A Contrary View: Stand-Alone Guaranty Agencies Have a Vital Role to Play

[Editor’s Note: At Higher Ed Watch, we have questioned whether student loan guaranty agencies are still needed in the federal guaranteed student loan program. In this guest post, Paul Combe, the president and chief executive officer of American Student Assistance, responds to our criticism and offers his own vision for reforming the federal student loan programs. In so doing, he calls for a reexamination of relationships between and among guarantors, lenders, and servicers, with the goal of eliminating potential conflicts of interest. Combe’s views are his own, and do not reflect those of the New America Foundation.]

By Paul Combe

In the minds of many, including Higher Ed Watch, the student loan guaranty agency is a mysterious middleman in the Federal Family Education Loan (FFEL) program, one whose purpose is unclear and whose value is now questionable. There is certainly some justification for this view. Over the past three-plus decades, technological advances and programmatic changes made by Congress have lessened the need for guarantors to carry out many of their traditional functions, such as “insuring” federal student loans.

One role that guarantors have been playing has become even more vital today: providing borrowers with comprehensive debt management services to help insure that they successfully repay their federal student loans. With the level of debt we are inflicting on students these days, the federal government has a fundamental obligation to make sure that they can manage it.

The need for such a role in the federal student loan program underscores the inherent difference between education debt and consumer debt. Education loan borrowers are consumers but they are consumers with extra rights. While we could be unsympathetic to a lender who made a sub-prime mortgage to a borrower whose debt-to-income ratio precludes their ability to repay, or feel less compassionate toward a borrower who racked up credit card debt or bought more house than they could really afford, student loan debt is different. We acknowledge the different nature of federal student loan debt by making it non-dischargeable in bankruptcy.

Non-dischargeable says the borrower has a higher “moral” obligation to repay this debt over other consumer debts. We also must acknowledge, though, that the different nature of this debt also places special obligations on the part of the federal government to assist these borrowers in managing that debt. If the federal government helped them get into debt, it also has an obligation to help them successfully get out of debt.

Rewarding Borrower Success

Just what is “education debt management”? It is access to timely, neutral advice, information and service over the life of the loan so that borrowers are fully informed of their rights and responsibilities. It is also proactive mediation of any issues that may arise. Debt management and delinquency prevention is not the one-size-fits-all, due diligence requirements dictated by the Higher Education Act. Instead, it’s proactive education, information, and counseling over the life of the loan. It starts with early awareness about available financial aid (after all, the best form of debt management is grants) and ends with the last loan payment. It is customized and individualized to the borrower. It speaks to the borrower where they are and gives them access to all the opportunities and remedies made available to them by Congress.

At American Student Assistance, we firmly believe that guaranty agencies are in the best position to provide these services over the life of the loan. As a result, we believe that the federal government needs to fundamentally change the reward structure it has set up for guarantors. Instead of paying guarantors to insure federal student loans and collect on defaulted ones, the government should compensate guaranty agencies for keeping students on the right repayment track. Guarantor fees and incentives should be focused on the relative success of the borrowers in their portfolio as measured by “Loans in Good Standing” and these results should be published and available to the consumer.

Eliminating Conflicts of Interest

But before the government can fully entrust this critical role to guarantors, it must make absolutely certain that the agencies working with the borrowers are completely neutral and objective parties. In other words, guarantors who provide these services must be independent of the loan holder’s interest in the loan, whether the “lender” is a bank, a state entity, or the federal government. Too often this is not the case. Many guarantors are part of vertically integrated lending organizations where the guarantor role is controlled by, or secondary to, the lender function. Although this vertical integration is efficient and cost effective for some state and private lenders, it does not provide the borrower with the un-conflicted advisor they need because the agencies’ roles and financial interests are so intertwined.

If these agencies want to provide debt management services to all borrowers (including those in the Direct Loan program), then they must be required to have a “bright-line” separation from their other relationships so that borrowers can be absolutely sure that the entities they are working with don’t have any competing motivations that can cloud their priorities. This is especially important because of the nature of the remedies that guarantors can offer borrowers who are in trouble. Some of these remedies shorten the loan, some lengthen it. Some remedies increase the lenders’ marginal revenue, some decrease it. Some leave the loan in the hands of the current holder; some move the loan to another portfolio.

Consumer-focused debt management is at its best when the service provider is neutral to the source of capital and the lender’s margin; in short, when the one giving the debt management advice is neutral to the results.

While we are examining the distribution of roles within the student loan program, we should also address the inequity that exists specifically for education debt management. The guarantor community has already been charged by Congress to provide student borrowers with early awareness, default prevention, and debt management service — but only to FFELP borrowers. All borrowers, including those with Direct Loans, should receive these debt management services.

Helping Borrowers When They Need It

As neutral, third parties, guarantors could lead the charge in making our federal college loan program(s) a “teachable moment,” where borrowers can and must learn debt management skills. For most college students, student loans are their first encounter with taking on consumer debt and the initial opportunity they have to impact their credit reports for better or worse. It’s a milestone moment in their lives.

To make the program truly effective as a teachable moment, though, we need to take the word “moment” to heart: education debt management must be provided at key decision points along the life of the loan. Providing students with in-school training on financial literacy, borrowing and budgeting, years before they ever begin repaying their loans, has value and should not be dismissed. But we all retain information best when it coincides with a life event that makes us have to use that information immediately. Education debt management lessons will be best learned when they’re “in the moment” — when borrowers are faced with that student loan bill and some tough budget decisions.

Let’s take advantage of the federal student loan process as not only the way to ensure college access and choice, but also as a vehicle to prepare students for a life as knowledgeable consumers. As the events of the sub-prime lending crisis demonstrate, our nation’s need for financially literate consumers has never been more pressing.

Paul Combe is the president and chief executive officer of American Student Assistance (ASA), the nation’s first student loan guarantor. Since joining ASA in 1996, he has been a strong advocate for guaranty agency reform. As part of that effort, he helped found the National Association of Student Loan Administrators (NASLA), a group of guarantors that was created to ensure consistent, reliable, and cost-efficient delivery of student loan services over the life of the loan. He has also written Breaking the Deadlock: Unifying Our Federal Student Loan Programs, a paper that calls for making education debt management an entitlement for all federal student loan borrowers.