Serial No. 105-79


Printed for the use of the Committee on Education

and the Workforce

Hearing on Issues in the Student Loan Programs Relating to the Scheduled

July 1, 1998 Interest Rate Changes





























Table of Indexes *


Thursday, March 5, 1998

Committee on Education and the Workforce

Subcommittee on Postsecondary Education, Training and Life-Long Learning

U.S. House of Representatives

Washington, D.C.


The subcommittee met, pursuant to call, at 11:00 a.m., in room 2175 of the Rayburn House Office Building, the Hon. Howard P. McKeon, [chairman of the subcommittee] presiding.

Present: Representatives McKeon, Goodling, Petri, Barrett, Graham, Upton, Deal, Peterson, Kildee, Andrews, Roemer, Woolsey, Fattah, McCarthy, Tierney, Kind, and Ford.

Staff Present: Jeff Andrade, Professional Staff; Sally Stroup, Professional Staff; George Conant, Professional Staff; Pam Davidson, Legislative Assistant; David Evans, Minority Professional Staff.




Chairman McKeon. Good morning. Today, we are here to examine the potential effects of the student loan interest rate change that is scheduled to go into effect on July 1st, 1998.

This subcommittee has worked long and hard over the last year, considering ways to improve the Higher Education Act. We have been guided by a common purpose. To see to it that every American has the opportunity to receive a quality education, at an affordable price.

I am proud to say that in our bipartisan reauthorization we have made significant progress in approving programs, and expanding opportunities, throughout the Higher Education Act. We cannot allow the dark cloud of doubt and uncertainty currently looming over the student loan programs to diminish these gains.

The Federal Family Education Loan (FFEL) program has been a solid, dependable source of higher education funding for students and their families for more than 30 years, providing $225 billion to students from every walk of life.

During all this time, the program has always been there when people needed it.

The Education Department estimates that over $40 billion in student loans will be lent during the upcoming year. Over two thirds of student loans are made by private lenders under the FFEL program. The FFEL program serves as the bedrock of our system financial assistance, providing about half of all federal student aide to students. That's three times more aid than Pell Grants, and four times more than the amount of the HOPE scholarship tax credit.

The challenge that is currently before us is to ensure that student loans continue to remain available to a broad spectrum of students and their families, for financing higher education. At the same time, we must also ensure that the interest rates that students and parents pay on their loans are low enough to keep their payments affordable.

These interest rate changes were enacted back in the Student Loan Reform Amendments of 1993, when the prevailing short-term and long-term interest rates were dramatically different than they are today.

Because of this, I believe that we need to re-examine this interest rate issue in the context of today's economic reality. I also believe that we need to change the tenor of the debate and public disclosure on this issue within the community.

Let's not get caught up in the disagreements, but instead, focus on the broad, mutual interest. We need to be coming up with creative solutions, not entrenched positions. I expect everyone to be working together to solve this problem. Borrowers and lenders, Republicans and Democrats, House and Senate, Executive and Legislative branches.

While I am disappointed that Secretary Riley and Secretary Rubin could not be with us today, I would like to let them know that we are glad to see that they have finally come forward, to admit that this scheduled interest rate change actually is a problem, and have said that they are willing to work with us on a solution.

While some may be tempted to play politics with this issue, we simply cannot allow that to happen. The stakes are too high, the consequences too alarming, and the purpose too important.

We are pleased to have three distinguished panels of witnesses today, representing a wide variety of viewpoints on this matter. This provides us with a tremendous opportunity to help sort through all the issues, and meet the challenges before us. We look forward to their testimony.

See Appendix A for the written statement of the Honorable Howard P. "Buck" McKeon


Chairman. McKeon. I would now like to turn the time to the distinguished ranking member of the subcommittee, Mr. Kildee.




Mr. Kildee. Thank you, Mr. Chairman. Again, as I said at yesterday's mark-up, I congratulate you for holding this hearing. I am very hopeful that this will be a very fruitful exchange of views of where we should set interest rates, and the subsidy we should pay lenders to participate in the student loan program.


Mr. Chairman, in the 105th Congress, I can't think of a more important hearing on higher education than the one we're having today. We in Congress face a very difficult decision. We must try to make sure that adequate student loan capital is available at very reasonable rates to students who need these loans to help pay for a college education.

I frankly do not believe that any of us know with complete certainty what that rate should be. I don't think you'll find any rigidity up here on either side of the aisle, because we don't really know what they should be.

We do know, however, that we face a July 1st deadline, and that we need to have charted a course of action before that date. The Treasury Department has given us a range of options to consider. And the Administration has made a very specific proposal.

In addition to responding to either the Treasury report, or the Administration's proposal, I would hope that our witnesses, from the education, student, and lending community would put solid proposals on the table, so that we could give them very careful consideration as we try to reach a decision in this area.

And again, Mr. Chairman, I thank you for having this hearing. Thank you very much.


Chairman McKeon. Our first panel is made up of our colleagues. I am pleased to welcome two of my Democratic colleagues, Mr. Kanjorski of Pennsylvania, and Mr. Gordon of Tennessee.

Mr. Kanjorski is a longtime member of the Banking and Financial Services Committee, and recently introduced H.R. 3291, the Student Loan Preservation Act, a bill to repeal the scheduled interest rate change.


Mr. Gordon, who is an original co-sponsor of H.R. 3291, has also been instrumental in working with Mr. Kildee and me, to address this issue, and to try to forge a consensus within the higher education community on a solution.

I would like to welcome our colleagues, and we look forward to hearing their testimony today. We'll hear first from Mr. Kanjorski. The red light doesn't mean your time is up.





Mr. Kanjorski. Thank you very much. Mr. Chairman, ranking members of the Committee. I thank you for the opportunity to testify on this technical, but vitally important issue.

I'll try to summarize my testimony as quickly as possible. But hopefully, with some of the feeling I have, and some suggestions that I think we can work to find a solution.

Your Committee was wise in deciding in 1993 to allow the Guaranteed Loan Program, and the Direct Loan Program, to co-exist. I think that competition and challenge is always good.

Little thought was given, however, in 1993, to all the consequences of changing the interest rate index in the Guaranteed Student Loan Program. On February 9th, I and eight of my colleagues on the Banking Committee wrote to the leadership of your Committee, to explain why the switch from the index based on a long-term to an index based on a short-term rate, does not make sense.

I will not recapitulate all the arguments here, except to say the lessons the Banking Committee learned as a result of the experiences of the 1970's and 1980's is that it was dangerous to have a mis-match between the interest rate, and the maturity of loans, and the interest rate and the maturity of funding sources used to finance those loans. It's known as the S and L design.

The Treasury report last week, The Financial Viability of the Government Guaranteed Student Loan Program, comes to a similar conclusion, I believe. On February 12th, I sent a letter to Federal Reserve Chairman Alan Greenspan, asking for his analysis of the issue.

Chairman Greenspan's response, which I received yesterday, and am releasing today, also suggests that the index based on the short-term rate is preferable.

Let me read just two short portions of Chairman Greenspan's letter, in the Federal Reserve report. Quote, ``One significant concern is that, by changing the rate on student loans to a long-term that is reset annually, the new formula would make the expected profitability of student loans more sensitive to the interest rate environment.''

``As a result,'' and I emphasize, ``the supply of student loans could be curtailed in periods when their expected profitability is low.''

Chairman Greenspan adds, ``It is difficult to know how large a spread is required to ensure that lenders provide sufficient credit but do not earn higher than necessary profits.'' And I think that's our dilemma.

The Federal Reserve detailed analysis explained that using the index based on long-term rates, quote, ``Creates a problem for banks, because none of their standard liabilities pay a similar rate.''

``Instead, banks will likely fund loans with liability having costs that are more closely correlated with short-term interest rates. Thus, the new formula will impose somewhat greater interest rate risk on banks making student loans, and require them to pay the cost of hedging those risks.''

``This increased sensitivity, coupled with the narrower average spread on student loans, raises the possibility that the introduction of the new rate formula could cause the supply of student loans to be curtailed in periods when the yield curve is relatively flat, or downward sloping.''

That is why, last week, I introduced H.R. 3291, the Student Loan Preservation Act. It keeps the guaranteed loan program tied to the short-term interest rate index that has worked so successfully for the last two decades.

Five Democrats, and seven Republicans are co-sponsors, and they represent all parts of the country, and all political philosophies in the House. My colleague Bart Gordon has co-sponsored. Doug Bereuter, Steven LaTourette, Vic Fazio, Jack Metcalf, Richard Baker, Tom Davis, Vince Snowbarger, Allen Boyd, Tom Sawyer, and George Nethercutt.

So, you can see that we do have a bipartisan interest in the House to see if we can't come to grips with this, without risking the viability of the student loan program.

After the Treasury Department issued its report last week, the administration also suggested that while we could retain the short-term interest rate index, that it was also possible to reduce the size of the ``spread'' or margin lenders are allowed to charge above the index.

The administration described its proposal as a, quote, ``Ten percent reduction in the interest rate on student loans, from an average of 7.8 percent to seven percent.''

While I have the utmost respect for the administration's good faith efforts to reduce the costs of student loans, it is disingenuous to describe this proposal as only a ten percent cut, because lenders' costs of funds is higher than the base index.

The administration's own position paper documents that this is really a reduction in the spread of 80 basis points, from 3.1 percent to 2.3 percent, when the student is not in school, and from 2.5 percent to 1.7 percent when the student is still in school.

To the lenders, this is a real cut of 26 percent when the student is not in school, and 32 percent when the student is still in school. Thus, it would be fairer to refer to the administration's proposal as a one-quarter to one-third cut in the margin.

And this does not take into account either lenders' administrative processing and collection costs, or the fact that the average cost of funds is higher than the Treasury's.

Now, reasonable people can disagree over the level of margin that is appropriate, but it is important to fully appreciate the magnitude of the proposed cut. It is equally important that we reach a reasonable accommodation on the margin that should be allowed over that index.

As a parent of a daughter who has just recently graduated from an expensive school, and is now in graduate school, I understand how expensive a college education is, and the financial pressures that are put on the family. Our natural inclination is to try and keep the cost to students as low as possible. And that's commendable.

But, we could reduce the lenders' margin to zero. We'd be heroes. That would result in a great interest rate reduction for students. But there wouldn't be any lender who would be willing to make such a loan.

Great rates are of little use to students if they are not available to make loans in the real world. As a member of the Banking Committee, I can tell you that we faced the same dilemma for many years in the FHA and VA home loan programs. The HUD Secretary used to set the FHA rate, and he constantly criticized for adjusting the rate too much, or too little, or too fast, or too slow.

We eventually concluded that the markets were better at setting interest rates than either elected and appointed officials, and we allowed the interest rates of FHA and VA loans to float, and be set by the marketplace.

That decision was made on a bipartisan basis, and I do not believe that any member of our committee has regretted it.

One of the strengths of the guaranteed student loan program has been, it has provided funding to students all across our country, in good economic times, and in bad, in periods of high interest rate, and low, and regardless of whether they attended expensive schools, or relatively inexpensive public schools.

We should not jeopardize that success by trying to squeeze the margin so tight that lenders drop out of the program, or start cherry picking by lending only to students from high income families, attending high cost schools.

Mr. Chairman, there are many things that we cannot be certain about, as we consider this issue. We cannot be certain, for example, how large a margin is necessary to induce participation in the program.

Federal Reserve Chairman Greenspan has told us, quote, ``It is difficult to know how large a spread is require to ensure that lenders provide sufficient credit.''

What we do know, however, is that the consequences of being wrong could be devastating to millions of students, and their families. We also know that the current formula is working. Students all across our nation continue to have access to guaranteed student loans.

Consequently, we should not rush to fix a formula that is not broken. That is why I introduced H.R. 3291, with a bipartisan coalition of cosponsors. It will retain the existing formula, while we review the consequences of changing it more carefully.

If Federal Reserve Board Chairman Greenspan is not certain how large a spread is necessary, are we confident that we really have better information than he does?

Mr. Chairman, I look forward to working with you, in finding a compromise acceptable to all parties. We should also be working with the lenders to find ways to reduce the administrative costs and default rates to our student loan programs.

We can find a win-win solution, and resolution of this problem, that represents a reasonable accommodation of all interested parties.

Let us resolve here today to find the bipartisan middle ground agreement, that can quickly be passed by Congress, and signed into law by the President, so the we can ensure that our nation's students and their families are having an uninterrupted flow of student loans. Thank you very much.

See Appendix B for the letter to Federal Reserve Chairman Alan Greenspan from Representative Kanjorski

See Appendix C for the response letter from Federal Reserve Chairman Alan Greenspan

See Appendix D for the written statement of the Honorable Paul E. Kanjorski


Chairman McKeon. Thank you very much.


