Sallie Mae’s Self-Serving Proposal

At Higher Ed Watch, we would be remiss if we didn't salute Sallie Mae for acknowledging in its student loan proposal that there is significant waste in the Federal Family Education Loan (FFEL) program and that the time has come for fundamental reform. We couldn't agree more.

Sallie Mae's plan, however, seems to be primarily designed -- surprise, surprise -- to maintain and even significantly expand the loan giant's predominance over the federal student loan program. Because of its size and economy of scale, Sallie Mae is a clear favorite to be one of a handful of student loan companies to win a highly coveted servicing contract from the U.S. Department of Education. As a result, the proposal would allow the company to make loans; sell them to the Department for a fee; and earn another payment from the government for servicing these loans. In addition, Sallie Mae would be paid to service Direct Loans and other loans made by lenders that don't wish to or cannot comply with servicing standards put out by the Department.

While the plan might make some sense politically (the more lenders buy in to change, the less resistance), it makes little sense from a public policy point of view. Why should the government pay lenders to originate loans when it can make the loans itself at a lower cost? Isn't part of the point of student loan reform to stop subsidizing unnecessary middlemen?

The plan also potentially opens up opportunities for abuse. The proposal would allow colleges to continue providing preferred lender lists to their students - and appears to leave out important protections Congress put in place last year to guard against "pay-for-play" conflicts of interest between lenders and colleges. While the plan includes perfunctory language to prohibit lenders from offering illegal inducements to schools, we know how well that has worked out in the past. In addition, the proposal would give colleges, in many cases, the power to choose the loan company it wishes to service its students' loans (from among those that have won the Department's servicing contract). We can only imagine the types of incentives these companies will give schools to try and win that business.

But even more fundamentally, the proposal fails the test because it would not deliver the amount of savings needed to make the Pell Grant program into a true entitlement for low-income students, as President Obama has proposed.

In a letter it sent to colleges yesterday, Sallie Mae said that its proposal would help President Obama "achieve his policy objectives" by increasing funding for Pell Grants. But this is a misreading of Obama's plan. The White House is not just looking to provide another short-term boost in the maximum Pell Grant, as Congress has done repeatedly over the last couple of years. It is looking to fundamentally restructure the way the program is financed to make Pell Grants into a more reliable and predictable source of funding for financially needy students.

Under President Obama's plan, money saved from ending FFEL would be used to turn the Pell Grant program into a true entitlement for low-income students by financing it entirely through mandatory funding. The president proposes raising the maximum grant to $5,550 for the 2010-11 academic year, and then indexing future increase to the Consumer Price Index plus 1 percentage point so that it will keep up with inflation.

As we've said before, this change is needed because the way the government is currently financing Pell Grants is a huge mess. Congressional appropriators currently set the maximum Pell Grant each year based on estimates of expanded demand for the grants made by federal budget officials. Because the estimates are made far in advance, they are generally off the mark. As a result, the Pell program has often been plagued by large budget shortfalls. To make up for the gaps, the Department of Education often dips into future program funds, pushing the shortfall off to the future.

Over the last two years, Congress has created new funding streams (through the College Cost Reduction and Access Act of 2007 and the giant stimulus package that lawmakers recently approved) to boost spending on Pell and increase the maximum award. These new funding source, however, are only temporary. When they run out in a few years, policymakers will again face the tough choice of either substantially decreasing the Pell Grant (by more than $1,200) or shelling out billions of dollars more just to keep the maximum award constant.

The president's plan would end this budgeting nightmare by removing it from the annual appropriations process. As a result increases in the maximum award would be reliable and predictable, making it easier for low- and moderate-income high school students to know how much financial aid they will be eligible for if they go to college.

The Sallie Mae plan would not achieve this crucial goal.