For decades, the state of California used an obscure student loan middleman to get more than a quarter of a billion dollars in additional federal subsidies. Some students got additional grants, agency executives went home with as much as $400,000 in compensation, and who knows where else money ended up.
But the state got greedy. And acrimonious relationships with the agency prompted California to try and sell its cash cow. Visions of a 10-figure payout and a potential quick fix to some of the state’s budget problems made the move even more attractive.
It turns out, though, that you can’t sell what you don’t own. The U.S. Department of Education squashed the deal (not that anyone was buying it at the anticipated $1 billion price tag). And then told California it was going to shut the agency down anyway, transferring its assets elsewhere.
It’s like something out of Aesop’s tales–the state killed its goose with the golden eggs. But this story has an even darker coda than the original fable–the student borrowers that helped create this lucrative revenue stream are still stuck with an agency whose very financial interests work against them. And their plight will now go to a company that significantly values compensation over student assistance.
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The agency in question is EdFund, a public not-for-profit corporation. It spun off from the California Student Aid Commission (CSAC), a public agency, in 1997. Ed Fund is a guaranty agency, it provides certain services for lenders and borrowers in the Federal Family Education Loan (FFEL) Program. Though Congressional action last spring ended the FFEL Program for new loans, guaranty agencies will continue providing services on existing loans until they are all gone.
Guaranty agencies’ primary function is to manage defaulted student loans. When a loan defaults, the agency uses a pool of federal dollars to pay the lender for the vast majority of the balance owed. It can then either collect on the loan or work with the borrower to rehabilitate it. In both cases the agency charges collection costs upwards of 18.5 percent of the loan’s value and retains another 16 percent or more of what it collects or receives from the sale of a rehabilitation loan.
Guaranty agencies do get a fee equal to 1 percent of a loan to help borrowers avoid default, but this pales in comparison to the earnings from dealing with defaulted loans. Last year, EdFund took in $113.7 million from defaulted loan collections versus $22.8 million for default aversion (PDF). This is pretty typical–over 60 percent of guaranty agency income in the 2008 fiscal year came from collections and rehabilitation. By contrast, just 11 percent of guaranty agencies’ fiscal year 2008 revenue came from default aversion.
Because the revenue from collections, rehabilitation, and other fees is typically greater than the cost of administering loans, guaranty agencies generally make money. And since the federal government pays the bills, this extra income amounts to a hidden federal subsidy. In California, this extra money helped fund the Cal Grant program for students; elsewhere it paid for smaller ticket items like financial aid awareness nights. But it also helped drive high executive salaries. EdFund gave salaries of over $200,000 for eight high-level officials, including its executive director who made over $418,000 in total compensation in 20007.
Just remember, this isn’t a win-win situation. EdFund’s golden eggs–and their benefits for other California students and the agency’s executives–were created off the plight of distressed and defaulted student loan borrowers.
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Despite being a moneymaker, EdFund and its parent agency, CSAC, did not get along. The two argued over mission, national vs. state priorities, business model, board members, etc. By 2008, the fights spilled over into the press (this Inside Higher Ed article has a great summary). Concerns popped up that EdFund violated federal student aid rules against illegal inducements.
Too many fights at what should have been a relatively quiet agency, coupled with budget shortfalls, eventually pushed the state to act. A 2006 legislative audit had recommended a number of options for reforming or getting rid of EdFund and Gov. Arnold Schwarzenegger included a proposal to sell the guaranty agency as a way to bring in additional money in his 2008 budget.
On paper, EdFund looked like a great asset. It held over $80 billion of loan guarantees in the 2009 fiscal year, all fulfilled by the federal government with minimal risk for the agency. The regular fees paid by the federal government on these guarantees, plus the significant income from collection and rehabilitation, all added up to an attractive investment opportunity.
There’s just one catch. The portfolio isn’t the state’s to sell. A large portion of EdFund’s assets are held in a federal fund that is treated as the property of the federal government. And the U.S. Department of Education ruled the state couldn’t decide to just sell EdFund to anyone. Then the Department added a kicker–it would shut EdFund down and transfer the assets to another guaranty agency, taking all the subsidies along with it.
Cue the sniping.
In a strongly worded letter (PDF), the chair of CSAC attacks the state Department of Finance for its actions throughout the attempted sale:
Had the Department of Finance left well enough alone, the State of California could have continued to receive revenue for several years from the Commission’s administration of the student loan guaranty program, which has provided hundreds of millions of dollars in support of Cal Grant awards and provided critical support to the Cal Grant delivery system.
However, it appears that the Department of Finance continued to badger USDE after May 14 for approval of a sale. To make its case, the Department of Finance argued that the relationship between the Commission and its auxiliary organization, EdFund, could not be fixed and that selling the Commission’s guaranty agency designation to another entity was necessary. Further, the Department of Finance apparently prevailed upon the California Secretary of Education to sign a July 7, 2010 letter prepared by Finance containing misrepresentations about Commission actions to protect public funds, while ignoring Finance’s malfeasance that undermined loan program oversight by the Commission and resulted in the waste of public funds.