Mr. Gordon?





Mr. Gordon. Thank you, Chairman McKeon, and Mr. Goodling. Also, ranking member Kildee, and all of the other members here today.

You know there's one thing that we have in common. All of us have spent a lot of time over the last few years trying to make student loans more affordable and accessible to students. Harold (Ford), a little less time than the rest of us, but you'll be putting a lot more time in, I know, as you've been here longer.

It's something that's very important. Although we may take different approaches, we all want to get to the same place. And Mr. Chairman, what I'd like to do is make my more formal remarks a part of the record, and try to summarize a couple of issues that I think are being missed out in all this discussion.

There's a lot of talk about numbers, and spreads, and basic points, and lots of other numbers. But I think we're missing the real point.

This debate goes back to the same discussion and debate that we had in 1992 and 1993. It really boils down to direct lending.

In 1993, when the interest rates we are talking about now were put into the Act, it was not put in there by some far-sighted individual who knew this would save students money in years to come.

As a practical matter, at that time, I think students would probably have been paying more under this. And over the last ten years, some years they would pay more, some years they would pay less.

So, this was no certainty, this was no great vision. Fortunately, it appears now we are in a point of a different economy. And that it would save students some money. But it was not because it was intended to. It was because at that time there was an expectation that we would be in a 100 percent direct lending. And it would be easier for the Department of Education to use this number.

That was the reason. Don't think it was anything other than that. Many of you were part of that debate, and you know that is the case.

Today, we are back to the same question. And that is, should there be a 100 percent direct lending program? I'm one that doesn't think that is the case. It would add billions of dollars of additional federal debt. It would mean hundreds of additional federal employees within the Department of Education, at a time when they are trying to reduce.

Taking the Department’s interest off of other very important issues. So, I think there's a variety of reasons that we don't want to do this.

But again, these are honorable people making honorable choices here. But make no mistake about it that is what this debate is about.

Now, the Department may tell you that that's not really the case, or that they don't, think they can make this work out.

Let me share with you, and I’d like to make this part of the record, a letter that Joe McCormick sent out recently from the Department to the various schools. I think it shows you just what they think the outcome is going to be -- direct lending.

The letter concludes by saying, ``The Department is confident that the direct lending program will greatly benefit your institution, and your borrowers. One important benefit is the assured access to loan capital. Given the pending change in interest rate calculations, your participation in direct lending would ensure an uninterrupted flow of loan funds to your students." They know that this change will force the private lender to pull out of the student loan program, and that the Department of Education will be the sole lender of education financial aid.

This concerns me not only because billions of dollars of additional debt will go to our taxpayers, but also because it's well documented the mess that direct lending is in right now. To dump all of these additional students into the direct lending program could very well mean its collapse.

So next fall, when your constituents and my constituents are going to school, they could very well be knocked out of having any kind of loan, because it was just too much for the Department to assume at one time.

I think that is one aspect of the debate that we need to keep in mind. The other thing I think we need to keep in mind, the broad view, is that it seems that what is happening now is, an effort to find this magic number.

What is the lowest possible number that we might get one or two banks to make these loans? And there's not a discussion about, what about servicing the loans? What about collecting it on the back end? Again, a little bit of history, back in 1992 and 1993, many of us spent a great deal of time trying to make a better student loan program.

You know, back in 1982, we had a $3 billion student loan program, and a ten- percent default rate. In 1992, we had about a $10 billion student loan program, and almost a 50 percent default rate.

Now, there were a variety of reasons. Poor management, proprietary schools were getting into the program, not with an interest in educating students, but with trying to get the federal dollars.

All of this was bleeding the taxpayers, and it was taking loans away from students. With most of your help, we were able to put together a program that reduced those interest rates the banks were charging.

Made them be more accountable, made the schools be more accountable. We kicked schools out that were irresponsible, and had high default rates. They weren't educating students, and helping them to get good jobs.

We are now saving the taxpayers over $2 billion, because of those reforms, as well as making loans much more accessible to students. That was important. But that was also because we were looking at the full picture. Making the loans, servicing the loans, collecting the loans.

If you focused only on what is that lowest possible number that one, or two banks might lend, for how long I'm not sure, you're going to lose out on the big ticket. And that is, making the loans, servicing the loans, and collecting the loans.

If you think it's important, as all of you I know do, that loans be made available for students, so that they can, as I was able to enhance my life by being able to get a better education. I'm of the opinion that you're going to have to have a loan program that is a dual program, now.

I'm not here to say that we should do away with the direct loan program. I think the direct loan program has found a role. I think it's time to have détente. To say that we have a dual program, that each one of them try to work to make the other better.

But if you take it to the margin, you take it to the edge, then next fall, when students in your home town start to go to school, and the program has collapsed, there's going to be blood on the hands of people who brought that about.

That's not what you want, I'm sure. But I hope, in your good faith and in your good wisdom, you are going to find that point. We are going to have one or two lenders that might be in the program for a while. We are going to have a program that is going to be sound, and that is going to work from today through collection.

A program that benefit’s the American taxpayer. That is in the benefit of students. I know with the work you have put into it, with the thought that's been put into this, that you're going to have a good conclusion.

I thank you for letting me testify here today, and join you in this discussion.

See Appendix E for the written statement of the Honorable Bart Gordon


Chairman McKeon. I thank you both. I appreciate your opening comments. As you see, we are in a vote. I think what we'll do is take a ten minute recess, or five. As quickly as we can get over to the Floor and vote, and come back. Then, we'll begin with questioning. Thank you very much.



Chairman McKeon. We will reconvene our hearing now. We will begin with the questions of the first panel. Mr. Kanjorski said that he had to go to another mark-up. So, I don't know if he'll be back with us or not. But Mr. Gordon is here.

I appreciated both of your comments. I think you really laid out the problem in a very concise, understandable manner. I appreciate your comments.

I've been really struggling with this problem now for several months. And it's difficult because as you stated in your comments, how much can we drive the bank profits down, and still maintain a viable program. Rather than just try to drive it down to one or two banks remaining, or drive them out totally, leaving only the direct lending program.

I've told this story before. I come from a retail background. My Dad had a little western wear business, and I started it with him about 30 years ago. I remember we had a customer come in one day that wanted to buy a pair of Levi's. We were selling them for $6.98.

A lady came in, and said, how come you're selling these for $6.98? I can buy them down the street for $6.50. And he said, well, why didn't you?


She said, they were out of my size.

He says, well, the sizes I'm out of I'll sell for $5.00.


It seems to me, what the danger that we may run into is, I think you or Mr. Kanjorski, I forget which one, made the comment that we could make the loans for no percent. In fact, we could probably give away free loans, but then the loans wouldn't be there.

I think we all have the same goal in mind, saving a program to help students. That should be, our only goal is providing financial means that students can go to school, and get an education, and come back, and use that education to benefit all of us, so that the country can continue to move forward.

I think that's our only goal. We all want to find out how we can accomplish that. Mr. Gordon, you've been working in this program for a long time. Do you believe that the direct loan program could handle even one half of the additional loan volume if the FFEL lenders exited the program?


Mr. Gordon. No, sir. I don't. I really don't know anyone that really thinks that is the case. I mean, it would be a situation with the dog catching the car. I'm afraid that they wouldn't know what to do. It's just too much.

And by the same token, I'm not sure that maybe this time, that maybe the private sector could have the whole direct lending program dumped on them all in one year to two. It would be too much of a strain either way.


Chairman McKeon. The first meeting that Mr. Kildee and I held in January of 1997, we had agreed that we were going to work together, this being this higher education re-authorization, being the biggest opportunity we would have in this Congress to work together. And we had a, we felt, a big responsibility.

In that first meeting, we agreed that while I had been an opponent of direct loans, and he had been a supporter, that neither of us had the votes to kill the other program.

We agreed at that meeting that we would spend this two years, this Congress, trying to do all we could to make things better for students, to just kind of level the playing field, to not do things to hurt one program or the other, but rather to make both programs better.

So that, ultimately, the students benefit.

I think we have remained true to that, in what we have tried to do. Unfortunately, that has not been the case with everybody. We are still working to that end. I see my time is up. I'll turn it over to Mr. Kildee.

Mr. Gordon. If I could just make a quick response. I admire that. I think it is a true effort. And that's where we need to be. There needs to be a détente between those folks, who are spending a lot of energy trying to do away with the directing lending program, and those people that are spending a lot of time and energy that are trying to have a 100 percent program.

It's really a power game. It's not a pro-student game. We need to get back to what's good for students. I think now that we have a dual program, that they're making each other try to do a better job. In the last four or five years, there's been all kinds of additional incentives that are pro-student.

We're at a good point. Let's keep this going. Let's keep the focus on the students, and not try to make one program or the other the complete program.


Chairman McKeon. Thank you. Mr. Kildee?


Mr. Kildee. Thank you, Mr. Chairman. To either one of you, in your bill, you propose to keep the 91-day index. What do you propose for the in-school interest rate, and the interest rate in repayment above the 91 day?


Mr. Kanjorski. Well, it would sit as it exists today, I think 3.1 and 2.7.


Mr. Kildee. 2.5.


Mr. Kanjorski. But may I say that if we were to pass that bill, and preserve the present system, then we really should look at a long-term analysis, and getting everybody involved. And are important people to get involved. The youth, obviously, the students. The money market people, the lenders and the buyers, of the secondary market, what appeals to them.

And then, look at the existing programs.

Unfortunately, I think that what has happened here is we're keeping our eye strictly on the rate. And politically, it's very attractive to say we're reducing student loan rates.

But if we do it, with the way the formula is set up today, you won't have student loans. And I think Bart made a great point. This is going to be blood all over this chamber, and all over the House, if come next September, all these students that really rely on that, and they do really rely on it.

A considerable amount of students in my district would have to give up their undergraduate or graduate operations. Now, we have programs like HEAL. Some people suggested, well, lets do the auction rate. I think you have to be very careful. That's a cherry picking operation.

If a medical student walked in to me, and wanted to have a loan, I wouldn't have a lot of hesitancy, knowing what his likely income will be, and need for it in the marketplace.

Then, we have the problem, and I think one of the major problems here, is that we have to make sure that we don't set up a situation where just a few very large lead banks handle these operations, or do the lending, or do the auctions.

Because this is basically a community bank program. The average family wants to walk down to their local bank, where they've done business for 20 or 30 years. Now their children are in school, and they have that particular need where they're stretched.

It's that local community banker that very often is prone to make the loan, and make it less painful for the family. And if we're just cutting margins 50 basis points, 30 basis points, we could easily end up driving the community bank operation out of this total package.

When you look at what we're talking about here are basic spreads. It's maybe eight percentage points more on the cost of the loan, over the life of the loan.

That's not a great deal of money for the opportunity of what advanced education offers to those students that otherwise would not get it. And if they had to choose between the cost of an additional eight or ten percent on the life of that loan, to them, or the opportunity to not being able to advance, or advance smoothly, as the loan program operates today, I doubt there'd be any smart individual that would be so toned to the interest rate level, and what it's costing them, as opposed to the opportunity that's offered.

And if we want to make adjustments later on, to save students, let's do it in credits, income tax credits. Let's do it in deductibility of loan interest payments. What we want to do, we can modify that to save the student side of it.

But what I'm worried about, is if we destroy the loan program as it exists today, it's not going to go away. It's only going to be shifted to the government, for us to come up with more grants, more direct loans, and more uncontrolled loans.


Mr. Kildee. If I can, Bart, address this to you now. Your bill apparently says not only the 91 note, but the 2.5 in school, and 3.1 in repayment. The administration says 1.7 in school, and 2.3 in repayment.

Is there any figure less than that 2.5 and 3.1 that you feel that the banks could accept and would still stay in the lending posture?


Mr. Gordon. Mr. Kildee, I don't pretend to have some margin answer here to what is that exact figure. You get right up to the edge of the cliff, and you don't go over. I don't think anyone else does.

I think there is a range. There's not a bright line, but there's a range. I think that you all have been studying that range.

Also, though, I think that you've got to be careful about getting too caught up in this numbers game. When the student loan program was first started, there was a big spread that was put in, to get the banks to come in originally, because there was no one there.

Well, through efficiencies, they are able to make too much money. That's why we changed that in '92. They had to take part of the risk, and their profit was cut.

There's been efficiencies in the last three or four years, too. And they can go down some more. But let's don't put so much emphasis on just trying to find that fine line. Part of the problem that we have is CBO scoring. And we're all caught up in this CBO problem.

One day, CBO will score it as a billion dollar loss. Another day, it's a billion dollar gain. Part of it is this shifting interest rate. I think probably more attention ought to be spent on helping students by some permanent types of benefits, like reducing the cap. Like reducing origination fees.

