Banks May Have to Compete for Student Loan Subsidies (Update2)

By Paul Basken

Feb. 15 (Bloomberg) -- Banks that provide college loans with U.S. subsidies would have to compete for the payments, possibly saving the federal government as much as $7 billion a year, under legislation being drafted by Senator Edward Kennedy.

Kennedy, a Massachusetts Democrat and chairman of the Senate Education Committee, plans to file the measure this week, spokeswoman Melissa Wagoner said. One ``rough'' estimate projects savings of $4 billion to $7 billion a year over the current system, in which Congress sets the reimbursement for handling the loans, Wagoner said.

The legislation is the latest proposal to cut the profits that lenders such as SLM Corp., known as Sallie Mae, reap from government-subsidized student loans. Banks make about $18 billion by helping the government supply about $90 billion a year in tuition financing, federal education officials have said.

``Clumsy government price controls can have unintended consequences,'' said Thomas Kane, a professor at Harvard University in Cambridge, Massachusetts, who is studying the system for the nonprofit Brookings Institution. ``Any of the market-based approaches are likely to generate savings for federal taxpayers and for students over the current program.''

Banks that handle the subsidized student loans are opposing a bidding system.

Quality of Service

``The auction concept was considered and rejected in a previous Congress, because it is not student-friendly and most likely will result in higher-cost loans and poorer quality service for students,'' said John Dean, special counsel to the Consumer Bankers Association in Washington. The group represents lenders including Citigroup Inc., Bank of America Corp. and Wells Fargo & Co.

Shares of Charlotte, North Carolina-based Bank of America slipped 20 cents to $53.85 at 4:02 p.m. in New York Stock Exchange composite trading. New York-based Citigroup gained 3 cents to $54.21, while its subsidiary, Stamford, Connecticut- based Student Loan Corp., rose $7.41, or 4 percent, to $192. Shares of San Francisco-based Wells Fargo were unchanged at $36.01.

Forcing lenders to compete for the subsidies also might create inequities among the schools if banks focus their bidding on the portfolio of a school such as Harvard while ignoring less- wealthy schools, Sallie Mae spokesman Tom Joyce said. Shares of Reston, Virginia-based Sallie Mae rose 39 cents to $43.

Affordability

The Bush administration has said the current system for government-backed loans leaves too many students unable to afford college. President George W. Bush this month proposed deepening cuts in federal payments to lenders for student loans in fiscal 2008. The savings would be used to help fund his proposed increase in Pell Grants, the main government grant program for low-income college students.

Education officials said they didn't have a position on Kennedy's proposal.

``The administration is in favor of efforts to increase access, affordability,'' said Katherine McLane, spokeswoman for U.S. Education Secretary Margaret Spellings. ``But until there's something to look at, we wouldn't be able to say one way or the other.''

`Industry-Transforming'

The idea would be ``totally industry-transforming,'' analyst Charles Gabriel of Prudential Equity Group Inc. said in a Feb. 7 conference call with investors.

``Sallie Mae and other large lenders might be expected to survive, if not dominate, such a regime,'' Gabriel said. ``But the uncertainty accompanying any serious debate of it would be potentially roiling.''

The banking industry should consider negotiating the terms of such an arrangement now, rather than risk having it imposed after 2008, when Democrats might control Congress and the White House, Gabriel said.

The idea didn't have enough political support previously, in part because the government was running budget surpluses, said Michael Dannenberg, a former Kennedy aide who is now director of education policy at the New America Foundation, a nonpartisan public policy group based in Washington.

That's changed because of ``a confluence of circumstances,'' including the growth of federal budget deficits, the Democratic takeover of Congress and Bush's own willingness to challenge lender subsidies, Dannenberg said.

To contact the reporter on this story: Paul Basken in Washington at pbasken@bloomberg.net

Last Updated: February 15, 2007 16:17 EST

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