9.5 Scandal Makes its Way to Sallie Mae

While cost and increased aid for low-income students have rightfully dominated the discussion of the proposal to end subsidies for private lenders making federal student loans, it's worth remembering that terminating the bank-based system would also help return integrity to a system with an ever-growing history of scandal and abuse.

Case in point, an audit report released Monday by the U.S. Department of Education's Office of the Inspector General (PDF), which found that a subsidiary of Sallie Mae -- the country's largest student loan company -- had improperly billed the federal government for an estimated $22.3 million in unwarranted subsidies.

This finding makes Sallie Mae the latest in an increasingly long line of lenders to get caught overbilling the government for student loan subsidies under the "9.5 percent student loan scandal."

The 9.5 percent scandal arose because lenders were taking advantage of an old subsidy rate from the 1980s that allowed them to receive a guaranteed 9.5 percent return on student loans financed by a tax-exempt bond -- a rate significantly higher than what they earn on loans now. Congressional action in 1993 should have prevented the growth of loans receiving this high subsidy rate, but several companies exploited loopholes to substantially increase the number of loans receiving this subsidy rate. Doing so allowed lenders to improperly bill the U.S. Department of Education for at least hundreds of millions of dollars in unnecessarily high subsidies until former Education Secretary Margaret Spellings put a stop this abuse in 2007.

(The complete story about the 9.5 scandal, including how the Department of Education granted amnesty to the worst offenders is too long to explain here, but for further reading check out this 2004 report and this blog post series.)

In many respects, the new audit's findings against Sallie Mae are not as bad as what similar audits turned up with regards to Nelnet (PDF) and the Pennsylvania Higher Education Assistance Agency (PDF). Unlike those two agencies, Sallie Mae and its affiliate did not exploit loopholes that allowed them to improperly increase the amount of loans eligible for the 9.5 subsidy. The audit did, however, find that Sallie Mae continued billing the government for 9.5 subsidies longer than it should have, allowing it to accumulate $22.3 million in unwarranted payments. Not surprisingly, the lender strongly denies this conclusion, claiming that the inspector general's calculations of 9.5 percent eligibility were flawed.

This is the fifth inspector general audit released released this federal fiscal year that is critical of the bank-based system. It's highly likely that it will not be the last. That's because history has shown that the lenders in the current system have repeatedly found ways to find loopholes or engage in illicit practices that undermine the integrity of the bank-based loan program. Each successful attempt to game the system results in yet another unnecessary instance of waste on the part of taxpayers or students. A transition to 100 percent government lending would certainly not eliminate all corruption in the system. But at least it would be a step toward eliminating the financial incentives and opportunities for abuse that have repeatedly jeopardized the federal student loan program. It might also make life a little less busy for the inspector general.

UPDATE: Higher Ed Watch weighs in with more detail on Sallie Mae's past claims about 9.5.