Did Congress Tame the 'Wild West'?

Opinions on the impact of New York Attorney General Andrew Cuomo's investigation into the student loan industry (which reared its head again Tuesday -- see related article) vary widely. Supporters champion it as having shined a light on sleazy practices in which some lenders and colleges engaged, and as ultimately helping students. Critics say it destroyed the careers of several financial aid officers and besmirched thousands of financial aid officers and lenders without ever proving that any individual student paid a penny more than he or she should have.

But what Cuomo’s investigation undeniably did was put significant pressure on the federal government to step up its regulation of the student loan industry. That was particularly true of the private or “alternative” loan market that had expanded widely -- virtually unfettered by federal oversight -- during the early part of this decade. While Democrats pummeled the Bush administration for its perceived lack of interest in regulating lenders who have long contributed heavily to Republican politicians, Education Secretary Margaret Spellings argued that federal officials, and especially her agency, had far less authority to rein in potential abuses in the private student loan market than they did in the federal loan programs.

The effort to change that equation -- a major section of the Higher Education Opportunity Act that Congress passed in July and President Bush signed last month -- is widely seen as giving federal regulators additional tools and consumers much more information with which to try to tame what Cuomo and members of Congress had dubbed the “Wild West” of the student loan market.

The new law restricts the relationships between college officials and lenders in an effort to avoid potential conflicts of interest; restricts certain kinds of marketing seen as misleading; and requires loan providers to give prospective borrowers significantly more information about their loans and about students’ alternatives to private loans, among other things.

But Congress stopped short of embracing two major changes that advocates for students and many financial aid officers argued would truly protect students from being hamstrung by unnecessary private loan debt: (1) requiring college officials to "certify" that a student needs the money he or she is preparing to borrow from a private loan provider and (2) allowing borrowers to discharge private loan debt in bankruptcy. The first provision was strongly opposed by some lenders who provide loans directly to consumers, and the latter ran into significant opposition from senators who had little interest in reopening wholesale changes made to federal bankruptcy laws in 2005.

While the National Association of Student Financial Aid Administrators and its president, Philip R. Day Jr., favored the certification and bankruptcy changes that Congress shunned, "on the whole, the bill is a win for borrowers," said Justin Draeger, a spokesman for the group.

Change in the Weather

The fact that there is reasonably widespread agreement on many of the new law's loan provisions reflects just how much the revelations from Cuomo's investigation (and its companion inquiries in Congress) changed the political equation on student loans. Some of the changes embraced in the legislation had been discussed and discarded in previous years, typically amid opposition from, or at least a lack of agreement among, lenders and many financial aid officials.

Even as many loan industry representatives have continued to assert that the Cuomo investigation greatly exaggerated the extent and degree of unethical and even questionable behavior by lenders, most came to see the inevitability, if not always the wisdom, of the changes.

Among the most significant changes made by the legislation are the following:

• Prohibiting private lenders (as well as providers of federal loans) from offering gifts or other items of value to colleges or financial aid officers in exchange for advantages related to the lenders’ loan activities.
• Prohibiting lenders from engaging in "co-branded" marketing with colleges, where a lender or marketer uses an institution's name, logo or other mark to create the impression that the college has endorsed the lender.
• Requiring private loan providers to inform borrowers that federal aid and loans are available, and to tell them about the (typically lower) interest rates available on federal loans.
• Requiring private loan providers to provide information about the rates and other terms of their loans at several points during the lending process, helping borrowers better shop for the best deals.
• Requiring lenders to sustain the terms of a loan for up to 30 days after they approve the loan, and giving borrowers three days to change their minds after signing up for a private loan.

"We're happy about the disclosures to students that have to be made," said Draeger of the financial aid officers' group. "A lot of private student lenders were doing this already, but this puts everybody on the same page. And the opportunity for borrowers to opt out of the loans is also a good thing. All of those things offer more protections for borrowers, and anything that does that is good, from our members' perspective."

Most lenders agree. "All of this information will help parents and students make a more informed decision," said Raza Khan, president and co-founder of MyRichUncle, a lender whose complaints about financial aid offices steering potential borrowers toward certain lenders (and hence away from his company) helped spur Cuomo's investigation. "This bill was crafted to make sure customers are informed and able to secure loans in a fair and balanced way."

