President Obama speaks to the media before signing a memorandum aiming to clamp down on companies that service federal student debt on March 10. (Andrew Harnik/AP)

The Education Department has grown into one of the biggest money lenders in the country, overseeing a $1.2 trillion portfolio of student debt rivaling the entire loan business of JPMorgan Chase with a staff roughly the size of the National Weather Service.

But instead of fulfilling a presidential mission of remaking and simplifying a confusing and corrupt system that enriched financial firms at the expense of taxpayers — and ultimately the nation’s college students — serious problems have emerged.

The government hired contractors to service and collect the loans, but state and federal authorities have accused the companies of ignoring borrowers’ requests for help, misleading them about their rights and mismanaging their payments. And while the government charges families lower interest rates than what banks typically offer, it is still making money on the program, raising questions about how it should balance its obligations to families and to taxpayers.

“Moving to direct loans was the right way to go. Now . . . we have growing pains in how the government handles this new responsibility,” said Susan Dynarski, a professor of economics, education and public policy at the University of Michigan.

For many U.S. families, taking out a loan to help pay for college is a significant decision that can shape their financial lives for years to come. Long after a student signs on to a loan, the way that debt is serviced — whether borrowers get the help they need or how the payments are collected — can make a big difference. When contractors mishandle payments or don’t provide the right information, students end up missing out on repayment programs intended to save them money or to keep them from defaulting on their loans, an outcome that can severely damage a person’s credit rating, making it much harder to buy a car or a house.


Katie Walkiewicz, 34, ran into trouble when she asked her servicer Navient about Public Service Loan Forgiveness, a program that wipes away the remaining debt of people in the public sector after 10 years of repayment.

She said Navient told her that working as a full-time professor at Kennesaw State University, a public college in Georgia, would qualify her for the program.

But Walkiewicz had student loans from an older program, which she needed to consolidate into a direct federal loan to be eligible for the forgiveness program. It took eight months before Navient mentioned that fact, even though she had called the company on several occasions, she said.

“Every time I asked, ‘I’m doing everything right?’ They said, ‘Yes,’ ” she said. “I can’t imagine my students going through this.”

Navient declined to comment on the case because of customer privacy rules, but spokeswoman Patricia Nash Christel said the company’s script and training for call center representatives gives a detailed explanation of the public service program.

The Obama administration said it is taking these issues seriously and that the president’s plan to transform the system by having the government lend directly to students — rather than working through banks to issue the loans — has ultimately resulted in gains for families.

“The move to direct lending is an incredibly important part of this administration’s legacy,” said Education Undersecretary Ted Mitchell. “Because we’re making the loans, we can help determine the terms . . . and that’s enabled us to be much more aggressive in meeting the needs of students.”

Unnecessary middlemen

Before President Obama’s makeover of the student loan system, the federal government was essentially a silent partner in a $60 billion program.

Private lenders used their own money to finance the loans, but behind the scenes the government paid a portion of the interest to make the debt more affordable. Whereas a private student loan offered by Citibank could cost a student 13 percent interest, a Citibank student loan backed by the government would cost half as much. And to entice lenders, the government guaranteed the debt, taking on the risk of default.

It was entirely possible that a student taking out a loan would have no idea that the government was behind a Citibank or JPMorgan loan.

“There was tremendous confusion,” said Pauline Abernathy, vice president of the Institute for College Access & Success. “Students had a hard time discerning whether they had a federal Sallie Mae loan or a private Sallie Mae loan, and the difference in the terms.”

The program drew little attention until 2004, when federal investigators caught several private lenders, including Nelnet and Sallie Mae, overcharging the government by tens of millions of dollars. Two years later, New York state settled with a dozen student lenders, including Sallie Mae, Citibank, NelNet and Bank of America, for allegedly paying college financial aid officers to steer students into their loans.

In the wake of those scandals, Congress reduced the amount of money that banks received. But Democrats wanted to scuttle the program and only provide direct federal loans, which the government started doing in the early days of the Clinton administration.

Tucked into Obama’s health-care legislation was a provision to end what he called “a sweetheart deal” for “unnecessary middlemen” in the college lending system. In 2010, at a signing ceremony at Northern Virginia Community College, he decried the billions of dollars the government paid financial firms, saying the money “could have been spent helping more of our students attend and complete college.” From now on, the government would lend money directly to students.

Obama channeled more than half of the $60 billion saved by ending the bank-based program into Pell Grants to help needy students attend college. The underfunded financial aid program needed every penny to support the influx of students struggling to afford skyrocketing college tuition.

The reluctant banker

The economic recession helped drive people back to school, and the demand for student loans exploded. The government held $750 billion in student loans at the end of 2010, an amount that grew to $1.2 trillion by the end of this June, according to the latest data available.

Critics say the department lacks the expertise to analyze student loan data and spot trouble in the portfolio. They worry that the agency is incapable of identifying risks and catching borrowers before they fall through the cracks.

“It is not a particularly robust organization,” Thomas Weko, a former agency official who is at the American Institutes for Research, said of the department. “Do they have the data and financial analytic capabilities sitting there to thoughtfully evaluate whether there are better ways of doing what they’re doing today? No, they don’t.”

Jeff Appel, deputy undersecretary of education, contends that the department has economists and statisticians who are “accustomed [to] doing . . . financial forecasts and the kind of sophisticated work” necessary to run the program.

