|Generation Debt: The New Economics of Being Young
by Amy Guthrie
Your Mi$ery I$ Their Profit
Up to your ear$ in $tudent loan$? That'$ good new$ for the bond trader$
Next time you sit down to sign your monthly student loan check, consider
this: Somebody out there is trading bonds made up of thousands of loans
like yours, profiting off your inability to pay for college. And it's not
just the guy that lives in a way nicer apartment across the street and dons
spiffy suits on his way downtown every day. It's also high rollers like him
in Chicago, London, and Tokyo.
Sound ugly? Well, that's the way the student loan business works. Private
lenders like Sallie Mae, and even state agencies, are increasingly funding
college loans through capital markets. The bonds are an easy sell because
most student loans are 98 percent guaranteed by the U.S. government. If Joe
College decides to move to Sweden and never pay a dime on his debt, Uncle
Sam picks up the tab. Plus interest.
What investor could refuse an offer like that? "You put it out there, and
people eat it up," said one veteran banker.
Congress is presently considering whether the government should, if not end
the party, at least turn down the music and raise the lights. It's been one
big bacchanal so far. Last month, the Senate passed a bill that would limit
the growth of loans qualifying for one generous federal subsidy, but left
other substantial handouts in place.
This year alone, industry leader Sallie Mae has already issued $31 billion
in bonds guaranteed by student loans. Since the banks that help sell these
bonds, known as underwriters, get about 1 percent of the sale for their
efforts, Sallie Mae's issuance should translate into at least $310 million
in bank fees. And that's just Sallie Mae. Over a dozen other lenders,
private and public, are also sharing the profits of your misery with bankers.
There are similar markets for credit card debt and home mortgages, but
right now the growth is in student loans. Each year, 13 million people
apply for federal student aid; the Department of Education expects to grant
about half those petitions in loans this year, to the tune of $52 billion.
The typical undergraduate leaves school owing $19,000, or double what the
average 1997 graduate owed. In the bigger scheme of things, 70 percent of
all federal student aid comes in the form of loans, while grants account
for just 22 percent. Thirty years ago that ratio was reversed. Meanwhile,
the U.S. is experiencing a population explosion among 18- to 24-year-olds
that rivals that of the baby boom generation. All of these trends are
playing right into the hands of the nation's big student lenders.
As recently as 2001, student loan providers sold just $11 billion in bonds.
That figure rose above $27 billion in 2002 and hit $52 billion last year.
Each bond consists of thousands of student loans, known as a pool, that
investors scrutinize to guess what percentage of borrowers will make
regular payments, default, or pay ahead of schedule. In a best-case
scenario for investors, everyone pays on time. The average trader rakes in
$500,000 to $2 million a year, and never considers that he is wagering on
"I think about it in pools," said Greg, a 38-year-old Sallie Mae bond
trader at a top-tier bank. Greg (not his real name) is a family man who
wears Burberry suits and lives in Connecticut.
Freddy, a trader at another top bank, said it doesn't make a difference to
him whether he's trading bonds backed by credit card debt or student loans.
When asked whether he's ever thought the practice might be morally
questionable, Freddy (also not his real name) got defensive. "Sallie Mae
could not possibly keep all the loans they have on their books. They have
to sell them; otherwise they wouldn't be able to make any more loans."
Graduating students facing huge debt find it a bit harder to be grateful
for the role the bond market plays. "That's just wrong," said Margarita
Testa, a 29-year-old confronting $35,000 in loans after receiving her
bachelor's degree from Florida International University in May. Testa said
she wouldn't mind that so many people are making a living off graduates
like her if the practice were more transparent.
Longtime bond analyst Jimmy Lawson says students shouldn't be bitter. "When
I was a student, I didn't know a stock from a bond. This is life. People
invest," said Lawson (not his real name). Lawson, like many other Wall
Street veterans who spoke with the Voice, declined to have his name used in
this article for fear of losing his job. "Are people in this business
highly paid? Certainly. But I'm a huge believer that this is nothing but a
world of good," he said.