So, rather than get caught up on taking this interest rate just to the edge, that one year could help students, and the next year not, and again, could push the private sector out, let's try to look at reducing origination fees. Let's try to look at reducing caps.

If CBO, as Chairman Goodling has been saying for a long time, would just score it as the way they have in the past, we could do that.


Mr. Kildee. We will look at that. But what I'm trying to avoid. Because I want to be fair.


Mr. Gordon. Sure.


Mr. Kildee. …to the students, and the lenders. And that takes the wisdom of Solomon. We don't have a lot of Solomic wisdom around here. But you know we have to arrive at a figure.

What I don't want is have this side of the aisle say, we're going to go 91 day, plus 1.7 and 2.3 in repayment, because that's what the administration wants, and have the other side of the aisle say, no, we're going to go 91 day, plus 2.5 or 3.1 in repayment, because that's what the present law, or the present situation is.

We really want to figure what is best for the students, and what's best for the lender. So, we do have to come up with a figure. And that's the difficult.


Mr. Gordon. I wish I had that figure for you. But let me just say this. I think that there is a consensus in the country now, among all groups, that status quo would be a tragedy, would be a complete train wreck. No one wants that.

No one wants to be getting into a political game.


Mr. Kildee. We don't want to do that, exactly.


Mr. Gordon. Right. You know which side I cast my lot. I really do think that you have demonstrated, with all the hearings you've had, with the Chairman, that you really are trying to do the right thing.

I think now is the time to come down to taking information you have, not playing games with each other, and making your best informed decision. I am totally comfortable with that. I have worked with all of you enough to know that you really are trying to do the right thing.

You really have looked at it, and you know that there is not a magic answer. I think you just come forward, and do it. I think that the so-called groups should also recognize this sincere effort to find this compromise. I think it's just time to do it. Or you're going to have a train wreck by no action.


Mr. Kildee. I think the Chairman and I totally agree on that. And we're trying to achieve it. I appreciate, really, all of your involvement. And Paul. Thank you.


Chairman McKeon. Thank you. Mr. Goodling, the Chairman of the Full Committee.


Mr. Goodling. I want to thank both of you for your testimony. This has to be solved. I estimate, within the next couple of weeks. Hopefully we'll be able to do that.

Congressman Kanjorski did view that we're disingenuous. Congressman Gordon read the last line of Joe McCormick's letter, the second to the last line.


``Given the pending change in the interest rate calculations, your participation in direct lending would ensure an uninterrupted flow of funds to students.''

I won't put him directly on the spot, by saying, you're aware that the one and the same in my estimation, are one and the same. If there's a level playing field. But if anybody can look me in the eye, and say there was a level playing field, you must have ice in your veins, or something. Because I don't know how you can look me in the eye, and say that.

But having said all that, we're 70-30. I think we can manage 70-30, as long as we know that we may have to come back and bail out the Department every now and then. That's understood.

If we talked about the scoring, one of my greatest concerns is that if we don't solve this problem pretty quickly, Bill Ford and I were probably the leading fighters in Congress for a long time, in trying to make sure good proprietary schools would be there for the 21st century, to do all the training and re-training that's going to have to be done.

My greatest fear is, that if we can't solve this problem pretty quickly, they'll probably be the first to suffer. Do you agree with that observation on my part?


Mr. Kanjorski. If I can, I've already been visited by some very effective proprietary schools, and they see this as a real threat to them. The hucksters that are in the business, they're going to try their way of making it, because they really didn't have the intent for educational purposes.

But as I look forward to the 21st century the hardest thing we're having to deal with now is the culture of the academic institutions, of changing to meet the challenges that are out there, I mean, the needs of presidents, the needs of schools. They want to keep the four-year curriculum. They want to have the broad education.

Then, you talk with the business side, and the cry is, we have a need for bodies. One of the things that has come to my attention recently is that a shortfall of computer programmers in the United States of 200,000. And that number would rose up to 500,000 within the next five years.

Yet, that's not going to allow for the classical average type of education to continue to occur. What we're going to have to do is reach out, enough training, enough skilled people, who are already in the field.

To give you an example, in my profession, I think Bart's a lawyer, too. There are probably an awful lot of lawyers who have been great computer programmers. But they're not going back for four or five years to become computer programmers.

But we've got methodologies and curricula that in nine months put these people in tremendous jobs. Filling this tremendous need that we have in the country. But if allow the institutions that are relying on the financing to be taken, and shaken out of the system, as they very easily could be, we're going to be aimed at building institutions in the government. We're going to finance building institutions.

We already have a lot of them out there. Obviously, we probably have enough. We don't have to do any more capital investments. All we have to do is encourage these people to be more effective in delivering the knowledge necessary to meet the gaps in the locations, in the trainings that are out there.


Mr. Goodling. Congressman Gordon, you mentioned our old system of scoring. It's kind of interesting that if we would continue doing what we're presently doing, and didn't make the change on July 1, under the old scoring, we save $2 billion. One the new scoring, we lose $2.3 billion.

I don't know who's doing the scoring, but I don't know where they came up with that nonsense. But do you have any suggestions? We can solve this problem pretty quickly if we can solve the scoring problem.


Mr. Gordon. Well, if the CBO would just score it as they have for the last several years, being, you're going to see that there'd be a surplus, you could come in, and do some real things, some long-lasting things for students.

You could reduce the origination fee. You can reduce the cap. These things won't go away as interest rates go up and down. I would ask you, and your leadership, and our leadership, to ask CBO to do what they've been doing for the last several years. Score it that way, so we can help do it.


Mr. Goodling. Thank you, Mr. Chairman.


Chairman McKeon. Thank you very much.


Mr. Andrews?


Mr. Andrews. Thank you, Mr. Chairman. I want to thank Congressman Gordon and Congressman Kanjorski, for caring so much about this issue, working so hard on it. That is unusual and commendable, and I thank you for the contribution you are making.

I do want to say to Congressman Gordon that I agree with one thing you said, and disagree with two things you said. I agree that we're all trying to go to the same place by different means, and you all are motivated by a desire to get there.

I disagree that this question really is about direct versus guaranteed lending. I think that we have, in fact, reached the time that you spoke of. As an advocate of direct lending, I believe that it should not be an exclusive program.

Second, it should co-exist on a level playing field with guaranteed loans, and let students and institutions make choices. And third, I think we have to come to grips with not whether we have guarantees lending, but under what circumstance we have guaranteed lending.

One of the concepts that Congressman Kanjorski alluded to was the idea of providing access for federal loan guarantees, by virtue of an auction, by virtue of market competition.

I wanted to ask Bart what he thinks of that idea, in terms of a longer range solution to fixing the level of the interest rate paid by the federal government, and by students, on loans issued by private lenders, and guaranteed by the federal government.

What is your view on fixing that interest rate by auction competition?


Mr. Gordon. Let me first go back to your first statement, and then I'll get to that.

I'll agree with you all, 100 percent of what you said, in that there ought to be a détente in the direct versus guaranteed competition.

I think on your committee, that's what's happened. And I think that's the feeling. The problem is that the Department, which is both, you might say a competitor, as well as a referee, is continuing, as the letter that I just read to you, making an effort to push, you know, for a total 100 percent program.

So, even though you and I have come to that agreement, the Department hasn't. So, that's where the problem lies, in terms of that issue.

I know in the auction, I think you've been a long advocate of the auction proposal, put it out there. Honestly, I don't really, don't have a good answer. I'm sure you know more about it than I do. My end result is that we have a bifurcated program that's going to be strong and healthy.

If the Committee thinks that's the way to go, then I would certainly defer to your judgment.


Mr. Andrews. Now, I don't have a judgment about it yet. And I asked the question most sincerely. I don’t know whether that's a good or a bad idea. I would say one thing.

I disagree, Bart, with your characterization of the Department. There are many people in the Department who share my conviction that direct lending is a good program. My view is that they have been even-handed and tried the best to make this work. And that's not your opinion, but I would disagree.

Paul, what do you think about the auction based idea? Let me define it before I ask you.


Mr. Kanjorski. Well, I think it's worthwhile looking at it from this standpoint. It's a very complicated field, and it has so many convoluted problems we're trying to solve.

First and foremost, I think we should have long-term stability. And if that means going back to the system that was, that worked so well for 20 years, do that for a period of time, so everybody knows that in planning the education over the next several years, both families, students, and lenders, they can make these plans.

Then, if we're going to look at auction, and I think it's worthwhile that we should do it in a demonstration mode, in defining certain conditions that we want. I mean, you may end up doing an auction that I think would be the worst in the world. And you'd get it down only to the very largest financial institutions in the country. They'd literally grab the market, and take care of it.


Mr. Andrews. Has that happened in housing?


Mr. Kanjorski. Well, in housing, there have been benefits that have belonged to those people that have been given advances. They have fulfilled the need, I think, as long as we keep our eye on what the target is -- better housing.

It accomplishes that. But it's been organized to be a flow to service all financial institutions. The one thing I'm worried about is getting too big, and think about, this is only a money problem.

And that, therefore, only the people who can shave, and the best ones off, get the work. Well, limit that to maybe five or ten large financial institutions in the country. I think that would be wrong.

It's very important that we recognize that a lot of these loans are made by communities, and small banks, and credit unions. And it's the long-term relationship…


Mr. Andrews. We won't have those loans if we don’t have credit union. Hopefully, because of your work, we will. I support all you are doing to protect credit unions from attack.


Mr. Kanjorski. But we want to make sure that they stay viable in that business. So, I think the way to approach the auctions decision is to define a demonstration project, and then, do a focus group. Bring everybody that's involved in it, and sit down, and have them work with us to run the experiment, the demonstration, and see how it works.

But what we are trying to do is, and what I get really worried about is, Mr. Goodling, the whole idea that we take a set interest rate, and freeze it. And somebody asks, well, what will happen under certain circumstance. Who can predict whether we're going to go into deflation in this country? Who can predict whether we're going to go into a recession or depression?

Who could predict? In my lifetime, I've seen interest rates hitting 20 percent. And now, the ten-year rate, and the nine-month rate, a matter of basis points apart.

I think we hold ourselves up to some sort of ridicule, to think that because we happen to be elected or appointed officials of the government of the United States, that we have some clairvoyance here. Where our, probably the chief person in the United States, Alan Greenspan, is telling us that he hasn't got his hands around this issue of how to predict what can happen under all different circumstances.

So, I think we have to really back off for a couple years. But we just can't do nothing. We've got to stabilize. That's why I introduced my bill. Let's stabilize the field. And let's add demonstrations.


Mr. Andrews. Thank you, gentlemen, and thank you, Mr. Chairman.


Chairman McKeon. Thank you, Mr. Graham?


Mr. Graham. Thank you, Mr. Chairman. I think it's a fair characterization that Mr. Andrews, a lot of us support, a demonstration project, but let's not underestimate what the focus is on, and anybody that's listening knows that this is a small crisis. One that needs to be resolved in a couple weeks.

Those debates about auctioning and demonstration projects are a good idea. I think it's something I definitely want to look into. But we have a real problem on our hands. And the Chairman is right, we need a solution within the next couple of weeks.

I guess we can't emphasize this enough. The letter from the Department says what it says. And you can put your own interpretation of what they're trying to tell people in the higher education community about the problem that it's facing in the guaranteed loan program.

I've got my own opinion about whether they're asking about the fairness of all this, and whether or not it's going to level the playing field. We do not need to get into that.

I would just like to emphasize again the effect it would have on higher education. In terms of student access, wanting to go to school if, in fact, we do not address this problem soon. And direct lending becomes the only game in town.

Would you please tell us again what you think would happen to the student in America that's going to college?


Mr. Gordon. Well, first back to your premise that if a decision is not made in the next few weeks, then that is a decision. And that decision is to leave things as they are.

And I think that it is clear that 90 percent or more of those folks that are involved recognize that under those circumstances the FFEL program would no longer exist. That you're going to have no other place to go, an avalanche of students going to the Department for student loans.


Mr. Graham. Excuse me. Would it be fair to say that the Department of Education becomes probably one of the largest consumer banks in America?


Mr. Gordon. I think they would become the largest bank in America. And we would also needlessly take on billions of dollars in additional federal debt.


Mr. Graham. If you were going to start a bank, would you hire the Department of Education to run it?



Mr. Gordon. Well, I think the Department of Education does a lot of good things. I think Secretary Riley is as fine a person, and administrator.


Mr. Graham. So is…


Mr. Gordon. …and he has good geographic roots.


I am very much opposed to the effort to do away with the Department of Education. Again, I am thankful for what they do.


Mr. Graham. Let’s talk about the banking side of this issue.


Mr. Gordon. But what this group does is, take their focus off the things they need to be doing.


Mr. Graham. Right.


