Student-Loan Shenanigans

April may indeed be the cruelest month. Families of college-bound students go hunting for financial aid at the height of tax season, and this year the money crunch is particularly vexing as headline after headline describes schools and lenders playing footsie over federal student loans. In an especially twinge-inducing bit of irony, at the same time that Columbia University is trying to help make higher education more accessible to low-income students–it’s set to host a conference that addresses the topic this month–word broke that a financial-aid officer at the school, as well as at least two counterparts at other colleges, allegedly owned stock in the parent company of a lender they had been recommending to students. The officials were placed on leave pending internal investigations. Meanwhile, financial-aid directors at three more schools were accused of getting consulting fees and other payments from the same lender, which they too had been touting to their students.

Mixed in with these scandals are revelations that dozens of universities have inked deals with various lenders to route a percentage of revenue from student loans back to the schools, with the funds often explicitly directed into financial-aid coffers. Congress and at least two states are looking into these inducements, which New York attorney general Andrew Cuomo calls “kickbacks”–a label that seems a tad unfair if the money helps cash-strapped students rather than enrich officials. But with the spotlight now on student loans, critics are clamoring to reform what has become an $85 billion industry.

The roots of today’s intrigue date back to 1965, when Uncle Sam began guaranteeing loans to needy students and paying the interest while the borrowers were in college. Because the private sector was still leery of loaning money to kids with no credit history or collateral, the government sweetened the deal by promising lenders a specified interest rate regardless of what student borrowers pay. Add low default rates (due in part to such dire consequences as garnisheed wages and torpedoed credit ratings) as well as soaring tuitions, and–voilà!–lenders are fighting one another to dole out $17 billion in supplemental loans that aren’t backed by the government.

The feds tried to cut out the middlemen in 1994 by letting students at participating schools borrow directly from the Treasury. But private lenders have held on to nearly 80% of the market by improving service and offering discounts for such things as on-time repayment. Knowing that many students choose the first entry on a school’s list of “preferred lenders,” lots of colleges have used these lists to get lower rates for more borrowers, and some lenders have tacked on revenue-sharing deals. “We believed it made good sense to use money that would otherwise go into Citibank’s pockets to give more financial aid to N.Y.U. students,” New York University spokesman John Beckman said in a statement. His school and five others agreed this month to swear off revenue sharing and repay students nearly $3.3 million.

Other industry tactics also need policing. “I have an invitation in my drawer here to go to the Caribbean for four or five days with my wife, all expenses paid, just to go listen to a student-loan lender,” says Dan Davenport, financial-aid director at the University of Idaho, which remains dedicated to direct lending. “There’s such big money at stake that people are willing to do many different things to get that piece of the pie.”

Now Cuomo and others are working to rein in private enterprise. The White House wants to cut interest subsidies to lenders 0.5%, which should save $12.4 billion over five years and leave the industry with less funny money. But lenders claim such a move could force them out of the market. “We make less than half a percent on a guaranteed loan,” says Tom Joyce, spokesman for Sallie Mae, the nation’s largest student-loan company. “You do the math.” And there is a renewed effort to get more schools into direct lending, which costs taxpayers an estimated $7.50 less for every $100 disbursed, compared with private loans. Massachusetts Senator Edward Kennedy is pushing a bill that rewards colleges for switching to the cheaper of the two lending systems by giving them additional need-based aid–a setup, many in higher education note, that is strikingly similar to the ones schools are in hot water for having negotiated with individual banks.

Competition from direct lending should lead to greater efficiency overall, but it won’t close the gap families face between what college costs and what aid is available. One short-term effect of the current scrutiny is that schools may be too afraid to try to broker better deals for students. “So you’re on your own, parents, on finding that extra $4,000 you need this year beyond the federal limit,” says an executive at an association of private colleges. But, alas, dear readers, the question of why college costs so much in the first place is another story for another day.