One of the benefits of turning loans into bonds is that cash in the lending
pot is quickly replenished. In theory, the availability of cash should
lower the cost of borrowing for the average joe. But since interest rates
on student loans are fixed by the government, the savings aren't passed on
to borrowers. Instead, the banks reap the benefits of playing with cheaper
As the student loan industry thrives, a debate is heating up in Washington
about how big a cut of the student loan business middlemen should get and
how much the program ends up costing taxpayers. Government-backed student
loans were born under the Higher Education Act of 1965, which needs to be
reauthorized every five years. The main proposal now floating to update the
act-the Republicans' College Access & Opportunity Act-would lower
government subsidies for lenders. A separate bipartisan bill, the Direct
Loan Reward Act, suggests giving schools an incentive to use the
government's Federal Direct Student Loan Program, which was created under
the Clinton administration to compete with the Federal Family Education
Loan Program, or FFELP, in which private lenders like Sallie Mae participate.
Both programs lend to students at the same rate, but some argue that FFELP
costs taxpayers more because the government guarantees a certain rate of
return to private banks. Also, if students consolidate their loans at a
low, fixed rate, the government covers the lost revenue for private
lenders. All of these extra payments have been a boon to private lenders in
"They're essentially funding their profits on the backs of excessive
student debts," said Ajita Talwalker, president of the United States
Sallie Mae has roughly doubled its profit in each of the past three
calendar years, closing out 2003 with a net profit of $1.53 billion on $89
billion in student loans managed. Those gains put the Reston, Virginia,
lender among the most profitable publicly listed offerings on the New York
Stock Exchange. Its chief executive, Albert Lord, has collected about $10
million in bonuses since he rallied support in 1997 to make Sallie Mae
fully private. Despite the change in Sallie Mae's corporate classification,
this year 90 percent of the company's $98 billion in student loans are
federally insured. And the company can now act as lender, servicer, and
Along the way to becoming a private banking superpower, Sallie Mae bought
several small lenders and seriously shook up student lending. "Nobody is
putting any significant money into this business to improve delivery and
technology," Lord barked at a Consumer Bankers Association conference in
1997. "You've got to get your tails out from between your legs and stop
apologizing for making a profit."
Since then, Sallie Mae has become the country's second biggest student loan
lender after Bank One, which for years has handed its loans straight over
to Sallie Mae for management. So, has Sallie Mae made our lives better?
Should all of us borrowers be writing the company thank-you notes? Well,
that depends on whom you ask.
"It's evidenced that the fat is there," said Robert Shireman, a former
Clinton education aide. He's crusading to have the government's direct-loan
program replace the guaranteed program. "The government takes all the risk,
and we give away the profit."
Shireman, founder of Student Loan Watch and a member of the federal
advisory committee for student financial assistance, argues that taxpayers
are forking over to the guaranteed program billions each year that could be
used for grants or other assistance. Shireman calculates that if all of the
loans given between 1995 and 2003 had been direct, then the government
would have saved more than $20 billion, or enough to give an extra $4,000
grant to every low-income student in college today.
The Direct Loan Reward Act, sponsored by representatives Thomas Petri,
Republican of Wisconsin, and George Miller, Democrat of California,
proposes doing just that. The bill would give schools an incentive to use
the direct-loan program by splitting the cost savings. Half of the savings
would be channeled into grants for the participating school's students, the
other half into the U.S. Treasury.
Policy and industry experts alike consider the start of the direct-loan
program a wake-up call for the student loan business, which was lazy and
complacent with its guaranteed returns on investment. Schools stampeded
into the streamlined new system. "We just love the program," said Eileen
O'Leary, director of student aid at Stonehill College, a small liberal-arts
school in Easton, Massachusetts. O'Leary and other financial-aid
administrators volunteer for the National Direct Student Loan Coalition.