MyRichUncle was among numerous lenders that opposed one other step that many financial aid officers and student advocates thought would go even further to protect prospective borrowers from unnecessary private loan debt. The proposal, which was offered by NASFAA and was favored by many lawmakers in the House of Representatives, would have required lenders to obtain "certification" from a borrower's college about the student's "cost of attendance" and the difference between that cost and the amount of federal financial aid for which he or she qualified. It also would have required the lender to let a college know how much it planned to lend to a borrower.

The proposal had widespread support from those who concerned about the growing private loan borrowing that students are engaging in. Advocates for the NASFAA plan sought to insert financial aid officers into the process in which many private loans are marketed directly to potential borrowers, who sometimes agree to take out private loans when they might qualify for lower-cost federal loans or even, in some cases, take on more debt than they need to.

"Some of the best prevention against unnecessary borrowing has come out of the advice that financial aid directors give to students," said Luke Swarthout, whose last day as a higher education advocate for the U.S. Public Interest Research Group was Friday.

Robert Shireman, president of the Institute for College Access and Success, said his group supported the certification idea as a way to to help financial aid directors keep students out of financial difficulty. "Financial aid officers will sometimes discover three years later than a student they thought was doing fine had a direct to consumer loan and is having trouble paying it back," Shireman said. "The FAO never had a chance to help that student make ends meet."

Shireman, whose group was among those that pushed the idea, said supporters considered the proposal a "mild" one and had contemplated proposing legislation that would have required all students to go through financial counseling before taking out a private loan, as Barnard College has begun doing to try to limit private loan borrowing. But "that seemed like too much to ask for at this stage."

Some lenders supported the certification proposal. "We thought that it was more responsible to have schools involved, and that it would prevent overborrowing," said Tom Joyce, senior vice president at Sallie Mae, which provides private loans as well as being the biggest originator of federal loans. “Schools can help more than anyone in assuring that students are maxing out on federal loans before they turn to private loans.”

Political considerations clearly played a role in killing the certification proposal. The leaders of the Senate Banking Committee, Sen. Chris Dodd (D-Conn.) and Sen. Richard Shelby (R-Ala.), had painstakingly negotiated an agreement on a specific set of ideas for regulating private loans and could not be pushed further by House lawmakers who supported certification.

And the idea ran into strong opposition from a group of lenders who market their loans directly to student borrowers. MyRichUncle led the way. It made its reputation (infamously, in the eyes of many financial aid directors) by arguing that financial aid officers, rather than honest brokers working on students’ behalf, too often directed them to lenders with which they supported (or with which they were cozy, depending on one’s view).

So where supporters of certification saw colleges ensuring that students don’t borrow too much, Khan of MyRichUncle said, the danger is that institutions would end up “steering or attempting to limit consumer choice…. We still see examples of specific lenders who are packaged into financial aid letters from schools,” Khan said, and mandating their participation in the private loan process could make it easier for institutions to nudge students toward private loan providers that they favor.

In lieu of the proposal requiring college financial aid offices to certify private loans, the compromise Higher Education Act legislation signed into law by President Bush last month instead requires students themselves to obtain much of the same information (about their cost of attendance, the amount of federal aid they qualify for, etc.) that the NASFAA proposal would have mandated. Supporters of this approach said it would serve much the same purpose as requiring the college itself to certify the loan, since students presumably would have to turn to college officials to obtain much of the information needed to fill out the form.

But the fact that officials at a college might never see the information the student provides to the lender, and is not in any way required to sign off on the form, significantly undermines the value of the information as a potential deterrent to students' taking on excessive loan debt, said Swarthout, the former PIRG official. "It would be a fundamental mistake to consider this an alternative, a stopgap, or even a partial effort at certification," he said. "It does not accomplish the proposed goal of certification."

The other policy sought by some college officials and advocates for students to protect private loan borrowers was a reversal of the change made to federal bankruptcy laws in 2005 that excluded private student loans from the assets that an individual could discharge during bankruptcy. Supporters, like Sen. Richard J. Durbin and Rep. Danny Davis, both Illinois Democrats, said the change was necessary to help protect borrowers from the crush of excessive debt burdens.

Opponents argued that the proposal could wind up increasing what students pay for loans, because lenders would have to increase their fees to cover the loans they'd have to write off. But the idea ultimately failed, most agree, because members of Congress were loathe to consider making one narrow change in the 2005 bankruptcy law that might reopen the intense battles over many other aspects of the law.

"It seemed to be the larger politics around bankruptcy in general" that killed that provision, said Shireman. To get that back on the table, he said, "will take some time and probably some grander strategy."