Nick Anderson/The Washington Post | Posted: Saturday, December 31, 2005 6:00 pm
WASHINGTON — Twelve years ago, Congress passed a law meant to phase out an obscure interest-rate subsidy for student loan providers.
But the lenders exploited legal loopholes and falling rates to enlarge their take from the federal government — aided, critics charge, by an acquiescent Bush administration.
Now, lawmakers are on the verge of passing legislation they say will eventually kill the subsidy that refused to die.
Behind the measure, tucked into a budget bill that could win final congressional approval in early 2006, is a saga of government action — or inaction — that helped some enterprising financial institutions in recent years reap hundreds of millions of dollars.
Nelnet Inc., a for-profit lender based in Lincoln, Neb., is a leader in the field. The company holds roughly $3.5 billion in student loans that qualify for a government-guaranteed 9.5 percent interest rate.
Interest rates paid by the student borrowers for government-backed loans are lower — often far lower. Some have recently financed their college education at less than 4 percent.
The government pays the interest-rate difference to Nelnet and other lenders that qualify for what is known as the 9.5 subsidy.
The lower the market rates, the higher the subsidy — and the greater the potential profit for the lender. That has proven costly for the federal treasury in what has been a decade of low rates.
The total federal payout in the first nine months of 2005 was more than $600 million, Education Department data show.
Nelnet reported $77 million in profit during that time as a result of the subsidy. Yet Nelnet agrees with lawmakers and Bush administration officials who say the subsidy should end in coming years.
“This is an opportunity for this Congress to say, today, this policy doesn’t make sense any longer,” Nelnet spokeswoman Cheryl Watson said in a telephone interview.
Watson said the company endorsed the pending legislation, which would end financing practices that extended the subsidy’s life. “We believe it makes good sense and will provide for better utilization of the funds. It’s a position that we support.”
Democrats say the subsidy’s demise is long overdue.
“This has been a run on the taxpayer,” said Rep. Chris Van Hollen, D-Md., a member of the Education and the Workforce Committee who has tracked the issue. “Certain lenders have lined their pockets at the expense of students.”
Republicans also lament the subsidy. But they say their hands have been tied by statute and legal interpretations dating to the Clinton presidency.
“The law is the law is the law,” said Sally Stroup, assistant secretary of education for postsecondary education. “What the law says is what you pay people. We didn’t make this stuff up.
We may not like it and nobody else may like it, but we can’t just unilaterally ignore Congress.”
Critics say the Bush administration could have stopped much of the subsidy growth but looked the other way. “Rather than taking steps to protect taxpayers,” said Robert Shireman, a student loan expert with a Democratic resume, Bush education officials allowed “these companies to engage in an outrageous misreading of what the law really was.”
The original rationale for the subsidy, established in 1980, when interest rates were high, was to encourage state and state-authorized institutions to raise funds for the student loan market with tax-exempt bonds.
In 1993, Congress decided to end the 9.5 percent guarantee for loans financed with new tax-exempt bonds. The law enacted that year created an exception for loans financed with previously issued bonds. It was widely assumed that the subsidy payouts would dwindle and in time disappear.
But a September 2004 Government Accountability Office report found that the opposite had occurred: the total value of loans qualifying for the 9.5 subsidy rose from about $11 billion 1995 to more than $17 billion in 2004.
The report found that lenders were using elaborate financing techniques — with bonds new and old, taxable and tax-exempt — to maintain and in some cases grow their subsidy income.
These arcane strategies were labeled recycling, refunding and transferring. The GAO said the Bush administration could crack down immediately through regulation, but the Education Department disagreed. It said Congress should provide the 9.5 percent solution.
An exchange of letters between the department and Nelnet illuminated the issue. In May 2003, the company alerted the department to a financing plan that critics called an aggressive reading of the subsidy rulebook. The government’s brief reply in June 2004 did not question the plan’s validity.
The company then began claiming more subsidy income.
Later that year, Congress approved a measure to partially shut down financing techniques that had been used to perpetuate the subsidy — but only through 2005.
Last May, Education Department Inspector General John P. Higgins issued a report contending that the government had overpaid a New Mexico lender as much as $36 million. The report faulted financing techniques the lender used to qualify for the subsidy, a criticism with potentially damaging implications for other lenders. The lender, the nonprofit New Mexico Educational Assistance Foundation, protested the finding.
In July, Education Secretary Margaret Spellings largely rejected the inspector general’s conclusions, announcing that the lender followed applicable laws and rules. Higgins wrote later in a report to Congress that the department had allowed lenders to retain and continue to receive “excessive” 9.5 subsidies. “These payments will not result in any identified benefit to the government,” the inspector general wrote.
With Bush administration support, House and Senate negotiators agreed to shut down the controversial financing techniques for good.
That would eventually end the subsidy as qualified bonds are retired and loans are repaid. The measure was attached to a larger budget bill that won Senate passage on Dec. 21. Earlier, the House had passed a nearly identical budget bill. The House is expected to give final approval early next year, sending the bill to President Bush for signature.
Senators inserted one caveat in the 9.5 subsidy provision: nonprofit lenders with qualifying loans worth less than $100 million would be able to extend the subsidy via financial “recycling” methods through 2010. Such lenders represent a small fraction of the market.
One protected lender would be the Wyoming Student Loan Corp. Its interests were guarded by a senior negotiator, Sen. Mike Enzi, R-Wyo., chairman of the Committee on Health, Education, Labor, and Pensions. Enzi’s staff could not be reached for comment.