About one-third of all student loans are direct, with around 1,100 schools
participating. But private lenders, and Sallie Mae in particular, have been
chipping away at those numbers. Sallie Mae has a sales force of several
hundred reps that make, on average, 1,500 visits to schools each week. Many
of these reps are former financial-aid officers, so they know the ropes.
This marketing onslaught, combined with rising tuition costs and the
schools' desire to provide discretionary loans to students, has contributed
to a recent exodus from the government's direct program.
Not everyone, obviously, is a fan of direct loans. Critics cite a May
report by the General Accounting Office that shows cash outflow for the
direct-loan program exceeding inflow by about $10.7 billion between 1995
and 2003. Congressman Pete Hoekstra, Republican of Michigan, calls the
proposal to reward the direct-loan program "an apparent admission that
Direct Lending can't compete."
But is the playing field truly level between the two programs if loans from
FFELP lenders like Sallie Mae are guaranteed by the government? And if
their profits are subsidized? Some would call this arrangement corporate
"If you really, truly wanted a free-market program, then you'd take away
all of these incentives," said the student association's Talwalker.
Eliminating lender subsidies would take a massive political fight. During
his presidential campaign, Democrat John Kerry proposed that banks wanting
to lend to students participate in a public auction, rather than having
guaranteed interest rates set by Congress at as much as 9.5 percent. Kerry
reckoned that the auction would drive down rates and save money for both
students and taxpayers.
That idea worries Wall Street.
"While it is possible that the U.S. government could reduce the margins
allowed on student loans (as it did in 1993), we believe this risk is
relatively low during a Republican administration," Citigroup analyst
Matthew Vetto, who covers Sallie Mae, told investors in an August research
Even so, there is dissent among the Republican ranks. After all, Thomas
Petri, a veteran GOP congressman from Wisconsin, is a lead supporter of the
Direct Loan Reward Act.
And George W. Bush's budget office included this note in its last
assessment of the loan programs: "Significantly lower Direct Loan subsidy
rates call into question the cost effectiveness of the FFEL program
structure, including the appropriate level of lender subsidies."
The lending lobby has tried to cover its tail with both parties. According
to political contributions compiled by The Chronicle of Higher Education,
sources affiliated with five big student lenders have given more than
$400,000 to members of the House Committee on Education and the Workforce
in the 18-month period ending in July 2004, with 75 percent going to
Since Republicans have a majority on the committee, their bill has taken
center stage. Parts of it actually threaten to make repayment more
difficult for graduates. For example, the College Access & Opportunity Act
suggests that loan consolidations be made at variable rather than fixed
rates. Critics of this measure say that it would force the average student
with $17,000 in debt to pay $5,500 more in interest over the life of his loan.
Bankers argue that further cutting lender subsidies and perks could push
more small players out of the market. Lots of lenders exited the business
when the Clinton administration launched the direct-loan program in 1993.
Bankers warn that lower subsidies and more support for the direct-loan
program could push interest rates up for students.
"No bank in their right mind is going to lend money at this rate to
students," said Matt Snowling, a stock analyst with Friedman, Billings,
Ramsey who has covered Sallie Mae for six years.
Around 5 percent of students default on their school loans, compared with
just over 1 percent of home owners who miss mortgage payments to the point
of foreclosure. Students with little or no credit history are able to get
large loans for school because of the guarantees and provisions in the
Higher Education Act, which itself was a by-product of the civil rights
movement. They're also entitled to flexible payment options, hardship
deferments, and in some cases loan cancellations. The flip side is that
it's virtually impossible to write off student debt through bankruptcy, the
way you can other debt. Uncle Sam can collect until you're old and gray,
seizing your tax refunds and attaching your wages without a court ruling.
He can even go after your Social Security benefits.
With collecting muscle like that, the big lenders have stuck it out in the
market even as their subsidies have been cut and their profit margins
squeezed. Of course, if the government decides to overhaul the system, say
by introducing auctions such as Kerry has proposed, then the middlemen will
end up with little say in the matter. And perhaps students and taxpayers
will get a bigger share of the profits. Otherwise, maybe we should all buy
stock in Sallie Mae.