Mr. Gordon. …putting it into an area that they don't need to be doing, it's working. And I'm afraid it's going to cause other kinds of problems.

So, taking this scenario, certainly there'll be this avalanche of people that will attempt to go to the Department, into direct lending. Very few people that are outside, maybe, that don't have a bias interest, think the Department can handle that kind of avalanche.

So, that means next fall, when people go to the University of Charleston, they go to the Citadel, and other schools in South Carolina, and to NTSU, in my home town, and Tennessee Tech, that there's going to be a train crash.

Many folks in my area have to have those loans. Where I went to school, at NTSU, about ninety percent of the students have some kind of financial aid. Many of the students can take that one, two, or three weeks of uncertainty.

It will be a real and a needless disaster, for a segment of our student population. It's tough to get out of school and get your finances in order. And if it doesn't work out at that time in your life, you may not go back to school.

I think a lot of people are going to be missing that opportunity. It's going to be bad for the country.


Mr. Kanjorski. If I can just add my two cents to that. I look from the students' side. I think it's going to cost this country millions of students a year. And they are not re-coupable. And the effect that will have on the long-term economy of the United States, and the general productivity, generation of wealth, will be catastrophic. Billions, and billions, and billions of dollars over their lifetimes.

All because we're playing around with three basis points. We have a stable system. Let's get to that system, and then make it work. I agree with Bart, and members of the committee. This is something that has to work.

But to give up on millions of students all because the Congress is paralyzed either with the Budget Act, or with playing with the basis points, I think would be the most foolish non-investment this Congress could make in America's students.


Chairman McKeon. Thank you.


Mr. Fattah?


Mr. Fattah. Thank you, Mr. Chairman. Let me again thank you for holding this hearing. Congressmen, let me try to put this in some context.

I believe that this administration has been more aggressive and more successful than any previous administration, in creating access and opportunity for Americans to go to college. Would you agree with that?


Mr. Gordon. I would wholeheartedly agree. And I'm proud of what they're doing.


Mr. Fattah. So, at first blush, it's difficult to assume that they, given that track record, would do anything that would make it more difficult, given their history. This being such a high priority in this administration.

And I heard, and read your comments about this past contract, relative private lenders and I also read the Department's position that they're going to articulate in the next panel.

Is there anyone that you are aware of, who's advocating that we eliminate private involvement in student loans, as part of the Department's position on this issue?


Mr. Gordon. Let me reiterate, again, my pride in this administration's efforts to reach out, and make more people have the opportunity to go to school. I think they're doing an outstanding job.

However, I think that just as…


Mr. Fattah. Let me try to rephrase it. The light is going to come on.


Mr. Gordon. Okay.


Mr. Fattah. The Department's position is that we should fix this problem. And they have a proposal. The administration has a proposal that is 1.7 in school, and then 2.3 out of school. You would agree that that is the administration's position?


Mr. Gordon. Yes.


Mr. Fattah. And your position is that the number should be a little bit higher. As you said earlier, that you don't have a crystal ball, and no one else does, right?


Mr. Gordon. Right.


Mr. Fattah. So, your position is not an issue of limiting the private participation in student loans.


Mr. Gordon. Well, I think you have a couple of different dynamics, when you say there and them you've got…


Mr. Fattah. The administration…


Mr. Gordon. …but the administration is a large gathering. The particular report you're talking about comes from the Treasury Department. The people that are running the program, is the Department of Education.

The first premise that we need to work from is that certainly no one in the administration or the Department has a vendetta against students. I don't think any of them want to do anything that they think would be harmful. I want to start that with a premise.

Now, but there is a certain thing called editorial pride. That you can get so wrapped up in a position that sometimes you may not see everything as well.


Mr. Fattah. Okay. But I…


Mr. Gordon. So, if I could go back to other issues. One issue was the specific right. I think what the Treasury Department was trying to do, was come down to that very fine line of what they think would allow at least somebody to make a loan in this country to students, without fully thinking it all through, because maybe that's not their full role, what about servicing that loan, collecting that loan, and taking it the full way.


Mr. Fattah. Let me continue.


Mr. Gordon. Okay.


Mr. Fattah. Because I've been very involved in this whole business for a long time.


Mr. Gordon. Yes.


Mr. Fattah. I've played a leadership role in our guarantee agency back home in Pennsylvania. And so, I understand some of the issues that you raised.

You are aware that all of these loans are guaranteed, and that these banks are almost risk free, in terms of their position in making the loan, that the federal government guarantees the loan. And that the interest rate therefore being set is not one to protect them against risk. You are aware of that?


Mr. Gordon. I am. And also, part of my legislation, I guess, before you got here, required that the banks do take a risk now. It used to be without risk. Now, they have to assume a part of the risk. And I think they should.

But what you have to keep in mind is, it's one thing to loan the money. There's a guarantee you'll get that money back. But there are additional expenses. You may not get your expenses back.

Once you loan it, there's servicing it, there's collecting it. So, in other words, you may loan $100. And so, if the loan goes bad, you get your $100 back. But what about the two or three dollars that were spent on servicing that loan? What about the three or four dollars on collection? On these various other things.

So, just because your loan is guaranteed doesn't mean that you can take the risk of losing money in other areas.


Mr. Fattah. I understand. And just one last point. The United States Student Association is going to testify after you conclude. And representing college students in America, one of the things that they point out is that obviously the issue of what interest rate is charged has a direct bearing on what it costs for the students and their families.

And looking at the long-term, we've crossed a fairly significant Rubicon in this country, in which now the majority of the aid supporting students going to college is in the form of loans, not in grants.

And so, this issue of interest rates, can't be just one of trying to make sure that anyone who wants to provide a student loan is guaranteed an interest rate substantial enough to make it profitable, when we have to look at the economies of scale, and other issues, so that we provide the resources so that the national asset that we're trying to develop, the student, in providing their education at some very fine institutions, is something that is financially feasible.

So that, I know there's a concern that, we have a kind of a broad participation. But we also have to be concerned that we bring some level of efficiency to this process, in not having enormous costs, to families in your district and my district.

I want to thank you, and my colleagues from Pennsylvania, for your participation today.


Mr. Gordon. You know, I agree with you. Just as we don't want to have a system that is so inefficient that a pawn shop on Murphy's-borough's main street can make student loans, and at such a high rate that students are suffering.

We also don't want to get into a situation where we have a consolidation of whether either to school direct lending, or even one or two lending operations.

That's why I think you can reach that balance. And I think that you will be able to reach that balance.

But also keep in mind that the students are feeling like there is some kind of an entitlement of a cut in their rates, that they see coming, come July. Because there was this wisdom in the past that made this available to them.

Once again, the system that set that up in the first place never really looked at reducing the rates for students. They were looking at a way to make it more efficient for direct lending.

In addition, over the last ten years (more years than not) with the plans being presented now, the students will be pay higher rates. It just happens that we're at a window where it benefits them. In three or four years, it may not.

So, what I would hope the Committee would not be just focused on this fine line of this interest rate, but also of making permanent benefit and changes for the students. That is, reducing the caps, and reducing the origination fees.


Chairman McKeon. Thank you. I think just for the record, we need to understand that the guarantee does not pay dollar for dollar. It's 98 percent to the banks, or the lending institution, now, of the amount of the loan. So that it's…


Mr. Gordon. It's reduced even more if their default rates are high. They've got a stake in this. As they should.


Chairman McKeon. Thank you.


Mr. Fattah. Just for the record, almost risk free, I didn't want to imply that it is totally risk free. Only 98 percent risk free.


Mr. Gordon. Assuming that they have a good default rate, it goes down below that. The 98 percent does not include servicing and other benefits that they try to do for the student.


Chairman McKeon. Thank you. Mr. Peterson?


Mr. Peterson. I'm going to defer questions. But I want to thank the two Members who have taken a sincere interest in this issue. I think you have contributed much, and I appreciate your involvement.


Chairman McKeon. Thank you. Mr. Tierney?

Mr. Tierney. I'm also going to defer questions. I think the Members have served us well by coming here, and contributing to this discussion. And I appreciate that.


Chairman McKeon. Thank you. Mr. Deal?


Mr. Deal. Well, I appreciate the gentlemen coming also, and I would not have any questions at this time.


Chairman McKeon. Thank you. Ms. MCarthy?


Ms. McCarthy. Thank you, Mr. Chairman. I have a quick point. While I’m home, I see my students a lot. And I'm agreeing with you, as far as how many jobs we need. But on Long Island, we can't fill the positions.

So, I agree with you 100 percent that we need to do everything we can to move our students into the workforce, especially those that are going through programs in proprietary schools.

These are just as important to me as the four-year colleges. I want to make sure that those students are not left out of this.

I'm not going to say that I know, or can understand all of the things that we've been going through. But I also think that we have to protect our community banks. I also am interested in the auctioning issue.

But that would probably leave our small banks out, because it will go to, the larger commercial banks. They're not going to give the services as you’d get around the corner. I know that, because I dealt with both.

Thank you.


Mr. Gordon. Mr. Chairman, if I could just quickly conclude. You've been generous with your time. I think 90 percent of those folks that are involved with this issue recognize that status quo means that the FFEL program folds. I think 90 percent recognize that if something isn't done very shortly, then that is a decision, and FFEL folds.

I think probably 90 percent recognize that the Department can't handle this avalanche of new students immediately. I think also 90 percent recognize that this committee has really, thoroughly looked into this problem, trying to do the right thing.

And I think, now is the time to make your best decision, to do what you think is best. And if we have to re-visit it later we can do that.

But we have to move forward. I think you've demonstrated that you want to do the right thing. And that is to protect students, and give them that opportunity to affordable and accessible access to higher education.

And I thank you for letting us come here, and be a part of this discussion.


Chairman McKeon. Thank you. I appreciate all of you being here.

We will excuse you now, and move to the second panel. Thank you.


Thank you. Our second panel of witnesses will discuss the economic analysis that has been done on this issue, both at the Treasury Department, and on Wall Street. We'll also be examining the administration's proposal for student loan interest rates.

We have us, from the administration Dr. David Longanecker of the Department of Education, and Dr. Jonathan Gruber, from the Department of the Treasury. Unfortunately, both Secretary Riley and Secretary Rubin were not able to come to this hearing, because of scheduling conflicts. This was called on very short notice. But we're glad to have both of you here, representing them.

Dr. David Longanecker, the assistant secretary for postsecondary education, should be no stranger to members of this subcommittee. We welcome him back, to discuss the administration's policy proposals for student loan interest rates.

I would also like to welcome Treasury deputy assistant secretary for economic policy, Jonathan Gruber. Mr. Gruber's office has just recently released a comprehensive report on the costs and net returns of FFEL lenders, under the current rates, and under the scheduled interest change.

We are grateful to Dr. Gruber, and his staff, for completing their work in time for us to use it in our considerations, and for coming before the subcommittee, to discuss the Treasury Department's findings.

Finally, I'd like to welcome Mr. Jonathan Gray. Mr. Gray is a senior research analyst with Sanford C. Bernstein and Company. Mr. Gray is one of the country's top research analysts on this issue, and has written extensively on the financial implications of the scheduled rate change.

We appreciate the fact that Mr. Gray was able to come down to Washington this morning, after getting back to New York from his vacation late last night. We're glad that you could be with us here today.

We'll start with Dr. Longanecker.




Dr. Longanecker. Thank you very much, Mr. Chairman, members of the Committee. It's good to be with you again this afternoon. I'm going to ask that the full text of my written remarks be entered in the record, and I will abbreviate them here for you.

I'm pleased to be before you today, to discuss the administration's response to concerns regarding the impending change in student loan interest rates. This is the issue of great importance to us. And we're pleased to have the opportunity to share our research and our proposal with you.

As you know, the administration is striving on a variety of fronts to make college more affordable. With respect to the specific issue before us today, the administration is strongly committed to both the FFEL program and the direct loan program. Competition between these programs has improved both of them.

As you know, the scheduled change in interest rate would reduce the cost of new borrowing for students by approximately ten percent. And contrary to Mr. Gordon's recollection, it was, in fact, intended to reduce the interest rate for students. I was here in 1993. I helped work on those discussions. And we clearly had the intention of both changing the instrument, and reducing new costs to students.

However, because the change also creates inefficiencies for banks that we did not anticipate at that time, it would reduce lender's profits below a reasonable rate of return, raising the possibility that the change could reduce the availability of funds in the FFEL program.

For that reason, this issue is a high priority for the administration, as it is for you. We thought long and hard about the proposal that we're presenting to you today.

The Treasury Department conducted a study on the scheduled interest rate change, and on lenders. Dr. Gruber, who was introduced earlier, will present those in a few minutes. He is on temporary loan to the Treasury Department from the faculty at MIT. And he will be presenting those findings.

