Reauthorization of the Higher Education Act
The Honorable Trent Lott
United States Senate
Washington, D.C. 20510
Dear Mr. Leader:
We are writing to express our concern about impending Congressional actions affecting the viability of the Federal Family Education Loan (FFEL) program. In particular, we oppose proposals that not only change the calculation of ceiling interest rates for student loans but also provide substantial unfunded subsidies to banks. The Administration strongly believes that we must remain committed to lowering the student loan interest rate, while seeking a compromise that maintains private lender participation, is fiscally responsible, and moves toward a market-based structure for FFEL in the future.
As you know, current law mandates a new formula, scheduled to take effect on July 1, that will provide a substantial reduction in interest rates for students. As part of this change, the formula would shift to a different index for determining student loan rates. Because this index would be a longer-term yield, it would lower returns and increase uncertainty for lenders, whose own financing is on a short-term basis. The Administration recognizes this problem for lenders and seeks to correct it.
In the spirit of balancing a competitive student lending market with students' access to an affordable education, the Vice President proposed on February 25th a plan that would deliver to students their full expected savings under scheduled law, while shifting back to a short-term index to provide a competitive rate of return for lenders. The Treasury Department's analysis of the FFEL program indicated that the rate of return under this proposal would meet competitive criteria for maintaining the participation of private lenders in the FFEL program. Other proposals also might meet our three key principles: maintaining student access to private loan capital, and providing the lowest possible rate for borrowers, while being fully funded. Unfortunately, the current proposals under consideration in Congress only meet the first two goals, while imposing an unacceptable burden on the taxpayers, who would subsidize high profits for lenders.
By maintaining the scheduled interest rate cut, the proposal passed by the House and reported by the Senate Labor and Human Resources Committee does deliver substantial savings to students. However, it also provides FFEL lenders with a 50 basis points subsidy above what students would pay, with the taxpayers financing the difference. Such an approach provides excessive subsidies to bank profits at the expense of scarce taxpayer resources, and threatens other domestic programs that would be cut in the Congressional budget process or by a sequester.
Two recent analyses, one by the Treasury Department and the other by the Congressional Budget Office (CBO), bolster the notion that lenders now earn a rate of return on equity from their student loans that substantially exceeds their overall rate of return, even in recent years of peak profits. Indeed, the CBO reported returns on equity for lenders that securitize their loans of almost double the overall average rate of return to the banking sector in recent years. Lenders reap these high profits on an asset that is much safer (in terms of both credit and interest rate risk) than the typical bank loan, and that banks should be willing to acquire at a lower than average rate of return. As CBO stated in its recent report, "In summary, banks do not require the same returns on FFEL that they require overall, since federally guaranteed student loans are less risky than the average bank asset".
The House-Senate proposal locks in these high rates of return. Treasury's study estimates that the proposed rates to be paid to lenders would yield an after-tax rate of return of 16 percent, a rate of profit above the recent high, banking industry average and one third above the average for the past 30 years. The CBO estimates of after-tax rates of return for banks that securitize average 19 percent, or almost one-third above the recent high profit levels. Thus, the House-Senate proposal provides returns substantially higher than banks' recent surging overall profit levels on loans which they should be willing to make at rates of return below the average for their portfolios.
Under the House-Senate proposal, the costs of subsidizing these high levels of bank profits would be borne by the taxpayers. The Office of Management and Budget estimates these costs to be $2.7 billion over the next five years. If these costs are not fully paid for, under Administration scoring, a sequester could be triggered with far-reaching consequences both for students and for other beneficiaries of mandatory programs. We should not be threatening other high priority programs, or cutting into the surplus that the President has declared should be reserved until the Social Security solvency problem has been addressed, in order to subsidize an excessive level of bank profitability.
The Administration supports an objective, market-based determination of appropriate lender returns under the FFEL program. The difficulty of the current debate highlights the value of letting the market determine the appropriate rate of return. A number of different auction models have the potential to achieve this outcome, and we are eager to work with Congress to find the right approach. We recognize the concerns of small lenders who worry about being excluded from the FFEL program under an auction model. One important feature of an acceptable auction-based approach will be a viable mechanism to allow the continuation of small lender participation in this program.
In summary, the Administration opposes the House-Senate proposal in its current form, and urges Congress to provide the lowest rate to students while maintaining lender participation, minimizing taxpayer subsidies, and setting in motion a process for developing a market-based mechanism to determine lenders' returns on student loans. We can continue to have a healthy FFEL program without expensive bank subsidies. We look forward to working with you in developing such a plan.
The Office of Management and Budget advises that there is no objection from the standpoint of the President's program to the submission of this report to the Congress.
Robert E. Rubin
Secretary of the Treasury
|Richard W. Riley|
Secretary of Education
The Honorable Tom Daschle|
The Honorable Newt Gingrich
The Honorable Richard A. Gephardt
The Honorable James M. Jeffords
The Honorable Edward M. Kennedy
The Honorable Pete V. Domenici
The Honorable Frank R. Lautenberg
The Honorable Ted Stevens
The Honorable Robert C. Byrd
The Honorable William F. Goodling
The Honorable William L. Clay
The Honorable John R. Kasich
The Honorable John M. Spratt, Jr.
The Honorable Bob Livingston
The Honorable David Obey
The Honorable Howard P. McKean
The Honorable Dale E. Kildee
The Honorable Alfonso M. D'Amato
The Honorable Paul S. Sarbanes
The Honorable James A. Leach
The Honorable John J. LaFalce