subsidy cuts and the credit crunch, which made it difficult for the loan agency to raise funds to make new loans. Undoubtedly, last year's crash in the financial markets was the final straw in the agency's decision to cut the program. But that certainly does not explain how the Kentucky student loan agency got itself into this mess to begin with.

The real story can be found in a report that the U.S. Department of Education's Inspector General (IG) issued on Friday that shows the extent to which the Kentucky agency engaged in the risky and illegal 9.5 percent student loan scheme.

Beginning in 2002, a small group of nonprofit lenders devised a strategy to improperly grow the volume of federal student loans that they claimed were eligible for the 9.5 guarantee available on loans financed through tax-exempt bonds issued before 1993. 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. These lenders then repeated this process over and over again.

The Kentucky student loan agency came a bit late to the scheme, but once it joined in, it became one of the most aggressive participants. According to the Inspector General's report, KHESLC engaged in a massive loan and bond refinancing and recycling project over the course of four days in January 2004 so that it could claim 9.5 subsidy payments on "nearly all of its loan portfolio." The Inspector General estimates that the Kentucky agency overcharged the federal government more than $80 million between 2004 and the end of 2006. [Officials with the Kentucky loan agency continue to insist that they did nothing wrong, saying that they complied with all of the Education Department's rules and guidance that were available on 9.5 percent funding at the time.]

Like the Pennsylvania Higher Education Assistance Authority (PHEAA) and the Iowa Student Loan Liquidity Corporation, the Kentucky agency used some of the windfall profits it received to compete against other lenders -- such as Sallie Mae and the federal government's Direct Loan program -- by offering more-generous student loan benefits to borrowers in the form of public service loan forgiveness programs, such as teaching and nursing.

The good times for KHESLC, however, came to an end in January 2007 when Education Secretary Margaret Spellings put a stop to the 9.5 scandal by barring lenders who refused to submit to independent audits from receiving any further 9.5 payments. Most of the nonprofit loan providers that had overbilled the government agreed to submit to the audits, which were designed to separate out the lenders' legitimate and illegitimate 9.5 claims. The Kentucky agency, however, declined the offer. A separate auditor, Strothman & Company PSC, wrote that KHESLC's management was unable to attest that the Department would certify its loans as eligible for the 9.5 guarantee.

But that is not even the whole story. At Higher Ed Watch, we have only recently learned that the Kentucky state government also shares some blame for the loan forgiveness program's unraveling. In 2005 and 2006, Kentucky's governor and legislators raided about $80 million the loan agency's coffers to help close the state's budget shortfalls. These losses are approximately four times higher than those that KHESLC has sustained annually as a result of the subsidy cuts Congress imposed in 2007. If the loan agency had the money the state took away, it potentially could have been able to meet its promises to teachers for two or three more years -- allowing it to fulfill many current commitments and giving state officials more time to find other sources of funding to help KHESLC meet its remaining obligations.

By letting officials at the Kentucky state loan agency and the state government off the hook for the collapse of the Best in Class program, The New York Times does a disservice to its readers and to the teachers who chose to pursue a low-paying public service career based on the promises that KHESLC made. The answer to the student loan mess is not to increase subsidies to lenders but to overhaul the federal student loan programs in ways that can ensure that these types of abuses no longer occur. That certainly seems like news that's fit to print.

[Editor's Note: Officials with KHESLC did not respond to a request for comment on this post]