In general, the study concluded that banks are currently receiving profits on student loans in excess of the competitive target rate of return. However, the study further concluded that banks would earn less than a competitive rate of return on student loans, if the scheduled change in interest goes into effect.

The study also found that it is not efficient for interest rates to be tied to the long-term interest rate, as it would under the currently scheduled change, because banks borrow money on the short term, as you've heard, rather than the long-term basis. And the funding mis-match creates additional cost to banks.

In seeking a solution to that problem, we have two goals at the Department. You actually espoused them yourself. Provide the lowest interest rate possible for students, and to maintain access in both the direct loan and the FFEL programs.

Our proposal will provide students with the same low interest rate they would receive under the scheduled change, and provide a rate of return to lenders that matches the target rate of return identified in the Treasury Department study.

Under this alternative approach, student interest rates will be tied to the 91-day Treasury bill, the same benchmark used currently, rather than to the longer term note used in the scheduled change.

Based on Treasury's analysis, we believe this change in benchmark will allow us to preserve the scheduled reduction in student interest rates, while continuing to provide a competitive yield for lenders.

Specifically, we propose that as of July 1st, maximum student interest rates should be 91-day Treasury bill, plus 1.7 percent during in-school, and 91-day Treasury bill plus 2.3 percent during repayment. For plus loans, the interest rate would be reduced to the 91-day Treasury bill and 3.2 percent.

This proposal would also benefit FFEL program, as well. Students will retain attractive interest rates, reducing the projected five-year weighted average interest from 7.8 percent to seven percent. And as indicated on our slide, would save students a substantial amount of money, on average.

We have estimated that students who borrow over the next five years will save an estimated $11 billion over the life of their loans, compared to the rates that students currently pay.

The proposal also benefits lenders. By proposing to return to the traditional pattern of basing student interest on the short-term rather than the long-term rate, we save about 30 basis points for the lenders, and ensure that students will provide sufficient profits, or that these loans will provide sufficient profitability.

To help ease the burden on lenders, we are also proposing a number of other improved items. We have proposed a comprehensive plan to restructure the guarantee agencies. That increases accountabilities, standardizes policies and procedures, and rewards guarantee agencies for high performance.

Then that will get them out of the way of some of the things that they currently impose on lenders. There are also a number of other things that we've done to develop lenders.

We have also been asked whether this would affect the availability of lending from small lenders. We do not believe so. Most of the smallest banks that participate in the FFEL program sell their loans shortly after origination to the secondary markets, and to the large banks.

Since the secondary market participants will still find this a profitable activity, there should still remain a viable role for small lenders to participate in the program.

Furthermore, you should know that many small lenders have already been leaving the FFEL program over the last few years for a variety of reasons. The number of lenders has reduced from 11,000 to 5,000. This reduction has not resulted in inadequate capital for the FFEL program, but rather in consolidation of loans with the largest lenders. Currently the top 25 lenders handle about 55 percent of the volume of the program.

We have no reason to believe that the administration's proposal will dramatically accelerate the existing trend. However, if lenders did leave the program, we expect that other FFEL lenders could easily step in to fill the gap.

We have ample time with you to come up with a proposal to solve this before July 1st. Therefore, we do not anticipate any problems with the availability of loan capital in the FFEL program.

If there are problems, however, the Department is prepared to ensure the availability of FFEL loans for all students. In your wisdom, Congress has given the Department two tools to ensure that students have access to funds they need in the FFEL program.

First, Sallie Mae is required by law to act as a lender of last resort. Second, the guarantee agencies are also required by law to act as lenders of last resort. And the Secretary of Education has the authority to advance them federal capital to use for that lender of last resort activity.

With regard to the direct loan program, which we talked about a bit today, the schools are certainly welcome to enter the program. And we will ensure that we have the capacity to respond to their requests.

However, we neither seek nor expect to use the direct loan program as a primary back up for this. There's been reference to the letter that Mr. McCormick sent. That was an unfortunate and unauthorized set of statements in his letter.

I'm very sorry that that occurred. It is not the Department's position. I suspect the senior executives at the Bank of America feel about the letter they sent out referring to the possibility that pens and notepads can no longer be available to people that get student loans. It's going to dry up.

Sometimes our folks, good folks, do unfortunate things. And that was the case, and the circumstance. I'm sorry it happened.

We are also committed to ensuring that all students have access to student loans. We want to work with you. And we certainly appreciate the opportunity this afternoon, to share our policy and position with you.

We look forward to working with you to come up with good legislation that will continue to provide access that will reduce the cost to students, and provide a cost effective program.

You may want to ask me questions. Or you may want to take Dr. Gruber's testimony, and then maybe we could answer questions between the two of us. It's your preference, obviously.

See Appendix F for the written statement of Dr. David A. Longanecker


Chairman McKeon. We'll hear next from Mr. Gruber.




Dr. Gruber. Thank you very much, Mr. Chairman. I'd also like to request that my written remarks be entered into the record.

Thank you for allowing me to come before you today, to talk about the Treasury Department study of the financial viability of the government guaranteed student Federal Family Education Loans (FFEL) program.

Last fall, the office of economic policy at the Treasury Department was asked by the National Economic Council, to consider in particular the costs and net returns to banks participating in this program under today's rules, and the potential impact of the interest rate change scheduled for July 1.

My office then undertook an intensive analysis of the functioning of the FFEL program for large, for-profit lenders. Although we recognize the diversity of participants in this market, we chose this particular focus because these institutions span the market in which other lenders operate, and represent the majority of loan origination today.

Our analysis is based on consultation with a number of large originators, holders, and guarantors of student loans, as well as several other banks that finance and follow the student loan business.

We also talked with numerous outside experts, including Wall Street analysts of this industry, academic experts on the banking industry, and the staff at the Federal Reserve. We relied as well on the helpful earlier analysis done by the Congressional Research Service.

Just to begin, by summarizing the results of our analysis, were as follows: First, under the current structure, banks earn returns well above the target rate of return that they would require to participate in the FFEL program.

Second, under the interest rate change that is currently scheduled for July 1, banks would earn returns below that target rate.

Third, there are inefficiencies associated with the mis-match of long-term student loan interest rates, and short-term bank financing under the proposed formula. Therefore, joint benefits could be realized to students and lenders moving back to a short-term index.

And finally, an alternative rate schedule, rate formula, that's been suggested by some, that returns the index for student loans to the short-term rate, while holding students at the same interest rate they would face if the scheduled law change were to take place, would provide a competitive rate of return for banks, and maintain bank participation in the program.

The analysis that underlies these results includes several steps. The first is to calculate the net income to student loan lenders. The gross income of these lenders is simply determined by the legislated interest rate.

We then subtract from the net income two categories of cost. The first is the cost of matched funds. To finance a loan to students, lenders must raise their own capital funds, giving rise to this cost. These funds are raised in ways that we can discuss, but they're basically tied to a short-term interest rate.

After the scheduled interest rate change, however, there will be an important mis-match the stream of payments from students, which are tied to a long term index, and the source of bank financing, which is tied to a short-term index.

This mis-match introduces risk into bank's portfolios, since they can't be sure that the income flowing in from students will match the required payments that they must make to the financiers.

Banks can see this risk by swapping, or giving up, their long-term income, for income that is tied to a short-term index. The price for doing so, however, is some extra hedging cost that is paid to a swap dealer who is willing to bear this risk.

The second category of costs is the direct costs of running a student loan origination and holding operation. The cost of servicing an overhead, origination, default risk, repayment risk, et cetera.

We take the sum of these costs, both under today's system, and under the scheduled system, and subtract them from the return from the student loan, to obtain the net income on assets. The second step in our analysis is then to compare this net income to a bank's target rate of return, or the rate of return that banks require to continue to participate in the student loan program.

Much of our report is devoted to computing this target rate. As I noted earlier, banks finance the vast majority of their student loans by raising offsetting funding. But regulatory requirements, and generally safe and prudent bank practice, requires that some part of the loan be financed by a bank's own capital, or equity.

This equity, in turn, must earn a competitive rate of return to maintain investment in the bank. Thus, ultimately, the target rate of return on a student loan is determined by the share of a loan that must be financed by the bank's own equity capital, times the rate of return that that capital earns.

So, that leaves two key variables we need to identify. The first key variable that pins down this target rate of return is the amount of offsetting capital banks must hold, which is called capitalization.

The minimum level of capitalization required by regulators for student loans, since they're such a safe asset, is two percent. However, regulators also require that, across all their assets, banks have a four to five percent capitalization rate.

To be conservative in this report, we have applied that same four to five capitalization rate to student loans. That is, this is well above the minimum capitalization they require, but what it does is sort of assumes that banks spread their overall capitalization across their entire portfolio.

The second piece of the puzzle is the rate of return on equity. We assume a rate of return on equity of ten to 14 percent. The upper bound of this range is just about the average rate of return on equity that large banks have earned over the last few years.

The middle of this range represents the longer run historical average. And the lower bound represents consideration that student loans are much less risky than the average loan a bank makes. So, they may require a lower return on equity capital.

Finally, the final step in our analysis was to compare the actual rates of return we calculated, to these target rates of return. And to reiterate and expand on the conclusions we get from that exercise, first, we find that under the current structure, banks earn a return well above their target range. That target range is about 0.8 to 1.15 percent. We estimate that banks currently earn about 1.6 percent.

Second, under the scheduled interest rate change, banks would earn returns somewhat below their target range, about 0.5 percent. Such a reduction need not imply an immediate crisis in the program, but it could be a problem in the long run.

Third, there is the mis-match between short-term bank financing, and long-term student loan interest rates that could be addressed.

Finally, if you consider an alternative rate setting formula that has been suggested by some, which is return the index for student loans to a short term rate, while holding students harmless, we would find that this would result in a rate of return to banks that is just at the bottom of their target range of rate of returns. So, it could maintain participation, but right at the bottom of that range.

Finally, we noted that the uncertainties of all this exercise point out the difficulties with regulatory determination of student loan interest rates. An alternative approach could be to use a more market based mechanism for determining those rates.

To the student loan program, this might mean using some form of auction system that’s been mentioned earlier. The successful experience of the HEAL program, using an auction system, suggests that this could be considered in the context of the FFEL program, as well.

I hope that this summary has served to explain the basic structure of our report. But obviously I've left a lot out, and I look forward to answering your questions on particulars.

Thank you.

See Appendix G for the written statement of Mr. Jonathan Gruber


Chairman McKeon. Thank you.


Mr. Gray?






Mr. Gray. Yes. Good day. If I could ask you please to refer to the written copy of my testimony, which you have in your folders. If I could ask you please to turn to page four.

There you'll find an exhibit, which is entitled, ``The value of originated production at a 310 basis point spread''.

What this is, is an effort to present some analytical perspective for you on the economic character of the student loan asset. In other words, what we're going to look at here is the revenues, the costs, and the profit margin, on student loans, as they exist today.

What you see here is that over the life of the asset, you see in the first column, in basis points, the spread above the Treasury bill. The next column shows servicing G and A expense, or costs. The next column shows in the first year about 180 basis points of origination costs. That's the cost to make a loan, plus a 50 basis point fee.

You then see the cost of funds for a bank, versus the Treasury bill. Banks pay 70 basis points more than bills, for money currently. And then, there are some miscellaneous costs.

The very far right hand column shows, over the life of the asset, the pre-tax spread, the pre-tax profit margin on a student loan. It varies from year to year. But the average, per year, over its 12-year life, by our estimate, is approximately 1.05 percent, or 105 basis points.

Now, this prototype is an over-simplification of a vastly complex business. There are all different kinds of loans; there are all different kinds of lenders, et cetera.

This data, however, I believe captures the essence of the student loan, which developed through a series of about a dozen interviews with the largest bank lenders in the country.

Now, I want to tell you something. Our conclusions depart sharply from those of the U.S. Treasury. The Treasury, in our view, has over-stated the profitability of the student loan dramatically.

Now, how is this possible? It’s very simple. When you call a bank, and you ask the gentleman in charge of student lending, what does it cost to make a loan, to service a loan? He really doesn't know in most instances, and for a very good reason.

Student lending may be only one or two percent of the bank's whole business. So, he doesn't know how to allocate costs. And what typically happens with managers is, they under-state costs, because they all want to appear efficient.

And when you try to take account of their costs, they say, well our costs to originate is 50 basis points, and our costs to service is 50 basis. And then you say, well, that's interesting, but that only accounts for half your total costs. What about all those other costs? They say, oh, that's corporate. That's headquarters’ costs.

It's very much like a young child, when you ask how many cookies have you consumed? There's a natural tendency to under-estimate. And it's conceivable that the Treasury encountered such difficulties.

The quality of the information on the student loans is very poor, for this reason. Because it varied within these giant businesses. I believe this captures the essence. We have discovered it to be.

