Not So Innocent After All

[This is the eighth in the Higher Ed Watch series "Revisiting the 9.5 Student Loan Scandal." The series takes a closer look at the origins of the scandal with the purpose of trying to resolve unanswered questions and dispel lingering myths surrounding it. Links to earlier parts of the series are available here, here, here, here, here, here, and here]

Sallie Mae has long boasted that it did not take part in the 9.5 percent student loan scheme. But a new report from the U.S. Department of Education's Inspector General (IG) refutes that claim.

According to the report, which was released on Monday, Sallie Mae improperly obtained $22.3 million in excess student loan subsidies from the federal government between Oct. 1, 2003 and Sept. 30, 2006. The actual amount that the company over-billed the government is probably substantially higher -- as the IG looked only at how the student loan giant handled the 9.5 loans it obtained through its purchase of Nellie Mae [NLMA], the Massachusetts non-profit student loan agency. Between 2000 and the end of 2004, Sallie Mae bought three other non-profit lenders, including the Arizona-based Southwest Student Services Corporation, which had increased the volume of federal loans that it claimed eligible for the 9.5 percent guarantee by 135 percent in the years immediately preceding the sale.

To be clear, Sallie Mae does not appear to have engaged in the type of loan and bond manipulations that other companies, like Nelnet and the Kentucky Higher Education Student Loan Corporation, did to massively grow their 9.5 loan holdings. Instead, the loan company violated the law by submitting 9.5 claims on loans financed by tax-exempt bonds that had matured and been retired, the IG report states.

In the 1980s, Congress guaranteed non-profit lenders a minimum rate of return of 9.5 percent on federal student loans made with tax-exempt bonds. As interest rates fell in the 1990s, policymakers became concerned that these non-profit student loan providers were making a killing. So in 1993, Congress rescinded that policy, but grandfathered in loans made from bonds that had been issued before the new law went into effect. By making that change, lawmakers believed that the volume of 9.5 loans would decline as they were paid off and the bonds retired.

According to the IG, Sallie Mae submitted 9.5 claims for, and received payments on, federal loans funded by bonds that had expired several years before the claims were made. Sallie Mae officials defended their practices, saying that it was entirely lawful for them to continue billing loans under the 9.5 percent floor until the last bond associated with an "indenture" -- "a formal agreement between the issuer of bonds and a trustee bank," according to the report -- was retired. In other words, the loan company argued that as long as one bond included in this type of trust agreement remained active, all loans financed by bonds included in the agreement were still eligible for the inflated subsidy rate.

The IG rejected this argument. "We do not agree that SLMA's position is a reasonable interpretation of the HEA [Higher Education Act] or regulations," the report states. As a result, Sallie Mae's "billing activities for its NLMA subsidiary did not comply with laws, regulations, and guidance for the 9.5 percent floor calculation."

Interestingly, Nellie Mae had been in full compliance with the law before the purchase. Sallie Mae "took the position that NLMA was mistaken when it ceased billing on a particular bond prior to the maturity of the particular bond indenture," the IG said.

Sallie Mae was certainly not the worst player in the 9.5 scandal. But like the other loan companies involved, it did exploit the law to gain windfall profits at the taxpayer's expense. Unfortunately, this type of waste and abuse appears to have become endemic to the Federal Family Education Loan (FFEL) program. Is it any wonder that the program is on the brink of extinction?