Student Loan Aid Is Test for Treasury

Groups Urge No Bailout Benefit To Private Lenders

Student advocacy groups are urging the Treasury Department to prevent a new $200 billion consumer-lending program from benefiting private student lenders, which they say are largely unregulated and prey on students with risky, high-interest loans.

The program, announced this week and developed by the Treasury and Federal Reserve, is not aimed specifically at the student loan market. Its much broader goal is to encourage lending to consumers -- including car loans, credit card debt and student loans -- as well as help the financial system by increasing liquidity in the credit markets.

But groups including Consumers Union, the nonprofit group that publishes Consumer Reports magazine, and the American Association of Collegiate Registrars and Admissions Officers say the money will also help prop up private student-loan providers, which often offer high and variable interest rates but not the consumer protections guaranteed under the federal government's loan programs.

Private student loans, which were a primary focus of a nationwide conflict-of-interest scandal last year, are the fastest-growing segment of the $85 billion-a-year student loan market.

"A bailout for the providers of usurious private student loans will not solve the college affordability crisis caused by the failing economy, and would actually be detrimental to many students and consumers," nine advocacy groups wrote in a letter sent last week to Treasury secretary Henry M. Paulson Jr., after he signaled that the department was developing the program. "However, if you continue to pursue any form of rescue for private student loans, it would be unconscionable to do so without also providing better consumer protections."

The plan's impact on student lending highlights the potential unintended consequences from the enormous bailout program as officials rush to rescue the nation's financial system.

Michelle Smith, a spokeswoman for the Federal Reserve, said the formulators of the program were solely concerned with trying to salvage the economy, not with broader discussions of the government's approach to student loan policy. Those types of issues, she said, would be more appropriately addressed by the Bush administration, which thinks private loans are an important part of the financial aid system.

Lending industry officials hailed the new lending plan as a critical step toward ensuring that the private student loan market does not collapse.

"The announcement of the intervention is welcome news to anybody concerned about not having student's education plans for the current academic year disrupted," said John Dean, special counsel to the Consumer Bankers Association, which represents many of the nation's largest student loan companies.

Democratic leaders on the congressional education committees, who have carried out multiple investigations into abuses by the private student loan industry, said they were alarmed that bailout money could be funneled toward private student loan companies. The lawmakers were not informed about the plan and were still unclear how it would be implemented.

"I'm very skeptical," said Rep. George Miller (D-Calif.), chairman of the House Education and Labor Committee. "My concern here is that what Paulson may be doing is borrowing the good name of student loans to bail out some very bad actors."

Michele A. Davis, the chief Treasury spokeswoman, declined to comment for this article. Education Department officials praised the plan for helping to create new private and federal loans. "The Department fully supports the program," said spokeswoman Samara Yudof.

The government's new program is meant to help the consumer-lending industry by lending as much as $200 billion to investors who hold securities backed by student loans or other forms of consumer credit. Government officials hope that lending will jump-start the credit markets and encourage companies to offer loans to help people to buy cars, borrow through credit cards, or pay for college.

The $17 billion-a-year private student loan industry has been particularly hard hit by the financial meltdown, according to industry groups and analysts. Thirty-seven firms have stopped issuing private student loans, and investors have been reluctant to put money toward them, according to FinAid, a Web site that tracks the student loan industry.

The government's plan will primarily benefit large lenders, which are more likely to have sufficient capital to participate, said Mark Kantrowitz, the publisher of FinAid. Smaller lenders, which often offer lower rates to compete with their bigger rivals, will be largely shut out, he said, making it unlikely that the plan will lead to significantly lower rates for students.

Sallie Mae, the nation's largest lending company, has offered private loans with an average interest rate of 11 to 13 percent, nearly twice as much as federal loans, according to Student Lending Analytics, a California-based firm that advises financial aid offices. It said Sallie Mae, which is based in Reston and controlled 42.5 percent of the private student loan market last year, has offered some private loan variable rates that are more than 17 percent.

Tom Joyce, a spokesman for Sallie Mae, said the average rate now is between 10 and 11 percent, around what most banks are charging for private student loans, which are not subsidized and government-guaranteed like federal loans. "The comparison to federal student loan rates is unfair and artificial," he wrote in an e-mail. "The comparison should be to borrowing on a credit card or other unsecured loans."

The student and consumer advocacy groups who wrote Paulson say that far too many students unnecessarily take on private student loans. One out of five undergraduate private student loan borrowers did not first take out federal loans, according to a study by the American Council on Education, which represents college and university presidents. Experts and government officials say students should always exhaust federal student loans before they turn to private ones.

The estimated 8 percent of undergraduates who take out private loans often are swayed by misleading and deceptive advertising, then saddled with interest rates two or three times as high as federal loans, according to the Nov. 19 letter to Paulson, also signed by the U.S. Public Interest Research Groups, U.S. Student Association, National Consumer Law Center and the Project on Student Debt, whose executive director is working with President-elect Barack Obama's transition team on education issues. The Treasury has not responded to the letter.

Industry officials counter that private student loans are critical for students struggling to pay the ballooning costs of college tuition. The National Association of Student Financial Aid Administrators called private student loans a "necessary evil" and supported the new plan to back them.

"How realistic is it to say that families shouldn't use private student loans when college costs are increasing faster than the rate of inflation?" said Kevin Bruns, executive director of America's Student Loan Providers, an industry trade group.

Federal loans for students and their parents, however, can cover the entire cost of tuition and living expenses in nearly all cases, consumer advocates say. They say the key exceptions are international and undocumented students, as well as those whose schools don't participate in the federal loan programs.

"The less dependent that students are on private student loan financing to pay for college, the better off they will be in the long run," said Christine Lindstrom, the director of the higher education project at U.S. PIRG. "Private student lenders and banks do not need further incentives to push market their expensive, risky loan products on vulnerable students and families."