Fontana's Follies and the Downfall of the Student Loan Industry

The news that Matteo Fontana, a former high-ranking official at the U.S. Department of Education, has pleaded guilty to charges that he lied to the government about his ownership of stock in a student loan company he was in charge of overseeing provides a timely reminder of why the student loan industry is in such hot water now.

During the Bush administration, the loan industry went virtually unregulated. Top officials at the Education Department did not just look the other way while widespread abuses occurred in the Federal Family Education Loan (FFEL) and private student loan programs. They actually helped lenders skirt federal laws and regulations so the companies could maximize their profits -- often at the expense of students and taxpayers.

The government's case against Fontana provides the most glaring example of the type of conflicts of interest that were rife within a Department heavily staffed by former student loan industry officials. As Higher Ed Watch first revealed in April 2007, Fontana, the general manager of the Financial Partners Division of the agency's Federal Student Aid office, held 10,500 cut-rate insider shares of stock, worth over $100,000 in the parent company of Student Loan Xpress for nearly a year after he joined the Education Department in the fall of 2002. At the time, we did not know whether Fontana had fully disclosed his stock holdings to his superiors at the agency.

According to federal prosecutors, Fontana repeatedly lied about his stock holdings on financial disclosure forms -- falsely claiming, for instance, that he had sold his Student Loan Xpress stock in December 2002. In fact, he didn't sell his stock -- including an additional 1,400 shares he purchased while at the Department -- until 2004 and 2005, for a total of around $219,000.

Federal employees are allowed to own stock in a company but are prohibited from working on issues affecting that company if their holdings exceed $15,000. But that didn't stop Fontana, the prosecutors say. In September 2004, Fontana overruled a decision by a lower-level Education Department employee that would have prevented Student Loan Xpress from expanding its business. Company officials had asked Fontana to intervene, saying in an e-mail that the employee's decision not to bless an arrangement they had forged with the Pennsylvania Higher Education Assistance Authority had left them "at a stand still and losing business by the day." By reversing that decision, Fontana, the prosecutors charged, "did participate personally and substantially as a Government officer and employee" in "a particular matter in which [he] knew he had a financial interest."

While the charges against Fontana are serious, at Higher Ed Watch we know that they are just the tip of the iceberg. Over the last two years, we have learned that under Fontana's leadership, officials in the Financial Partners Division:

• Turned a blind eye while student loan providers routinely violated a federal law forbidding lenders from providing "illegal inducements" to colleges and financial aid administrators in exchange for getting the schools to steer borrowers their way. Department officials ignored concerns about these "pay for play" practices, even from the agency's own Inspector General and lenders who complained about their competitors' activities.

• Looked the other way and, in some cases, actually provided assistance and encouragement to lenders as they systematically overcharged the federal government hundreds of millions of dollars in improper 9.5 percent loan subsidy payments. As we have previously reported, officials within the division wrote a series of program review reports from 2005 to 2006 in which they signed off on some non-profit lenders' 9.5 billion practices and, in at least several cases, showed the loan agencies how they could take greater advantage of these inflated subsidies.

• Allowed lenders specializing in offering consolidation loans to mine the National Student Loan Data System (NSLDS) to collect personal information about borrowers for marketing purposes. While civil service employees at the Department had loudly complained about these practices, the agency's leaders didn't do anything about it until Higher Ed Watch broke the story and the national news media picked up on our coverage.

• Emphasized partnerships over compliance in overseeing lenders and guaranty agencies. As a result, the division frequently overrode decisions made by program review specialists that were critical of student loan companies and limited their ability to effectively carry out investigations of these companies' practices.

Meanwhile, Student Loan Xpress was not the only loan company that directly benefited from its ties to the general manager of the Financial Partners division. Prior to joining the Education Department, Fontana worked at Sallie Mae for 11 years. In 2004, that connection paid huge dividends to the student loan giant and its shareholders.

At the time, Sallie Mae's long-sought goal of becoming a fully-privatized corporation was effectively being held up the Department's Inspector General, who had determined that a lucrative arrangement between the company and USA Funds, the country's largest guaranty agency, violated the law and needed to be severed in order to protect borrowers. The IG argued that the arrangement effectively put the guarantor under Sallie Mae's control, creating twisted incentives that allowed the lender to reap huge profits by growing its borrowers' debt to unmanageable levels. Fontana ultimately overruled the IG -- offering the nonsensical opinion that because the Sallie Mae subsidiaries that helped manage USA Funds had separate tax identification numbers from other parts of the company, they were officially separate entities. Why the former Sallie Mae official was allowed to make ruling of such critical importance to the company has never been clear to us.

The revolving door that existed between the student loan industry and the Department of Education under the Bush administration provided license to lenders to pursue their own self interest with little regard for students or taxpayers. The level of corruption that has since been uncovered makes it abundantly clear that a fundamental overhaul of the federal student loan programs is needed. President Obama and Democratic Congressional leaders clearly recognize that a shift to 100 percent Direct Lending would make the federal loan program much less susceptible to the types of abuses that have plagued it in recent years.

So if loan industry officials are looking for someone to blame for their predicament, they need only to look to themselves and their former cronies at the Department of Education, such as Matteo Fontana, who failed to rein them in and, in fact, enabled them.