Article in NYTimes:Federal Audit Says Lender Exploited Subsidy Rules

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June 12, 2005
Federal Audit Says Lender Exploited Subsidy Rules

By TAMAR LEWIN
A nonprofit student loan company in New Mexico improperly exploited a federal subsidy program that guaranteed it 9.5 percent interest on loans, a federal Department of Education auditor has found. The auditor recommended the recovery of millions of dollars in overpayments.

A Department of Education spokeswoman, Stephanie Babyak, said that the recommendation was being reviewed and that department policy barred her from making additional comments.

Before the audit report was issued May 25, the New Mexico Education Assistance Foundation, the subject of the audit, went to federal court in Albuquerque, trying unsuccessfully to stop its publication and asking the court to direct the department not to enforce the recommendation.

The 9.5 percent loan guarantee was established in the 1980's, when interest rates were high, to keep lenders in the low-interest college loan business. Congress tried to phase out the guarantee in 1993, but the loans ballooned as lenders exploited a loophole allowing them to refinance pre-1993 loans at the 9.5 percent rate.

The report found that the New Mexico lender had wrongly received payments for two classes of loans: those that had been used as security for a new bond after the pre-1993 bond had been retired, and those financed by bonds issued after Oct. 1, 1993, the cutoff date in the legislation.

Elwood G. Farber, the loan company president, said the firm had acted under Education Department guidelines allowing lenders to refinance their pre-1993 bonds.

"I totally disagree with the findings, which are based on a misinterpretation of the guidance and the statute," Mr. Farber said. "If we have to pay back the government, the real-world effect is that our student borrowers' rates will go up."

In a letter to Education Secretary Margaret Spellings last week, Senator Edward M. Kennedy, Democrat of Massachusetts and a prime critic of the loan guarantee, said the inspector general's report and recommendations "potentially have multibillion-dollar budget implications far beyond the single lender studied" and urged the department to audit all lenders that claim entitlement to the subsidies.

Other critics saw the New Mexico audit as a possible signal of broader action.

"This is a potentially big moment, because it points to the possibility that a lot of these payments have been illegal and could be recovered," said Robert Shireman, an education policy adviser in the Clinton administration who now directs the Institute for College Access and Success. "This is a moment when the department could take the bull by the horns and save taxpayers some money."

With borrowers paying as little as 3 percent in the recent low-interest-rate years, student loan companies have had an incentive to find ways to expand their portfolios of loans subsidized at the 9.5 percent rate.

According to federal records, Nelnet, a major student loan company, billed the government for $48.7 million in quarterly subsidy payments in June 2004, compared with $4.6 million at the end of 2002.

Mr. Shireman said it was unclear just how widespread the practices described in the audit had been. Until now, he said, the data available on the 9.5 percent loans have been the amounts billed the government; the audit, for the first time, traced the genealogy of the tax-exempt bonds that finance the loans to assess what actually took place before and after Oct. 1, 1993.

Last fall, Congressional Democrats accused the Education Department of being lax in preventing loan companies from exploiting the loophole, in part because of the Bush administration's political connections with lenders.

The Education Department said that it was following policies established by the Clinton administration and that it lacked the authority to close the loophole. But a Government Accountability Office report said the department could have stopped the program at any time.

In October, Congress unanimously passed a bill to help close the loophole, but the legislation was to last only a year, and it allowed lenders to reinvest their income at the same high subsidized rates.

In April, federal subsidies to lenders were as high as ever, with most government officials saying they would remain that way for months.

Payments to lenders under the guaranteed rate rose to $262 million for the first quarter of the 2005 fiscal year, about $22 million more than in the last quarter of fiscal 2004, before the legislation. It was unclear why the payments increased.