Honest brokers? Not always

August 31, 2007

Revelations that some administrators and universities in the US were profiting from links with loan companies have rocked America's student financing system. Stephen Phillips examines the impact of shifting costs from the public to the private sector

Craig Munier admits that his frank observations about the perils of campus financial aid offices getting too chummy with student loan companies haven't always sat well with his peers. "In my humble opinion, I've been somewhat ostracised within the professional association, seen as one rocking the boat," reflects Munier, who is financial aid director at the University of Nebraska, Lincoln.

His admonitions, which date back to the mid-1990s, look prescient now. Recent revelations of largesse flowing from private lenders to financial aid offices have featured four administrators who personally enriched themselves through off-market share deals with loan company executives and another four who raked in lucrative consulting fees. There have also been cases of campuses collecting "referral" fees from lenders - all of which went undisclosed - when they recommended the firms to students. Such scandals have cost seven financial aid chiefs their jobs, and led several campuses and lenders to pay out more than $3 million (£1.5 million) in compensation to students (plus $13.7 million towards a student financial literacy fund) and adopt conflict-of-interest codes of conduct. Lawmakers, meanwhile, are scrambling to craft reforms to America's $85 billion-a-year student loan industry.

The scandal penetrates to the heart of the profound shift from the public to the private sector as the means by which students in the world's most high powered higher education system finance their studies, says Richard Lee Colvin of Columbia University's Hechinger Institute on Education and the Media. Private borrowing - calculated by the College Board, a non-profit-making body concerned with preparing students for university, at $17.3 billion in 2005-06 - has swelled 1,200 per cent in the past decade and could outstrip government loan volume in the decade to come, according to some projections.

For many students, private credit is an economic lifeline. US university fees have risen 35 per cent, after inflation, between 2001-02 and this academic year; meanwhile, the shortfall between tuition costs and government grants and loans is estimated at $120 billion.

Many observers worry about the implications of more students turning to loans that often carry far higher (and variable) interest rates than those offered directly or guaranteed by the US Government. Many are also concerned by the marketing tactics employed by lenders participating in the Federal Family Education Loan Programme - in which the Government acts as guarantor and subsidises them to offer the same interest rates as those available directly from the Government under the parallel Federal Direct Student Loan Programme - as well as those marketing loans directly to students.

The affair also offers a salutary glimpse into the dynamics that could be unleashed in Britain (where America's largest student loan company, Sallie Mae, opened an operation in May) should ministers continue down the path towards the US model of granting institutions greater financial autonomy by, for instance, lifting the ceiling on top-up fees.

Lender representatives observe that the really egregious cases - such as the former University of Texas financial aid chief who rode a gravy train of lender perks laid out in a 134-page internal report; his former equivalent at Columbia University who gained $100,000 profit from selling shares he had acquired in a lender he endorsed to students; and the former Johns Hopkins University administrator who amassed $133,000 from consulting gigs - constitute a tiny minority of officials across America's 5,000-plus campuses. Things "need to be put into perspective", says John Dean of the Consumer Bankers Association.

Meanwhile, Kevin Bruns of America's Student Loan Providers casts campus industry fraternisation in innocent terms as a social lubricant, in line with business norms, and something that was hardly expected to sway officials. "It's foolish to think a large institution could be influenced by someone taking [officials] to a baseball game." But others dispute this picture of isolated instances of cosy relationships amid otherwise arm's-length dealings. "Our profession has become accustomed to permitting industry to provide... personnel, resources of time [and] support for our professional association," Munier says.

After accusations that it had allowed lenders to hijack its agenda, the National Association of Student Financial Aid Administrators agreed in May to adopt the code of conduct followed by individual campuses "and prevent lenders from using their annual conference as a promotional vehicle to recruit financial aid officers". This was under an agreement with the New York Attorney-General, Andrew Cuomo, who has led the investigation into loan marketing practices.

NASFAA declined to comment, citing prior staff commitments with its annual conference. But Munier recalls an invitation to a lender-sponsored reception at NASFAA's 2006 conference inside Seattle's most iconic landmark. "They rented the Space Needle, for cripes' sakes. What do you think that cost?" he said.

"We've come to accept [industry picking up] the financial cost so we can have a more robust annual conference [and] lower registration fees because lunch was sponsored by Chase. People didn't see the harm.

"We don't even know the degree to which bias has entered the profession. It's not that these are bad people, but I'm amazed at the insidious complacency."

Kent Kostka, a University of Texas lawyer involved in investigating that institution's former financial aid chief, concurs. "It's interesting to see the ways lenders have infiltrated universities - donating to minority outreach programmes, printing brochures and making officials dependent on donations [for such community programmes].

"Ask financial aid officers why they take these things and they say, 'We need it.' In part, they're buying into lenders' party line, but it's hard to fault them when cuts make it hard for them to fund operations."