The Department of Finance, however, misplayed its hand. Rather than authorizing a sale that would benefit California, USDE was instead convinced by Finance that USDE needed to protect federal interests by terminating its agreement with the Commission and transferring the federal guaranty designation to another entity, all without compensation to California.
At the end of the day, the biggest losers in all of this are the students. They will still face the same lousy subsidy structure that provides greater incentive to let loans default than it does to keep them in repayment, but now the state won’t even be able to use some of those proceeds to help other students.
By the end of October, all of EdFund’s loans are going to Minnesota-based Education Credit Management Corp. (ECMC). That agency has stepped in to take over failed guaranty agencies in the past and also often takes over the loan guarantees for students dealing with bankruptcy.
But ECMC’s compensation makes the Ed Fund salaries look like chump change. The executive director/CEO pulled in more than $850,000 in 2008, which is actually a pay cut from the $928,000 he received the year before. The general counsel earned over $500,000 and four others topped $400,000. By far the best deal is the board of directors, who for about 3 hours a week, received anywhere from $59,000 to $83,000.
Even ECMC’s foundational arm is an excuse for more spending on salaries. In 2008, ECMC paid $2.25 million to its foundation. The ECMC Foundation used $584,000 of this to make grants for students and $757,000 for employee compensation. The year before, it spent $963,000 on compensation versus $431,000 on grants.
Even if you add in a few other scholarships and grants paid by ECMC directly, the story doesn’t change–the company spends hundreds of thousands of dollars more on paying its employees than it does on benefiting students. Say what you will about Ed Fund, but at least more of that money went to the Cal Grant program than into people’s pockets.
That’s how California’s greed and the constant bickering between the two agencies turned what should have been a pretty profitable endeavor for the next few years into nothing. California lost its subsidy gravy train. The state needs another source of money to help fund the Cal Grant program. Students could get smaller grant awards, and still must seek help from an agency whose financial interests are not aligned with the best outcomes for borrowers. And somewhere in Minnesota, a bunch of executives seem primed to get much richer.
At least you can eat a dead goose.
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5/11/2012 | U.S. News & World Report highlights ideas from "Moving On Up: How Tuition Tax Breaks Increasingly Favor the Upper-Middle Class." 
5/11/2012 | In Diverse, Steve Burd comments on the Obama administration's plans to address student debt. 
5/11/2012 | Kevin Carey talks to Salon about the government's role in rising student debt.
{ 3 comments }
Thank you for you comments, Ben. I should have been more complimentary of our writing overall. It is nice to see a more fair representation of how things work. Very refreshing.
Your point is well taken, the structure needs improvement. it’s just that there are (and were) many good people who worked hard and believed in what they were doing for the students and for the state. Clearly I have my (rather strong) opinions, but was grateful to read your piece.
Hi Victoria,
Thank you for your comment. One thing that your comment makes me realize I should have done a better job pointing out is that this subsidy structure is set at the federal level, so it is not like these agencies went out and decided to create such an unbalanced situation. (Though some certainly did lobby to get this system in place and preserve it). In addition, CSAC attempted to change these incentives through a voluntary flexible agreement with the Department that allowed them to do default aversion sooner and get paid more based on savings from that work. (You can see it here: http://www.fp.ed.gov/fp/attachments/activities_whatsnew/CAFinalAgreement.pdf) Those are all good things and definitely an improvement over the standard guaranty agency incentive structure.
And it’s worth noting that in that regard, CSAC (along with American Student Assistance and Great Lakes) are among the better guaranty agency actors. Unfortunately, not every guaranty agency may want to take that approach and the incentive structure is designed to make it far more lucrative to collect or rehabilitate, rather than avert default.
If the reporters had actually done their job rather than regurgitating stuff fed to them by special interests, if SOMEONE had actually done a comparison between EF and other similar agencies early on there would have been no story. It would just be another example of CSAC shooting themselves in the foot (a talent that they have finely honed over the years).
I worked near the Default Prevention Department for a while. They were given incentives (gasp) for saving students from going into default and they took their role seriously. Of course EF was taken to task for these ‘gifts’. Perhaps knowing some of those incentives were used to encourage employees to celebrate saving a student from default, maybe THEN they would approve. We’ll never know.
The people I knew in this department were compassionate and celebrated when they were able to work out an arrangement to save a student from default. To even hint that this wasn’t a priority at EF demeans and insults a group of people who put a tremendous amount of effort and compassion into their jobs. Honest reporting would compare EF to similar agencies, where they would fare quite well.
Was EF perfect? Nope, but they’ve done a lot of things right, including preventing CSAC from destroying a very successful nonprofit that was able to do a job that they couldn’t.
A little even handed reporting word be a refreshing change. This is progress, though.
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