I want to tell you that if the current law is not changed, this Treasury bond formula that is written into current law, there is no question as to whether or not it will curtail the availability of loans. I promise you it will. Whether the bankers want to make loans at a loss, or not, they are not allowed to do so. Their shareholders won't permit it.

The pre-tax profit margin on a student loan, as we see it, is about 105 basis points. The current formula sets a student loan yield at about 8.35 percent. The T-bond formula at today's interest rate could set the rate at about 6.8 percent. It would reduce the profit margin, pre-tax for banks, by 155 basis points.

So now, it doesn't take a rocket scientist to tell that if you start with 105 and subtract 155, there isn't much of a profit left. Let's look at something else. Please look the next exhibit, Exhibit 2. This presents an analysis of what banks are actually earning on their assets.

The very first column shows you that in the first nine months of '97 banks earned just less than 15 percent return on equity. The next column shows under current law what they appear to be earning on student loans. They're earning about 11 percent on equity.

The current spreads are already probably inadequate. If you look across two columns, you'll see that if you assumed the capital ratio which Dr. Gruber assumed, five percent for student loans, which I think is entirely acceptable, banks could earn a 15 percent return, an acceptable return, perhaps with as much as a ten basis point reduction in the spread.

The far column shows you what will happen if the Treasury proposal is introduced. Return on equity would be cut to about six or seven percent, half of what banks earn on other assets. You would be telling the banker, only make a student loan if there's absolutely nothing else to do with your money. If anyone wants an auto loan, or a home equity loan, or a loan for any other purpose, that's what you should do. Because those loans are more profitable than student loans.

Now, what originally happened was, I guess with the T-bond formula, somebody concluded there would be $5 billion of cost savings for students, if only banks would make loans without a loss. That is correct. It would be $5 billion.

But the problem is, banks won't. They can't. There would be no loans. As Mr. Chairman's humor very succinctly captured for us. And now, we're in the curious point of view of being trapped in logic you would expect to find at the Madhatter's tea party.

That any alternative to the T-bond formula, which is a disaster, must preserve cost savings for students. Cost savings that don't exist. Because there are no excess returns being earned by lenders.

One last point. The Treasury has its findings. We have ours. And I am the first to agree that the quality of the information must be improved. However, we can look, there is a laboratory test that's been conducted for us. There is one student lender, one bank, that does nothing else, where its entire balance sheet is student loans.

We can look, and see what returns it's earning. If the Treasury's analysis is correct, they're saying a normal return is 12 percent on equity, they're going to reduce the return by essentially a 10 percent amount.

They're saying, in essence, their numbers would lead you to expect to find The Student Loan Corp., which is a pure student lender, and it's the largest lender in the country, you would expect to find it earning a 10 percent excess return, above a normal 12 percent return. A 22 percent return on equity.

Guess what? They're earning a 16 percent return. Only slightly above the average that banks earn on other assets. They're the largest, most efficient bank lender in the country.

So, I submit to you that the Treasury Report somehow has arrived at inaccurate conclusions. Thank you for your attention.

See Appendix H for the written statement of Mr. Jonathan Gray


Chairman McKeon. Thank you very much for your testimony. We have been called to a vote. My understanding is this is the last vote of the day. We have not had a break for lunch. I'm sure all of you would not mind a short break.

We will break, then vote. Grab a sandwich, or something. And we will reconvene at 1:30 p.m. to begin questioning. Thank you very much.



Chairman McKeon. I appreciate your hurrying back. I figured if I was able to eat a sandwich, as slowly as I eat everybody probably had time to eat a full course meal.


Again, I want to thank you for your testimony and for being here today. One thing that I would like to clarify, and was evident in all your testimonies, is that, there is a sense that there's a consensus on the panel that basing student loan interest rates on the long-term ten-year index is not a good idea. And we should stay with the short-term index.


Dr. Gruber. Absolutely. That conclusion is very important. Yes.


Chairman McKeon. I think we'll take that, then, as a principle, as we move forward onto the rest of our work, trying to solve this problem.

Mr. Secretary, Dr. Longanecker, you said that the direct loan program is not a backstop for loan access. How much additional volume do you believe that the direct loan program could handle, if there is a great number of banks that leave the student loan process?


Dr. Longanecker. Again, our expectation and hope is that we don't need to use that as a back up to this purpose. We want the program, but we want it to grow because people want to be in the direct loan program, not because they feel they have to be in the direct loan program.

Currently, our current capacity would allow us to grow about 500 to 1,000 schools, actually, in that program, because much of the work for us occurs not as a function of volume, but as a function of the nature of the schools we serve.

That's sort of argument analysis. We could absorb about 500 to 1,000 without substantially grinding up our own internal staff, and our contractor staff. At that point, we would have to do that. That would take us more time. Obviously, over time we could expand to whatever needs are there, and that was our long-term goal.

But it's not our desire at this point to have that rapid growth. We would hope to be growing about three to five percent of the market per year. That would be our target growth rate, and is what we would hope.

If we have to grow more rapidly, in the short-term, we could pick up about 500 to 1,000 schools. And in the longer term, which would probably be six months or so, we could pick up more than that, and continue to grow, as the need is.

But we really want to relay here, first of all, is we believe that there is plenty of room within the discussions that are going on, for reducing what we believe are the excess profits of lenders, and still providing a viable FFEL program.

And I think if there isn't, we have the two lender of last resort components that are written into law, that would give us our initial backstop.


Chairman McKeon. You commented in your statement that over the years, the banks have dropped from 11,000 who are participating, down to 5,000. Now, one of the problems in trying to solve this is, as I have heard from some who have been involved in this much longer than I have, when we were working on this problem the banks have always said that they have a problem with cutting profits. They wouldn't be able to continue in the program.

Now that's the first thing people say. I say, well, it's like the little boy that cried wolf, eventually there was a wolf. It looks to me like, if we've already lost over half of the banks over the years, for one reason or another, and in discussions I've had, many of the lenders have told me they would get out of the program.

I think that from the previous panel, and from what I've learned over this period of time I've been working on this, I think there's serious concern that we would lose a great number of banks, and the volume.

And we're talking about trying to fix this by July 1st. But schools are already receiving applications. They're already in the process of determining loans. There's already concern as to where we are in this program.

I have a letter that was written to the Treasury Department from the Student Loan Corporation. They say, and I will submit this letter for the record, the main conclusion of your report that you gave Dr. Gruber was that the conclusion that current private lenders could, and would continue at a below market rate of return, is unrealistic.

There’s a lot of information and footnotes that he puts in the letter. But I think that coming from a business that is $8 billion, serving over a million students, is something I think we have to really look at carefully. I see my time is up.


Mr. Kildee?


Mr. Kildee. Thank you, Mr. Chairman. I'll address the first question we should raise. Right now, under the current situation, we have the 91-dayT-bill, 2.5 while in-school, and 3.1 in repayment.

The administration has proposed in the 91-day, with 1.7 while in school, and 2.3 in repayment. We have to put a figure in this bill. Do we have any idea what the in-school rate should be? Assuming we use the 91-day note, do we know what the repayment should be?


Mr. Gray. Well, the exhibit that we looked at, this Exhibit 2 on page five, doesn't dis-aggregate between in school and in repayment. But what's the profitability over the life of the entire loan. It addresses the question of how the spread should be changed, in various ways.

It says, well, let's assume one to produce a return on equity of 15 percent, akin to what banks earn on other assets, and assume a 5 percent capital ratio, for example.

If you look up above the gray shaded row, it shows the spread change that would produce that. It suggested perhaps ten basis point reduction in the spread, versus the T-bill, would produce this roughly 15 percent return on equity that banks earn on other assets.

I would say, however, that the quality of the information upon which all of this analysis is based is not satisfactory quality, from my perspective. I would very much appreciate better quality information be gathered from the participants in the program, so that policy makers would have what they need to begin any kind of decision-making process, which is what the reality is.

Unfortunately, the participants in this industry themselves don't always have the best information. But I think there's a need to gather data, and look at it. I don't think it would be a very big task, frankly.


Mr. Kildee. What I read down on your chart here would be 2.4 in-school, and three percent, rather than 3.1 in the repayment period.


Mr. Gray. Correct.


Mr. Kildee. Mr. Longanecker, have any institutions of higher education indicated to you that they are not able to get lenders to make loans to their students, after July 1st, when the current law provision regarding the ten-year note goes into effect?


Dr. Longanecker. No. We have heard schools express anxiety about whether, but none have indicated that they have explicitly. In fact, we are aware that schools continue to sign preferred lender relationships with lenders at the present time.


Mr. Kildee. I understand that your study, Dr. Gruber, concentrated primarily on the large for-profit lender. How would this change impact the small community lender who might face higher servicing and overhead costs due to lower loan volume?


Dr. Gruber. That's an important question. I think our study definitely did concentrate on the larger lenders. I don't think our results are totally inapplicable to the smaller lenders. But I think it's fair to say that their servicing costs are going to be a bit higher.

I think that it's important to remember the role that small lenders are largely playing right now, which is, they're really brokers for the secondary market. The bottom half of lenders, the predominant activity is to originate loans, then sell them to the secondary market, to Sallie Mae, and others.

As a result, as long as the secondary market is profitable, it should still remain profitable to these smaller lenders to participate in the student loan program. And I think our numbers suggest the secondary market, particularly since Sallie Mae has very low capitalization, much lower than we assumed in our report, there is reason to believe the secondary market will remain a very profitable activity. And as such, there's reason to believe that they'll still be needed for small banks to originate these loans.


Mr. Kildee. You provided the administration with a range, and they picked the 1.7 and 2.3. Would you agree that would allow the lenders to remain in business in substantial numbers, and to take care of the needs of the borrowers?


Dr. Gruber. Yes. The range we presented was a range that our analysis suggested would allow banks a competitive rate of return, and to continue to participate in this program. The bottom end of that range I recognized in my statement. But it certainly is in that range. And the design of that range was a range where lenders would still find it profitable to participate.


Mr. Kildee. And is it at the bottom of that range?


Dr. Gruber. The bottom end of that range.


Mr. Kildee. Thank you very much, Mr. Chairman.


Chairman McKeon. Thank you. Mr. Petri?


Mr. Petri. Thank you. I apologize for not being able to hear your excellent presentations. I do want to ask you, if you could, I’m not sure if you've had a chance to review any of these other witness' statements.

But Mr. Carey, from Sallie Mae, in his statement recommends to the committee that we review proposals for a market-based system with operational reforms. It would encourage competition, investment, and quality services, at the absolute lowest possible cost. And he adds, however, these reforms should be studied carefully and implemented prudently, not in a rush because of a pending crisis.

It occurs to me that no matter how smart we are in analyzing things, and what the number should be that we come up with, the political process isn't the most efficient way to do it. Different organizations will have different efficiencies.

And maybe some kind of bidding process, or a little more carefully designed process, where people would host the bid, and the customer can decide if they want to be for more quality, so that they can be different places that would be out there, and you could look at transparent.

I don't know how you would design this, but it seems to me we could come up with a system where we're not politically setting a price as one-size-fits-all, and within the market, they all broker, more than it should, really, I would say, divide up the melon among themselves, which is what really happens here in the marketplace.

So, do you have any reaction to letting us stop being commissars, and start being free market capitalists here in Washington? Let the market set the price, and give the students and government both the best deal we can?


Dr. Gruber. I guess I have two reactions. One is, I want to second the statement Mr. Gray made, that this is a very difficult undertaking, trying to figure out what the right number is here because of lack of data, and because of the incredible diversity in this market.

And I think that my second comment is, the advantage of some kind of market-based approach would be exactly, that it would get us out of that business of trying to pick the right number.

I think there's a lot of difficult issues that need to be thought through. But I think we do have one small piece of evidence that suggests that it could work, which is an auction for the HEAL program, which is much smaller.

We can't necessarily conclude that it would work for FFEL, but works for HEAL. But it least is encouraging that there's a functional auction in that market. I think it's something that should be considered as we go forward.


Mr. Gray. I would simply make one observation, and that is that the rates on student loans now are maximum rates, rather than minimums. So, the opportunity for participants to operate, offer lower interest rates, to try to capture business, exists.

And yet, this is barely in evidence, with only a few exceptions. Suggesting that returns on investments today are only barely acceptable, or slightly below.


Mr. Petri. On that point, though, wouldn't the incentive, isn't it for people to give discounts to the schools and make loans to schools that are a little bit below market rate?

These sorts of things take less from the federal government, because they can get the guarantee at the set rate? And they can get the difference by passing some of the government money through the system. I think that's what's really happening.


Mr. Gray. When you think about it, the problem is free market bidding. The sort of auction system that if you allow lenders to charge higher rates for riskier borrowers, you would then begin to ration student loans, which is, I think, perhaps not consistent with the policy of giving those an opportunity to complete a college education who might be high risk.