A Senate report issued in mid-June details how firms homed in on the pressure points of cash-strapped, short-staffed campuses - and what they expected in return. Widespread "value-added services" included printing informational literature for students and providing staff and other resources at high-demand times, such as freshers' week, to handle student inquiries - both instances in which students were looking for impartial guidance.

To judge from corporate documents that the report quotes, commercial considerations were (unsurprisingly) uppermost in the companies' thinking. "This is the first time we have been asked by the school to do a print piece. I am looking to grow the volume with this school as we are a [preferred lender]," reads the reaction to one campus solicitation.

Another lender views a print commission as an opportunity to trump rivals: "Tallahassee Community College: BOA [Bank of America] had printed a lender list moving SunTrust to obscurity on it. We just had the list reprinted moving us into the top tier lenders so we should see improvement soon."

The report also indicates that the prevailing practice of appointing university administrators to lenders' "advisory boards", publicly positioned as forums for professional dialogue, was viewed as a device to curry favour with officials at institutions where business opportunities were eyed. Lavish expenses incurred at meetings undercut official characterisations of them as strictly business.

The bill for Citizens Bank's three-day April 2005 meeting at Arizona's Sanctuary Resort came to "almost $43,000", including such items as a $450 "Jeep tour", golf at more than $2,000, more than $1,500 in "spa treatments" and a $15,000 dining tab. Another lender, Northstar, spent "more than $350,000" on "advisory board expense categories" from 2005 to 2007. It also ran a "mentor programme" under which existing board members were enlisted to cultivate officials from other campuses in return for "value-added services". "What we're trying to do is get some new folks in with the desire that they'll want to get to know us better (in the volume sense of the word)," reads a 2006 e-mail from an employee of one lender.

Revenue-sharing pacts with lenders, with proceeds ploughed back into scholarships, have also come under scrutiny.

Barmak Nassirian of the American Association of Collegiate Registrars and Admissions Officers says these receipts could have been used to offer still lower interest rates. "Officials justified taking goodies from lenders because they claimed they were doing good, [forgetting] they were being funded by a tax on their students."

Such arrangements, adds Thomas Kane, professor of education and economics at Harvard University, are sub-optimal in promoting access, a goal better served by concentrating funding where students would otherwise be unable to afford college - rather than, for instance, on aid to students admitted to the Ivy League University of Pennsylvania (which had such a deal with Citibank).

"Even if it were true that all this [money] were being ploughed back into means-tested aid, why would we be providing this federal subsidy for student aid at institutions serving the least disadvantaged students?" Kane asks. "If there's excess, taxpayers ought to be capturing that to plough back to low income students wherever they decide to enrol."

Kane's observation cuts to what many see as the heart of the matter: the subsidy paid to lenders to participate in the Government-guaranteed scheme that, in light of the largesse being splashed about, many suspect is excessive.

At the scheme's inception in 1965, the subsidy was conceived as a way to galvanise industry participation and promote access to private capital when, under government accounting rules of the day, it was cheaper than using public funds. It was intended to ensure the then-untested student loan market was commercially viable for lenders.

Industry representatives contend that competition among lenders spurs efficiencies and innovation, yielding consumer savings. Many firms waive certain fees, for instance.

But Munier says this argument is seductive but misleading, calling many of the benefits touted by lenders, such as reduced interest for on-time payments, "illusory".

The University of Texas report notes that Tim Fitzpatrick, Sallie Mae's chief executive, wrote in an "open letter" to student loan consumers in February that less than 10 per cent of borrowers would earn all the repayment benefits offered by lenders.

Besides, critics argue, it's less about the workings of the market than crony capitalism. Former loan-company officials have figured prominently under the Bush Administration in roles overseeing the Government-guaranteed scheme, including one former staffer who, it emerged, held $100,000 worth of stock in a firm he was supposed to be monitoring. "What started out as a well intentioned social programme [has] degenerated into a racket," Nassirian says.

The fundamental issue for many is that the subsidy is politically set, subject to the lobbying clout of lenders, rather than determined by the market. Proposals before Congress would strip $18 billion from the subsidy. Kevin Bruns warns that this would prompt a mass retreat of companies by "wiping out [their] margins". "It's a game of chicken, with the industry threaten[ing] to take [their] marbles home," Nassirian observes.

Ultimately, no one really knows if there's surplus in the system, Kane says. But one way officials hope to flush any out is by piloting an auction in which the Government-guaranteed loan franchise would be awarded to the two providers prepared to operate it for the lowest subsidy in each state, a key plank of legislation being considered by lawmakers.

"We don't know how much banks need to stay in business," says Sandy Baum, professor of economics at Skidmore College. "This would change that."

If lenders are crying wolf, officials hope the market can call their bluff.

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