Borrowing trouble

AFTER 15 YEARS of reporting on the student-loan industry, I didn’t think much could surprise me. But even I was shocked last week when I discovered Securities and Exchange Commission documents revealing that financial aid directors at three prominent universities -- as well as a senior official at the U.S. Education Department -- each had significant personal investments in a private student-loan company

What possibly could have motivated these officials to take tens of thousands of dollars in stock options from Student Loan Xpress? Has the whole student-loan business become so corrupt that they failed to see the conflict of interest?

If so, Washington is most to blame. For the last seven years, federal officials have turned a blind eye to problems with the companies that participate in the government’s student-loan programs.

When it came to power, the Bush administration -- with its reverence for the private sector -- rewarded loan industry officials and lobbyists with prominent positions throughout the Education Department. Meanwhile, lenders such as Sallie Mae have showered Republican congressional leaders with hundreds of thousands of dollars in contributions each campaign cycle. “Know that I have all of you in my two trusted hands,” Rep. John A. Boehner (R-Ohio), a top recipient of that campaign cash, once famously told a gathering of student-loan providers.

The cozy relations that developed among the Bush administration, the Republican-led Congress and the lenders have left the loan industry essentially unregulated. Some observers liken it to the Wild West: Lenders and colleges pursue their own self-interest with little regard for students or taxpayers.

Every company wants to be a college’s “preferred lender,” competing fiercely to get on such lists. But the dirty little secret of the guaranteed student-loan market is how concentrated it is: Only 32 lenders hold 90% of the loan volume. What’s more, the Education Department has found that at about 300 colleges, one lender controls 99% of the loan volume -- essentially holding a monopoly on those campuses.

Any company trying to break into the market has to rely on unconventional means. Some upstarts have promoted revenue-sharing arrangements, in which colleges get a cut of each loan that their students take out. Established lenders, worried about losing market share, have taken up similar kickback practices. One of the most egregious schemes is called an “opportunity pool,” which was pioneered by loan giant Sallie Mae. Here’s how it works: A lender hands a college a fixed amount of private loan money that the institution then can lend to students who otherwise wouldn’t qualify for loans because of credit problems. These are private loans -- ones that typically come with higher interest rates and fewer consumer protections. In return for the “opportunity pool,” the college makes that company its exclusive provider of federally backed loans.

Soon after Sallie Mae started its Opportunity Loan Program in 2000, some of its competitors questioned whether it violated the provision of the Higher Education Act that bars lenders from offering inducements to colleges “to secure applicants” for federal loans. They brought their complaints to the Education Department’s inspector general, who wrote a memo to department leaders urging them to examine “opportunity pools.” Department officials, however, refused to take action, insisting that the loan industry should regulate itself. Many lenders took that to be tacit approval of the deals. As a result, other companies, such as Citibank, started offering similar arrangements.

Giving credit-unworthy students high-interest private loans is a recipe for disaster -- a disaster that the department could have stopped. Loan industry officials acknowledge that these deals are “loss leaders,” meaning the companies are willing to absorb some defaults in exchange for a greater presence on a campus.

Recently, as outrage over these types of deals has grown and the Democrats have gained control of Congress, the Education Department has had a change of heart. Officials are considering more heavily regulating how colleges choose lenders to recommend to their students. For example, the agency may require financial aid administrators to include at least three choices on their “preferred lender” lists.

The department’s proposals, which are being contested by lenders and aid administrators, are welcome but unlikely to go far enough. Instead, policymakers should consider a complete overhaul of the federal student-loan programs so that college aid administrators are no longer in the business of recommending favored lenders.

If there can be a lendingtree.com for home mortgages, there can be one for student loans too. Lenders should bid for student-loan business. Students would get cheaper loans. And there would be fewer incentives for the kind of unseemly activity that has been coming to light.