Because for everyone who defaults, or doesn't make it through, if one does get through, the most valuable thing is to get the marginal student through, who otherwise might never go to college. I don't if I made my point well. But there's a problem with auctioning.


Mr. Petri. I don't see…


Mr. Gray. For example, suppose…


Mr. Petri. I see the default…


Mr. Gray. …well, students who went to, let's say Harvard, to pick an example, might be charged lower interest rates than student who were being trained in a proprietary school, where default rates have historically been higher.


Mr. Petri. Well…


Mr. Gray. Might be charged prohibitively higher rates. Mr. Petri, the school subsidy, guaranteed to the student doesn't make any difference. And then, when they get out of school, they can turn it over with the guarantee. So, whether they paid or not, doesn't determine the profitability of the loan to the banker making it.


Dr. Longanecker. If I might join the discussion, I think there are some really interesting possibilities for looking at the way to introduce the market more significantly into the program.

I think we would agree that it's a very difficult issue for us to address. And what you don't want is to have a red-lining, or adverse consequences, or perverse consequences for certain students. But you do want to somehow work the market in.

All of which suggests some very interesting possibilities for the longer-term future. Probably not in the next two weeks.


Chairman McKeon. Probably not. Mr. Andrews?


Mr. Andrews. Thank you, Mr. Chairman. I want to say that, with respect to the longer term problems, just really beyond the next two weeks, Mr. Petri is on the right track, as he usually is on these things. And I share a lot of his assumptions behind these questions.

In the short-term, though, I hear two points of consensus. One is that the ten-year instrument is an irrational and unpredictable instrument. That ought to be changed. There is virtual unanimity on that.

Second is, to take some language from Mr. Gray's statement that we want to avoid creating a powerful disincentive for private sector participation in FFEL. I think everyone agrees with that.

The issue is what would create such a powerful disincentive? And Mr. Gray, I want to ask you some questions along those lines. In your written testimony, you refer to banks, uniformly. When you say bank, do you mean a bank? Or all private lenders participating in the program?


Mr. Gray. I'm only aware of two that participate that aren't strictly banks. And there are 2,000 participants. One of them is very large, Sallie Mae. And another is the Money Store, which is sort of a strange…


Mr. Andrews. But the data aggregates all those participants together, I assume?


Mr. Gray. Well, it depends upon, the exhibit that I've developed. I've looked at the student element from the perspective of the commercial bank.


Mr. Andrews. When you say the return to the banks from the student loans is between 11 and 15 percent return on equity…


Mr. Gray. Yes?


Mr. Andrews. Do you mean for every private participant?


Mr. Gray. Absolutely not. This is sort of a model, a prototype, an example.


Mr. Andrews. This is a model based on how many cases?


Mr. Gray. It's based on as many cases as we answer the phone and give them the information.


Mr. Andrews. How many were there?


Mr. Gray. About 12. Probably represent, I would say, 40 or 50 percent of all loans made in the country, by dollars, is the best information I could get. And I believe the Treasury used the same methodology, if I'm not mistaken.


Mr. Andrews. Now, if I understand the essence of your conclusion is that the administration's proposal would so severely cut the revenue of these participants that it would drive their return on equity so low, to create that powerful disincentive. Is that the conclusion is?


Mr. Gray. No rational entity will invest money on which it earns an uninteresting return. It loses money.


Mr. Andrews. Right. And your proposition is that the administration’s proposal would create such an uninteresting rate of return, right?


Mr. Gray. Well, that's what the arithmetic suggests.


Mr. Andrews. Okay. So, that is your conclusion. I assume the answer is yes. What's the source of the estimate of 15 percent return on equity? What's the basis of that assumption?


Mr. Gray. That is data provided by the FDIC.


Mr. Andrews. For all banks?


Mr. Gray. That is correct.


Mr. Andrews. All FDIC participants?


Mr. Gray. I believe so.


Mr. Andrews. What's the return on equity for the 12 cases that you studied?


Mr. Gray. I haven't got a clue. I can tell you that the Student Loan Corp., which is the single largest bank participant, and therefore in theory would be the most efficient, had a return on equity slightly above this 16.4 percent. It was actually lower, but they took a charge of three and added back to their earnings. Because we didn't think it was a charge.


Mr. Andrews. Can you tell me what percentage of the revenues of these lenders, student loan revenues, represent, in the 12 that you studied?


Mr. Gray. No. I can't. I would say that in many instances, the student lending business represented less than two percent of total assets. Which is why it's extremely difficult to get information. This is all information, by the way, which we can, if you would make a list of questions, I would do my best to get answers for you as soon as possible. I've only been in the country less than ten hours.



Mr. Andrews. I understand. Please feel free to supplement your testimony with that information. Would you agree or disagree with the statement that a bank participates in the student loans for reasons in addition to the quantitative profit and loss. Is that true, or untrue?


Mr. Gray. In some instances, it's true. In others it's not true. Banks don't all do business from the same philosophical position. There are bankers that will tell you that they're well to do and engage in some activities at an unsatisfactory low return. This is because they feel they will get the consumer loans, the mortgage loans, that kind.


Mr. Andrews. Affinity business.


Mr. Gray. Yes.


Mr. Andrews. Is that the term? I'm a lay person.


Mr. Gray. Yes.


Mr. Andrews. They keep sending these credit cards. Would you agree or disagree with the statement, there may be some institutions, banking institutions, that would, even if they suffered the loss of return you outlined in your testimony, that would continue in the student loan program for reasons other than the returns they would enjoy?

Especially, given the fact, I think you just told me that about two percent of their revenues come from student loans. And if those revenues fall by 40 percent, that's 0.8 percent of their revenues, which I assume represent eight one hundredths of one percent of their mortgages. Might they continue, anyway?


Mr. Gray. It is possible, in some banks. Whether that's correct. There are, however, examples of management’s that have been thrown out of their offices, because they haven't done a good job for share holders.

The largest participant in this industry is such an example, Sallie Mae. So, I can't disagree with anything. You suggested there may be instances.


Mr. Andrews. I'm not sure that the prior management would agree totally with that characterization. But, okay. I would invite you to supplement your statement and information.


Mr. Gray. Well, I think your proposition is not entirely unreasonable. But it does entail risk, to try and find out whether and to what extent banks will participate, even if their returns are unsatisfactory.


Mr. Andrews. I'm thinking of trying to measure the depth of the disincentive that you point out. And I would say to you that, if we're dealing with an institution that is very largely dependent upon student loan revenues for its survival, and its profitability, then very clearly, that kind of profit is very, very slim.

If we're dealing with an institution that may have marketing motivation, any motivations beyond the bottom line, and its return is a very small part of its revenue picture, and perhaps we're over-stating the depth of the drop, perhaps the conclusions aren't quite so great as you suggest.

I yield back the balance of my time.


Chairman McKeon. Thank you. Mr. Goodling?


Mr. Goodling. Just a couple statements. I'm trying to save 700 small businesses upstairs from the unbelievable power of the EPA. And so, I must run back up. I just have a couple statements.

Dr. Longanecker, you listed some reasons for the reduction in participation. One that you didn't mention, however, was the fact that some of those didn't cry wolf, as we said they were crying wolf.


Dr. Longanecker. That is correct.


Mr. Goodling. They couldn't afford to stay. Mr. Gruber, I must say, for as young as you are, you spoke with one of the most authoritarian manner I have ever heard. And when you become twice as smart, and twice as old as you are, you are going to be something else.

But let me tell you, I've been here a little longer on this earth than you. And I almost fell off my chair when you used HEAL as a model program, HEAL as something that was successful.

HEAL was one of the most unsuccessful programs ever created. We have so many at the federal level. But HEAL was one of the most unsuccessful programs.

Now, why was it so unsuccessful? Well, first of all, the default loans were just out of this world. We finally got rid of it, because the Department of Health and Human Services couldn't manage it. They couldn't handle it. They couldn't direct it.

So, I hope you go back and double check your information on HEAL. Please don't sell HEAL to this group, because there are a couple on either side of this aisle that I think would like to sell HEAL. And I think if anything, it sure wouldn't heal the mess we're in now.


As a matter of fact, it would cause the worst infection that you'll ever find, probably, coming out of Washington.

I don't have time to stay and question the panel, because both issues I’m working on now are very important. But 700 small businesses in my district are also extremely important. For ten years, they have been paying unbelievable fees to attorneys for doing exactly what they were mandated to do. And now, all of a sudden, they're paying bigger bucks.

Thank you. I know you're happy to see me go.



Chairman McKeon. Thank you very much. We appreciate your testimony. And if there is anything further that you would like to add, we will keep the record open. We would be very amenable to that. Thank you very much.


Mr. Gray. You're welcome. Thank you, Mr. Chairman.


Chairman McKeon. If we could ask the third panel, now, to take their seats at the table, please.

I would now like to welcome Ms. Erica Adelsheimer, Legislative Director of the U.S. Student Association; Mr. Barmak Nassirian, Director of Policy Analysis for the American Association of State Colleges and Universities; Mr. Jerry Steele, Executive Vice President and chief operating officer for EdFund, in California; Mr. Jon Veenis, President of Norwest Student Loan Center, in Sioux Falls, South Dakota; and Mr. Paul Carey, Executive Vice President of Sallie Mae.

Thank you all for being here, and for being patient. I'm sure you've learned a lot so far today. We'll start first with Ms. Adelsheimer.





Ms. Adelsheimer. Thank you. I am Erica Adelsheimer, and I am the legislative director of the U.S. Student Association (USSA).

USSA is the nation's oldest and largest student organization, representing over three million students at over 350 public and private universities and community colleges across the country.

I would like to thank you for allowing me to testify today, and I also want to offer my testimony on behalf of USSA's entire education project, and the National Association of Graduate and Professional Students.

At both our 1996 and 1997 national student conferences, USSA's membership prioritized lowering the cost of student loans, not because they were aware at that time of any arguments to appeal the scheduled rate change, but because they felt overwhelmed by their mounting debts.

It is within the broader context of student debt that USSA believes the issue of interest rates must be analyzed. As the GAO report recently released to Senator Carol Moseley-Braun demonstrates, student debt is soaring out of control.

In just three years, between 1992-1993 and 1995-1996 the average amount borrowed by undergraduate students increased by more than $3,000. Furthermore, the percentage of graduating seniors who had borrowed $20,000 or more rose from less than ten percent to nearly 20 percent during the same period.

For professional students, the average loan debt jumped nearly $15,0000. And 60 percent of these students completed their program with more than $50,000 in debt.

It's important to note that these figures are now almost two years old. That debt will continue to rise. And that these figures only reflect federal student loan borrowing. The figures do not account for debt students may have accumulated on credit cards or on private loans.

Mr. Chairman, the USSA are intimately familiar with the full meaning of these statistics in student's lives. Every day our office receives calls from students who are anxiety ridden about the amount of loan that they have taken on, and are literally terrified as to how they are going to repay their student loans upon graduation.

USSA views the very real anxiety about college debt as a function of three separate factors. First, is the question of college costs, and the high rate of inflation in college tuition.

Second, the failure of student aid programs to keep up with costs, and the dilution of these programs in terms of targeting the neediest students, which has resulted in more and more needy students having no other option but to borrow.

Third, is the issue of the cost of borrowing. Significant borrowing for college has now become the norm. Thus, it is crucial that improving the terms and conditions of borrowing become a top federal priority.

Clearly, a reasonable interest rate on student loans is the single most important factor in making borrowing more affordable. The new formula for determining the interest rate on student loans scheduled to go into effect in July, would produce a significant drop in interest rates.

To most students, an interest rate of 7.11 percent, which is what the rate would be, looks similar to market rates on other familiar types of loans.

Students have witnessed the effect of the nation's improved economy on market loans for mortgages, and automobile loans. Just as consumers of those markets have experienced significant drops in their interest rates, students have expected a major decrease in their loan interest rates.

Thus, while we fully understand that lenders do need to make a profit, a rate in excess of seven percent, does not strike students as unreasonably low. In our negotiations with lenders a rate of about eight percent was the lowest they could offer.

The difference between these two rates may not strike many as significant when borrowing was not as prevalent, nor the amount of loan debt nearly so high, the difference between the two rates would not have been so crucially important.

But today, given the increased number of borrowers, and the increased loan amounts, the difference in cost would be enormous for students. For a student with $40,000 in loan debt, a one percent drop would mean a savings of over $2,500 under a ten year plan, and more than $6,000 if the student needs 20 years to repay the loan.

For the many graduate and professional students, graduating with loan debt of $80,000 or more, and who very often do need 20 years to pay back their loans, a single percent drop in the interest rate would mean a savings of over $12,200.