There are also questions about whether the federal government is making money off of student loans. It costs the government almost nothing to borrow money to lend to students and families, yet it sets interest rates as high as 7 percent on some federal loans.

“The government is charging interest rates and origination fees that are high enough that over time they make money off the program,” said Richard Kogan, a senior fellow at the Center on Budget and Policy Priorities.

Hillary Rodham Clinton, whose husband ushered in direct lending as president, is among the Democratic presidential candidates promising to lower interest rates on federal loans to ensure that the government does not make money off of students.

Budget projections indeed show the government taking in more money than it lends at times, but Appel called those forecasts “well-informed best guesses” because of the uncertainty of the amount of money extended or repaid in any given year.

“It’s not money left over at the end of any particular year,” he said. “If you look at how much the government is laying out in any given year . . . versus how much it’s collecting in repayment, there’s more funds going out than coming in.”

And while borrowers are paying more than what it costs the government to borrow, Appel stressed that the rates are far lower than what banks would charge. The government does lend to students without any sort of credit check, but the risks are limited because it can garnish wages, Social Security benefits and tax refunds to collect the money.

Still, the lenient terms of some federal loans have raised concerns about whether the government is lending as a public good or simply making money off of vulnerable people.

Parents and graduate students can borrow up to the full cost of attendance as long as they haven’t defaulted recently on a loan, declared bankruptcy or had any other black marks on a credit report in the past two years. There is no accounting for credit scores, employment or debt relative to income.

In exchange, the government charges nearly 7 percent interest and a 4.2 percent fee for making these Parent PLUS loans. The government earns roughly $3 billion a year off of the loans, according to the White House Budget Office.

A new set of headaches

To manage its outsize portfolio of loans, the government essentially swapped one set of middlemen for another.

In fact, the Education Department gave contracts to some former lenders, such as Nelnet and Sallie Mae, to collect and apply borrower loan payments. The department even used a Sallie Mae subsidiary, Pioneer Credit Recovery, to go after students for past-due debt.

But problems have emerged. A report from the National Consumer Law Center in the fall accused the department of creating a system that encourages collection agencies to use high-pressure tactics. Researchers found that the more money debt collectors recouped in loan payments, the higher they scored and the more money they received from the department.

As a result, the president has asked the department to make sure that its debt collectors are working with borrowers to return them to good standing and not charging them exorbitant fees in the process.

Prior to the president’s request, officials at the department fired five of its 22 private collection agencies for allegedly lying to borrowers about having their credit repaired or collection fees waived if they paid up.

Still, the department’s Office of the Inspector General has been critical of officials for not doing enough to track and respond to complaints filed against collection agencies. The Treasury Department is now running a pilot program to determine whether debt collection services are best left with the government, rather than third-party contractors.

There are also questions about whether servicers, to maximize their profits, are misleading people about their repayment options. Advocacy groups say rather than helping struggling borrowers enroll in income-driven plans — a time- and resource-heavy effort — servicers opt for an easier, short-term solution such as deferring the payments.

More than 30,000 borrowers shared their servicing experiences with the Consumer Financial Protection Bureau earlier this year, complaining about servicers losing paperwork, giving inconsistent information or neglecting to tell them about repayment options.

“It is pretty clear that [the Education Department] has not done a great job of maintaining oversight of its servicers,” said Dynarski, the University of Michigan professor. “There need to be clear performance objectives, they need to be reviewed and if a company is not living up to them, they need to get booted out of the system. And all those are things that we haven’t seen happening.”

In 2014, the Justice Department fined the servicer Navient $60 million for charging military service members higher interest than the law allows. Still, the department has kept the company on as one of its 11 loan servicers. A group of Democratic lawmakers, led by Sen. Elizabeth Warren (D-Mass.), has criticized the department for renewing Navient’s contract one month after the settlement was announced.

Although Education Undersecretary Mitchell would not directly address the criticism, he said: “We constantly monitor and evaluate our servicers. And where we believe they have acted inappropriately, we will take action.”

He added that the department is working with its 11 servicers to drive down complaints.

The department has renegotiated its contracts with the companies that manage the government’s portfolio of student debt, offering bonuses to those that reduce delinquencies or defaults.

Navient chief executive Jack Remondi said his company has a stellar record of keeping customers current on their loans, with a 40 percent lower default rate than the national average.

Remondi said Navient, which up until two years ago was a part of behemoth Sallie Mae, is experienced enough to handle any changes the department sends its way. Still, he said, borrowers and servicers could benefit from a simplification of the mushrooming list of repayment plans.

“The student loan programs have grown in complexity every single year. Adding layers sometimes creates confusion,” he said. “If customers can go to a Web site and start reading the different options available and feel overwhelmed, how does that impact their behavior? Does it make them more likely to call us? Or more likely to throw up their hands and avoid the problem?”

Earlier this year, Obama signed a memorandum called the Student Aid Bill of Rights that gave the department a series of tasks to fix the servicing of student loans.

The agency has to create a new Web site for borrowers to file complaints and provide feedback about federal student lenders, servicers and collection agencies. It also must establish a central point of access for all people repaying their federal student loans to check their accounts and track their payments, rather than leaving it up to each servicer to furnish that information.

“We want to continue to innovate,” Mitchell said. “One of the things we have learned over the years in direct lending is one size rarely fits all, so we want to have a range of options. But we want those options to be small enough so that people aren’t overwhelmed.”