Monday, June 18, 2007

Loan Auction Proposal Becomes a Bill; Is it Better than Direct Loans?

From the New America Foundation's Higher Ed Watch blog:
House Committee Embraces New America's Loan Auction Proposal The House Education and Labor Committee has embraced the New America Foundation’s proposal to use an auction mechanism to set student loan subsidies. The Committee unanimously adopted an amendment to the College Cost Reduction Act of 2007 proposed by Representative Tom Petri (R-WI) that would test loan auctions in the government-guaranteed loan program.

Student loan auctions are a way to set subsidy levels competitively, by having lenders compete for the right to make loans in the FFEL program. Right now, for example, the law guarantees 97 to 100% reimbursement rates for loan defaults. If there was an auction, maybe there'd be a lender who'd say, "I only need 50% reimbursement to make a profit." Presto: big subsidy cut.

Auctions are sort of a moderating proposal favored by the New America Foundation, among others concerned with college access. Others, like presidential candidate John Edwards (and Billl Clinton, back in the day) say we should throw out the lenders altogether and go 100% to the government-administered Direct Lending program, which is much cheaper for taxpayers.

As a journalist who doesn't have to sit in the room for higher ed bill markups, I feel like the second approach is just cleaner and more appealing. The FFEL program is a semi-monopoly anyway. If you institute an auction or some other kind of forced "competition", what's to stop Sallie Mae and the other big lenders from simply colluding to keep the subsidies high? They have the market share to force out any upstart (read, MyRichUncle) who wants to demonstrate that loans can be done cheaper.
I feel like the burden is on the lenders to show that they can actually add value by competing on price and offering better service. And they can do that just fine on the other side of the line: the private loan market.
What?! Ok, this needs a new post.


Anonymous said...

Congress, not Sallie Mae, is going to force out MyRichUncle. The Miller budget cut will emasculate any chance a company like MyRichUncle could ever make money in federal student loans.

Anonymous said...

That is a myth. Since the beginning of time, many entrepreneurs and smaller businesses have dreamed of selling for the right price to a much larger company. That is life. That is business. If they choose to sell out to Sallie Mae, it is because they choose to sell. Not because "profit margins are tight." They aren't tight. Surprising to the Chicken Littles who testified at the last Reauthorization in 1998, there are now far more lenders than there were 10 years ago. The maturation of securities markets and the commoditization of student loans over the past 15 years have allowed tiny participants to become just as profitable as the bigger players. Look at School As Lender. The school nominally owns the loan for what, one minute, and then a whole orchestra of financial partners take charge. 20 years of future borrower payments and federal subsidies are simultaneously monetized and compensated on net present value.

Entrepreneurs have learned not to listen to the longtime student lending folks who tried to put up false barriers to entry by claiming that it was difficult to comply with "federal servicing regulations." Anyone with a credit card system can set up a system to send late notices, automate phone calls and send a final demand letter. This isn't rocket science. And, when was the last high profile case where a guaranty agency shut down a lender (or even denied a stack of default claims) for not following federal servicing regulations?

Anonymous said...

To "anonymous" #2:

Are you saying that MRU and other loan providers would make a reasonable profit (MRU hasn't made any yet, by the way) from federal student loans if Congress cut the subsidy by 55 basis points? Other than gripes about past lender behavior, what's the financial basis for such a view?

Anonymous said...

According to UNCL's latest quarterly and annual SEC filings, MRU's loan business is still almost 100% alternative education loans (not FFEL). As they say, past results may not be predictive of future results. Nevertheless, of the FFEL loan providers that make such information publicly available, the data indicate high profitability, even if there was a 55 bp reduction in legislated lender yield.

Despite angst about SLM going private, the public has no access to financials on the typical FFELP lender. This is a govt program, folks. Why aren't lenders required to provide their financials? And we're not talking fly-by-night operators alone. The integrated international financial services firms that participate in FFEL do not break out their consumer lending channel to provide detail on FFEL. And let's not forget the state lenders and secondaries who don't have to follow GAAP or SOX. Lenders can continue to argue that their financials are "proprietary," but they have a matter of weeks to release this "private financial" info to prove their case to Congress. If they choose not to, then their profitability will be judged by SLM, NNI and STU. If ASLP was smart, it would set up a web page for the FFEL-only financials of the top 250 FFEL holders and top 250 FFEL originators. This isn't rocket science. On the other hand, both the House and Senate bills make a strong effort to protect mid-size and smaller lenders from the impact of subsidy reductions. Thus, if ASLP members vote by pure numbers, they may ultimately decide to keep their federal program financials "confidential."

Here again is a chance for MRU to practice what it preaches. MRU has provided students and parents with a list of salient questions to ask their financial aid officers. What about adding some questions to that list?: (1) Who is/are the financiers for your FFELP loan providers? (According to GAO, it is primarily Asian and European capital markets.) (2) What is the loan provider's cost of capital? (very relevant for ability to perform long-term for schools and students) (3) Who is the loan provider's loan servicer? (4) What is the loan provider's policy on loan capitalization? Will this capit. policy be guaranteed to continue when the loan provider sells the loan? (FFEL capit. regs are quite flexible for the lender and, for most borrowers, allow quarterly capitalization; DL capitalization is limited to when entering repayment and exiting a forbearance.)