New York Attorney General Andrew Cuomo described higher education institutions as relying solely on perks to determine lenders on their preferred lender lists at a hearing on "Paying for College: The Role of Private Student Lending" held by the Senate Committee on Banking, Housing and Urban Affairs on Wednesday.

The hearing consisted of two panels, with Cuomo testifying by himself in the first panel and six others representing various parties in the student loan market testifying in a second panel. During his testimony, Cuomo described unethical practices by lenders in the private loan sector as "rampant," indicating that he felt the instances of unethical practices he uncovered were the standard and that lenders could not get on a preferred lender list without offering perks to an institution.

"Unfortunately, we have found that lenders have often corrupted these preferred lender lists by paying schools to put them on the lists, even if they are not the best for students," Cuomo said in his opening remarks. "The best interests of the lender and the institution, rather than the interests of the student, all too often have become paramount."

However, representatives of Bank of America and Sallie Mae, two of the largest student loan providers, testified in the second panel that their companies did not participate in the types of practices highlighted by Cuomo's investigation.

"Sallie Mae did not participate in any of the most egregious activities that have been described in recent media reports, such as revenue sharing between lenders and schools on private loans, offering stock to financial aid administrators or providing cash payments to schools as a quid pro quo for specific loan volume," noted Barry Goulding, senior vice president of Sallie Mae, in his opening testimony.

Similarly, Tracy Grooms, senior vice president of Bank of America, assured committee members in her opening testimony that the company had never provided lavish trips or gifts to financial aid officers, used "advisory boards" of school representatives, given stock to financial aid officers, or provided staff to operate call centers on behalf of schools or provided computer hardware or software to schools.

Goulding's description of the criteria financial aid offices use to create preferred lender lists also varied greatly from Cuomo's description.

"Financial aid offices frequently select their preferred lenders through a competitive Request for Proposal (RFP) process," Goulding noted. "The result of preferred lender lists is, therefore, that lenders are competing to offer the best terms and services to students and schools but students in the FFEL program are free to choose whichever lender they want to do business with."

Cuomo did praise institutions and lenders for their willingness to adopt codes of conduct to eliminate any questionable practices and urged the federal government to take the lead and provide guidance for the industry to follow.

Investigating Student Loan Underwriting

During his testimony, Cuomo indicated that his office has begun an investigation into the underwriting criteria student loan companies use when deciding loan eligibility and terms.

Cuomo and Senate Banking, Housing and Urban Affairs Committee Chairman Sen. Christopher Dodd (D-CT) expressed concern that companies may consider the university a student attends and a student or cosigner's credit score and income to determine loan eligibility and terms.

Low-income student borrowers are more likely to pay higher rates or not qualify for loans because they have little or no credit history, poor credit scores, and no parental co-signers or parents in a similar economic and credit situations.

Cuomo indicated that he is looking into the civil rights ramifications of this system.

"In some regards, this model runs counter to the longstanding federal purpose of student aid - targeting low-cost financial assistance to students with the greatest needs and those from the humblest of backgrounds," Dodd said in his opening statement.

Dodd asked Goulding why Sallie Mae used the institution a student attends as an underwriting criteria.

Goulding responded that the institution a student attends is one criteria the company considers because there is a high correlation between academic progression and a borrower's ability to repay. He noted that the institution a student attends would never make him ineligible for a loan and that credit score was the primary criteria, but the institution factor could affect loan rates by 50 to 100 basis points.

Dodd questioned the fairness of this practice and asked why a student should be disadvantaged because of the school they attend.

A Federal Solution

Like in his testimony before the House Education and Labor Committee, Cuomo offered harsh criticism of the lack of federal oversight for the private student loan program and urged Congressional action to protect students and ensure ethical practices among lenders and institutions.

"Private loans have been growing at break-neck speed and regulation and oversight of these loans has been lacking," Cuomo said. "The federal banking regulators, for example, have failed to aggressively protect student lenders. Additionally, despite being aware of the problems, the Department of Education has neither sought authority to stem abuses in the private loan market nor has the Department of Education referred the matter to the banking regulators."

Cuomo criticized the Education Department's proposed rules, describing them as too little, too late. He argued that the draft regulations were still inadequate because they allowed perks to be dangled before financial aid administrators, they did not make it clear that only student interests could be considered when constructing a preferred lender list and they did not apply to private loans.

He expressed support for the Student Loan Sunshine Act (H.R. 908) which was overwhelmingly passed by the House.

