$112 Billion Student Loan Industry Bailout a Lesson in Corporate Welfare

With little public notice or fanfare, the federal government has been providing financial institutions involved in the student loan business with a bailout projected to be over $100 billion. This makes it one large part of the hundreds of billions of dollars the government has directed to prop up banks, financial institutions, and credit markets. What makes this even more egregious is that the current student loan industry is already built on one of the most corrupt forms of lemon socialism ever created. The government stepped in to bailout a fundamentally unsound industry that has been for years wasting billions in taxpayers' money.

The Federal Family Education Loan program (FFEL) allows private financial institutions to provide students with loans, but the government assumes the risk of default, and pays the financial fees while the student attends college. This amounts to privatized gains combined with socialized loans. The CBO found that compared to the William D. Ford Federal Direct Loan program, an alternative system in which the government just directly provides students with loans, FFEL loans cost the government 10 to 20 percent more (PDF). Eliminating the unjustified subsidies and government financial backing for the FFEL program by expanding the existing direct loan program is projected to save $67 billion over the next decade.

Under the FFEL program, financial institutions like Sallie Mae, Bank of America, National Education Loan Network (NELNET) JPMorgan Chase, Wachovia, and Wells Fargo would originate these FFEL loans with students, and then sell them on the secondary credit market. In 2008, the credit market dried up, and the private lenders had nowhere to sell these government loans. So, the government stepped in to buy up these loans and protect a program that was already a massively wasteful corporate boondoggle.

The bailout was authorized with HR 5715 Ensuring Continued Access to Student Loans Act (ECASLA). The bill allowed for the Department of Eduction to produce three different programs, the Loan Purchase Commitment Program, the Loan Participation Purchase Program, and a buyer-of-last-resort Asset-Backed Commercial Paper Conduit.

ECASLA was billed as a temporary program, to last until only February 28, 2009, and would only use roughly $6.5 billion. From Department of Education press release:

This will be a short-term program designed to act as a mechanism to minimize disruptions in the interim until the conduit(s) are operational, or until February 28, 2009, whichever occurs first. The Department will purchase loans at 97 percent of the principal interest coincidental with the standard guaranty rate for these loans. The Department anticipates purchasing up to $500 million in loans each week, up to an aggregate of $6.5 billion during the designated time-period.

Thanks to then Treasury Secretary Hank Paulson and extender bills (like HR 6889) that passed with almost no notice, the ECASLA has been extended through today, and turned into a behemoth bailout.

Earlier this week, President George W. Bush signed H.R. 6889, the extension of the Ensuring Continued Access to Student Loans Act. We appreciate Congress providing the Department of Education, in coordination with the Treasury Department and the Office of Management and Budget, renewed temporary powers to use federal funds to ensure students and families continue to have access to student loans.

Based on the latest public reporting, the Department of Education has already directly purchased roughly $52.3 billion in loans from private companies through Loans Purchase Commitment Program. While also providing tens of billions of liquidity to the market through the Loan Participation Purchase Program and Asset-Backed Commercial Paper Conduit.

The Department of Eduction is projecting that it will eventually buy $112 billion in FFEL loans (PDF) from private companies.

Overall, under the ECASLA authority, the Department has purchased approximately $50 billion through FY 2009 and estimates that it will purchase approximately $62 billion more for a total of approximately $112 billion in FFEL loan purchases. [snip]

New FFEL loan volume was $66.8 billion in FY 2009, accounting for about 69 percent of all new FFEL and Direct Loan (non-consolidation) student loan volume. It is estimated that about 80 percent of this FFEL volume will be financed through the ECASLA authority.

With the federal government now helping to provide the financing for 80 percent of the "private" market for FFEL loans, it is ridiculous to classify it as anything other than a massive corporate welfare system.

It is important to note that indications are that this represents only some of the money the government has injected into the "private" student loan market. A GAO report from February 2010 (PDF) found that the TALF program spent $7.15 billion on student loans. It is also important to note that many of the financial institutions involved in the student loan business have also received significant additional general bailouts from TARP not specifically connected to their student loan divisions.

The government did not just originally guarantee against default on these wasteful FFEL loans created by private finance institutions and then step in to buy up these loans creating an artificial market--the government also looked for someone to service these loans they just bought.

U.S. Secretary of Education Arne Duncan today announced that four companies were awarded contracts to service a portion of the approximately $550 billion outstanding federal student loan portfolio held by the Department. The selected contractors will also service loans originated by and sold to the Department in the future. The award of these contracts provides the Department with the capacity necessary to support anticipated increases in the number of loans owned by the Department and ensures borrowers receive the assistance they need to effectively manage their federal student loan obligations.

AES/PHEAA of Harrisburg, Pennsylvania; Great Lakes Education Loan Services, Inc., of Madison, Wisconsin; Nelnet, Inc., of Lincoln, Nebraska; and Sallie Mae Corporation of Reston, Virginia, were awarded contracts under the Title IV Student Loan Management/Servicing procurement. [snip]

As a result of the state of the credit markets and subsequent passage of the Ensuring Continued Access to Student Loans Act, the Department will be acquiring a large volume of federally guaranteed loans in the coming months. In addition, the President's FY 2010 budget proposes originating all new federal student loans through the Direct Loan Program starting in 2010.

It is amazing how companies like Sallie Mae and Nelnet have managed to use the federal government to create profit through public risk. How many times do they get another bite at the apple at taxpayer expense? The "heads we win, tails you lose" model seems to be a specialty of Sallie Mae.

To add insult to injury, these same companies are now pushing a “compromise” to water down President Obama's proposal to reform the FFEL program, use the money saved to provide much needed aid to community colleges, provide low-income students with help affording college through Pell Grants, provide financial assistance to veterans attending college, and create an “Early Learning Challenge Fund” to help states increase the number of children attending preschool. The private lender compromise would cost roughly $8 billion over ten years. It would take money currently meant to help community colleges, struggling college students, low income children, and veterans, and give it to the same banks and financial institutions that are projected to get over $100 billion in government bailouts.