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White House Plan Would End Subsidies to Student Lenders

By Alejandro Lazo and Maria Glod
Washington Post Staff Writers
Friday, February 27, 2009

The Obama administration has proposed a sweeping change in the $85 billion-a-year student loan industry, one that could fundamentally alter the business of lenders such as Sallie Mae.

The proposal, included in yesterday's budget outline, would end a program that pays government subsidies to private student loan companies. The administration said the shift, which would mean that all federal loans would come directly through the government, would save $4 billion annually and $47.5 billion over the next decade.

The changes could be a blow to companies such as Sallie Mae of Reston that receive subsidies to originate federally backed student loans. Shares of Sallie Mae, formally known as SLM Corp., plunged 31 percent yesterday on the news.

The profitability of the student loan industry has faltered in recent years, first as Congress cut subsidies and then because of turmoil in the credit markets.

Last year, dozens of lenders stopped issuing federally guaranteed loans, prompting concerns about whether students would get the money they needed for college. The Bush administration took several steps to shore up student lenders.

Yesterday, Education Secretary Arne Duncan signaled a shift from that approach, saying the program that subsidizes private lenders is "on life support."

"Rather than continuing to subsidize banks, we want to help dramatically more students get more access to more aid," Duncan said in a conference call with reporters. "Big picture . . . We're going to save about $24 billion dollars over the next five years, and we want to actively invest that money in our students."

Since the early 1990s, federal student loans have been implemented through two programs. The program that the administration proposes ending, the Federal Family Education Loan Program, uses private-sector lenders such as Sallie Mae and Citigroup to originate and service the education loans, keeping the debt off the government's books.

Under this program, the government pays a subsidy to private lenders. Congress sets the interest rate on loans, and the federal government covers nearly all the losses if a student defaults.

The other program, Direct Loan, is administered by the government and includes student loan debt in the government's deficit. Under the proposal, this program would handle all federal loans.

The approach outlined yesterday echoes one long favored by Democrats. House Education Committee Chairman Rep. George Miller (D-Calif.), who has been a vocal critic of what he has called "corrupt practices" in the student loan industry, said the proposal was a "a solid plan to make federal student loans more reliable while saving taxpayers billions of dollars."

But there's already been pushback from Republicans. Rep. Howard P. "Buck" McKeon (Calif.), ranking Republican on the House Education Committee, lashed out against the proposed shift, calling it a "government takeover of the private-sector-based student loan program, taking away options and benefits from students while adding tens of billions" of dollars to the deficit.

The proposal to do away with the Federal Family Education Loan Program stunned investors and Wall Street analysts who follow Sallie Mae, the nation's largest student lender. Loans originated through that program made up about 80 percent of the company's total student loan portfolio at the end of 2008, with the rest being private loans.

"We believe this announcement essentially blindsided the industry -- ourselves included," Matt Snowling, an analyst with FBR Capital Markets, wrote in a note to investors. "We view this proposal as meaning that lenders such as Sallie Mae will face continuous threats during the current Administration's tenure, which will likely cause significant risk and turnover of the shareholder base."

"It could precipitate a collapse of the . . . industry because a lot of the lenders were holding on and hoping to survive until the end of the credit crisis," said Mark Kantrowitz, publisher of the Web site FinAid.org. "But they could pull out completely because if there is no future, then there is no reason to stay."

Sallie Mae stock fell $2.59 yesterday to close at $5.80. Shares traded as high as $25.05 in the past year.

Under the administration's proposal, the private sector wouldn't be completely cut out of the equation. The Education Department would contract with companies to service loans and collect payments.

Officials yesterday said they expected some companies that now participate in the loan program to take part in a competitive process to service the loans.

Sallie Mae made clear yesterday that it intended to bid for such contracts.

"We also note that the budget proposal looks to obtain 'high-quality services for students by using competitive, private providers to service loans,' " the company said in a statement. "Sallie Mae is the largest and lowest-cost provider of student loan services, and we deliver the highest quality for students, schools and families."

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