Cuomo urged the committee "to enact stringent legislation to clean-up all of the student loan industry, including the burgeoning private loan market" in his opening statement, but then repeatedly told lawmakers that current laws and regulations were sufficient, federal banking regulators simply needed to act.

He told Congress that it should provide more clarity and direction on how regulations apply to student loans and used revenue sharing as an example. "I believe that revenue sharing is illegal in the private loan program, but there is some lack of clarity," he said.

Disclosure and Transparency

Grooms and Goulding highlighted Bank of America and Sallie Mae's efforts to be transparent and disclose information to borrowers and their families, but Cuomo, lawmakers and others testifying stressed the need for more disclosure and transparency in the private loan sector.

Cuomo and Luke Swarthout, the higher education associate at U.S. PIRG, argued that it was nearly impossible for students and parents to compare rates on private student loans because consumers don't get the actual rate until they are about to sign the MPN. Cuomo argued that this made the preferred lender list valuable to consumers, but only if it is created to solely benefit the borrowers.

Peter Tarr, General Counsel, First Marblehead Corporation testified that the fact that the industry was new caused the complexity in comparing loan products. He said that Web sites are already being created to compare private student loans and as the industry matures it will be easier for consumers to compare products.

Swarthout also testified that more needs to be done to ensure that students used all the federal aid they are eligible for before turning to private loans.

Grooms and Goulding said that their companies work hard to inform students they should exhaust federal aid before borrowing private loans, but Swarthout argued that more needs to be done because there are still many students who took out private loans before exhausting federal aid.

"A significant number of borrowers took private loans when they had additional capacity to borrow more affordable federal loans," Swarthout said. "At best this trend suggests confusion on the part of borrowers; at worst, it is a symptom of misinformation and manipulation by lenders advertising their private loan products."

Jennifer Pae, President, United States Student Association testified that students are inundated with information and marketing materials making it difficult for them to discern the correct information.

To help protect borrowers from unmanageable debt, Pae suggested:

• Clearly labeling private student loans as different from federal loans
• Making it easier to compare private student loans
• Protecting borrowers from being harmed by conflicts of interest or fraud
• Requiring private lenders to disclose, in plain English the rates, terms, and conditions of private loans when the student or parent receives approval

Bankruptcy Law

Pae and Swarthout also advocated lawmakers to repeal the law that makes it nearly impossible for students to discharge student loan debt in bankruptcy.

"Student loans, both private and federal, are currently treated more harshly than almost all other forms of debt in bankruptcy," Swarthout said. "People who borrow to pay for college, and are subject to the high costs and harsh terms of private student loans, deserve fair treatment, especially given the societal value of higher education."

Dodd agreed with Swarthout and asked representatives of the lending community if they agreed with the bankruptcy law.

Tarr argued that the law was appropriate and that changing the law would have a negative impact on private student loans by limiting the amount of private loans available to cover the widening gap between student aid and the cost of tuition.

The Growing Gap

Everyone at the hearing agreed that the lack of federal funding for student aid in recent years has caused the explosion in private loans and all the problems that followed as a result.

"The federal government's commitment to student financial aid has waned in relation to the rising cost of a college diploma," Dodd said. "Federal aid in the form of grants and federal loans has failed miserably to keep up with rising costs."

Dodd expressed optimism that Congress would increase student aid, but admitted that it was unlikely to eliminate the growing gap between the cost of college and federal aid. He said there would continue to be a need for private loans and the question was how the program would be run and regulated.

Dodd said that if the private loan system was the Wild West, then he wanted an aggressive cop watching it.

"We have an obligation in this Committee to ensure that this market is functioning effectively and efficiently - for lenders and borrowers alike," he said. "We must act - including legislatively if need be - to ensure that young people of this country have an opportunity to rise as high as their talents will take them."

Additional Media Coverage

Taming the Student Loan 'Wild West' (Inside Higher Ed)

Cuomo Takes Aim at Federal Regulators and Education Department in Senate Hearing on Student-Loan Scandal (The Chronicle of Higher Education) A paid subscription may be required

Cuomo Plans to Broaden Student-Lending Inquiry (The New York Times)

Student-Loan Probe Expands Into Possible Discriminatory Practices (The Wall Street Journal)

Cuomo urges stronger student loan oversight (USA Today)

Congress should reform student loans: Cuomo (MarketWatch)

By Haley Chitty
NASFAA Assistant Director for Communications

Posted 06/07/07 to www.NASFAA.org. Redistribution to non-NASFAA institutions is prohibited. Please submit Web Site questions or comments to Web@NASFAA.org.