USSA and students in general fully appreciate the importance of maintaining sufficient profitability for for-profit lenders in the FFEL program. We understand that reasonably low rates would be meaningless if no lender would be willing to offer them to students.

Thus, we have made concessions that have included some higher costs for students. Regrettably, however, the distance between the two sides has proven too great, and thus this subcommittee has been compelled to make decisions they may have preferred to have had negotiated.

We believe the subcommittee has listened carefully to students, and shares our concerns. We have talked with the subcommittee over the past several months, and now we urge the subcommittee to guide Congress in providing low cost loans to students, while ensuring adequate access to capital.

We do not, however, believe that Congress should maintain a loan program that protects the profits of each and every lender who desires to be in the business of student lending.

Again, on behalf of millions of students, I want to thank the sub-committee for the opportunity to speak here today, and trust that you will strive to provide the anticipated and desperately needed guidance for students in any policies you may decide to pursue.

See Appendix I for the written statement of Ms. Erica Adelsheimer


Chairman McKeon. Thank you.


Mr. Nassirian?



Mr. Nassirian. Thank you, Mr. Chairman. My name is Barmak Nassirian. I am director of policy analysis with the American Association of State Colleges and Universities. We represent about 400 public four year institutions, and some 30 state systems of higher education.

I appreciate the privilege of testifying before the subcommittee, and view this as the most recent example of the manner in which you and the ranking member leadership of the full committee have really attempted to be balanced and fair about the process of attempting to address the substantive difficulty on the question of student loans.

In terms of addressing the substance, I guess I should sort of begin with a set of quick points. One of which is that interest rates, as has been noted in prior testimony on student loans, are legislated rather than market based.

We have had over the past decade and a half, seven percent, eight percent, nine percent, ten percent, if you include supplemental loans for students, 12 percent, and up to 14 percent, as the right number written into the Higher Education Act.

One difficulty we all confront today strikes certainly those of us who have been in negotiations with lenders as particularly painful, and I'm certain that you, too, have suffered along with us, this is not a new confrontation.

Successive Congresses have had to exercise the kind of prudence judgment that the subcommittee now has to exercise. They have had, on the one hand, a desire to lower rates to the maximum extent practicable. On the other hand, they have had a real concern about the availability of loans being guessed wrong.

Now, we've had this repeatedly over the entire history of this program. What happened, in my judgment, was that initially, obviously, those of you who recall the beginnings of this program, Congress guessed wrong in the direction of setting the inducements too low.

As a result of that capital problems confront the other extreme. And we ended up with a system that really, in retrospect, we know had excess profits built into the subsidy. We know this, because after we really did go to one extreme, Congress then began to make incremental cuts to bring it back down to what it could anticipate lenders to still tolerate.

That has been the way that this whole mechanism has worked over the years. And once again, the choices before Congress today are just about as stark as they have been historically.

So, the discussion of a market-based mechanism I think is worth pursuing. Again, I agree that it's not going to happen overnight. Certainly, not in the next two weeks.

I do note that certainly higher education students share the concerns which your actions over the last years have convinced us are your goal. Your goal is to lower the rates. We view you as our ally, because you have convinced us that, in fact, you are striving to find the lowest rate possible, but you are also legitimately concerned about access to capital.

Lenders, on the other hand, very naturally, very appropriately, are in the business of seeking the highest rate they can. It's their job. They have a fiduciary obligation to maximize returns. The final arbiter of attempting to balance both, the credibility, the extent of knowledge on each side, falls to you. And we're very comfortable, I know, much to your chagrin, because you would have preferred for us to come up with a solution.

I have included in my rather lengthy analysis of where I think the Treasury report has sort of been revealing. I candidly have to tell you that I find the Treasury report quite compelling, but it masks a series of policy problems. Not the least of which is the question of mass exodus of banks from this program.

I will quickly quote by pointing out that banks are an endangered species in FFEL. Competition from not-for-profit lenders coming at them from one side, and then from certain non-bank lenders from the other, has put them at risk. It will be a mistake to assume that the interest rate, or the question of yield alone is going to exclude banks.

There is sort of a perverse process, in fact, by which the very exodus of lenders from the program is being cited, where people were driving the banks out, the issue of yield only affects the timing.

My testimony indicates that I can subscribe to what has emerged as a consensus point of view here. That the long-term indexation is a mistake, needs to be addressed. And that provided certain other conforming changes are made, that we probably will have to move in the direction of a somewhat less severe cut to yield than the administration has proposed.

I would close by thanking you, and looking forward to your questions. Thank you, again.

See Appendix J for the written statement of Mr. Barmak Nassirian


Chairman McKeon. Mr. Steele?




Mr. Steele. Good afternoon, Mr. Chairman and members of the committee. My name is Jerry Steele. I am the executive vice president and chief operating officer of EdFund, a California based non-profit student loan corporation.

I will abbreviate my comments this afternoon and ask that my full text be entered into the record.

EdFund performs all the services for the Federal Family Education Loan program for the California Student Aid Commission, which is the California designated student loan guarantee agency.

In that capacity, EdFund administers all of the commission's guarantee programs for $1.8 billion in student loans during just this fiscal year, which is approximately 400,000 student loans in California.

EdFund also manages default prevent and defaulted loan collection activities on an existing $12 billion portfolio of outstanding student loans.

California students will borrow approximate $1.2 billion just between the months of July and September, the cycle for when the academic year starts, under the FFEL program. This is the high point for our borrowing cycle.

During the remainder of the upcoming year, they'll borrow an additional $1.1 billion. The amount of financing needed on a daily basis during this high season is $23 million a day. And loans in California account for 60 percent of the financial aid provided to students and schools in California.

This information is designed to help illustrate the importance of maintaining the flow of student funds in financing. As I'll point out a little later in some of my comments, any reduction in lender financing and participation in this program is a significant issue for our agency, and would have a dramatic impact on college access for California students.

During fiscal 1997, $2.2 billion of California's total student loan volume was originated through the FFEL program. That's 72 percent comes through FFEL. The balance of the 28 percent is provided through direct loans.

We believe that the original ten-year note program that was recommended would disrupt financing for the FFEL program by either restricting or eliminating many of the lenders from the program. The loss of private sector capital will translate into reduced access for education, higher education for students.

The lenders who participate in our California market have characterized this as a serious problem, and our own analysis confirms that. We talk about this spread, and the basis points, and the profit margins.

It's not profit. Someone mentioned the profit margin. That spread covers operating costs, making the loan origination, the two percent credit risk share that they have to participate in. Also understand that that loan can be on the books for a long period of time. You're a college freshman you take out a loan. Four years of school, six months of deferment after graduation, then ten years of repayment.

That loan is on the book for 14 years, on the bank's books. The economic cycle goes through one or two gyrations, maybe three gyrations during that 14 year period. Looking at it at any spot period of time, you can make a good decision, bad decision.

But you must look at it as a portfolio over 14 years as a freshman, 12 years as a junior, maybe ten years as a graduate student.

We understand that there is a dilemma that you, as Members of Congress face. But the issue becomes one of what is attractive to student borrowers, but potentially singularly unattractive to people who provide the money.

EdFund and the Student Aid Commission who we work for, have not advocated a specific proposal. But clearly the lenders in our area are supportive of a short form index, because a long-term index creates an unacceptable alternative.

They will either withdraw from the program altogether. Or, in response to one of the committee member's questions, they will actually exclude schools who have a higher historic default rate, to protect their own default rate protection.

Or, if they don't have an ongoing business banking relationship with that school, that school will no longer become an attractive candidate for them to deal with. So, they will become very selective, even if they would stay in the program at a reduced level.

California's market requires that a great diversity of lenders be available to fulfill its responsibilities at all levels of risk. California's portfolios of FFEL participants include 80 percent of those students enrolled in the four year colleges and universities, and 20 percent of all those enrolled in two year schools and Vo-tech.

We serve over 400 public and private schools, 106 community colleges, and 300 vocational schools. Consumer choice is imperative. Now, choice is fostered by competition between the direct loan program and the FFEL program.

Competition amongst lenders in the FFEL program increases the level of service to the consumer. Service is all about what we are trying to deliver.

The NASLA, the National Association of Student Loan Administrators, of which EdFund is a charter member, also advocates this choice in competition.

To address one of the remarks earlier by one of the other speakers, if lenders are not willing to serve a portion of these schools, they either can turn to the direct lending program itself, or what is referred to as the Lender of Last Resort program under the FFEL program.

As a lender of last resort in that program, let me explain to you, please, that this program was only designed to serve small pockets of borrowers or schools who do not have access to loans.

It requires a lender to originate the loan, and it was not intended to serve as a safety net for schools or borrowers that could be impacted by this kind of interest rate change.

We in California do about 3,500 of these loans a year, for about $15 billion a year in volume. We do 400,000 loans a year, a 25 percent reduction, is 100,000. I need to work with nice, round numbers. I can't divide.

To take a program from 3,000 loans to 100,000 loans in a period of a couple months, I don't think it is scalable in the short term. It is not a fix, which is an ideal solution, and it will come back, and bite all of us.

California has always advocated competition between the FFEL program and direct lending. The Student Aid Commission feels that both programs should be allowed to co-exist for California schools. And that open, freedom of choice is important, the same as there should be comparable program cost and benefits both between direct lending and FFEL.

Continuous access to the Federal Family Education Loan program is essential for California students, and students throughout the nation. Thank you.

See Appendix K for the written statement of Mr. Jerry Steele


Chairman McKeon. Thank you very much.


Mr. Veenis?




Mr. Veenis. I've submitted a full copy of my full testimony into the record. I'll also make a few additional comments.

Thank you, again, Mr. Chairman. My name is Jon Veenis. I am president of Norwest Student Loan Division. I am also chairman of the Education Funding Committee for the Consumer Bankers Association.

My testimony today is on behalf of those two organizations, both the American Bankers Association, the Education Finance Council, and the National Council of Higher Education Loan Programs.

Collectively, these organizations guarantee over two thirds of the cost, over $20 billion made to students each year.

Since last Wednesday, financial institutions have spent considerable time in reviewing the report of the 1990 interest rates prepared by the Department of the Treasury. We are very pleased that Treasury agreed that the current statutory formula for rates after July 1st is not working, as we discussed in the last panel.

This primary Treasury finding is an important step in resolving problems created by the 1998 interest rates. Unfortunately, it's only the first step.

I am also submitting with my testimony a report prepared by the firm of Ernst and Young, addressing what we consider to be errors in the assumptions of the recently completed Treasury report. These assumptions result in conclusions that are in fundamental discord with how we evaluate these assets.

Time does not afford a full view of our analysis, so let me summarize our conclusions. First and foremost, Treasury used incorrect assumptions regarding lender expectations related to return on assets and return on equity. By assuming lenders are willing to accept lower returns, Treasury assumes reduction in yield from lenders leaving the program. As I will explain later, our survey of student loan lenders proved this assumption wrong.

Second, Treasury also assumes that lending costs associated with student loans were lower than those actually experienced by lenders in the market. This incorrect assumption resulted from reliance on data from only the largest student loan providers, though I know even those lenders are not in agreement with Treasury assumptions related to costs.

Our differences with Treasury assumptions are therefore so large in our report. We also note that four other analyses prepared by various entities identified other differences with Treasury that are consistent with our suggestion.

In preparing for my testimony today, I was warned, Members of Congress are not interested in exchange of technical numbers where it will be difficult to tell who is right and who is wrong. I can fully understand and appreciate that.

However, we would ask that you look at our suggestions, verify them through publicly available information on how financial institutions evaluate asset opportunities, and use them as replacements for Treasury's assumptions, if you so agree.

Treasury's report, and Vice President Al Gore's proposal to reduce borrower rates to 1.7 and 2.3 are not realistic proposals. They don't work. They must, in my view, be rejected.

In looking at student loan interest rates, CBO and others involved in this issue have reached out to the higher education community. In one of our first meetings, we were pleased that four principles were articulated of which we could all agree.

First, maintain a healthy FFEL program and a healthy direct loan program.

Second, avoid a train wreck. We must make certain that all eligible students who need a loan can obtain a loan.

Third, assure an adequate lender return. The good elements of FFEL, such investments in technology, borrower benefit programs, and reliability of loans, must not be sacrificed as we work through this issue.

Finally, all of us want to reduce the borrower interest rate as much as possible.

We continue to believe that these principles can guide Congress as it moves forward. But unfortunately, a train wreck is definite possibility. Immediately after the Treasury report was released, CBO polled its committee members, and asked them confidentially whether or not they would make loans under your proposal.

Two said yes, nine said no, and two responded that they were not certain.

We also asked these lenders whether they thought enactment of your proposal would result in major loan access problems. Ten responded yes, with another saying they were uncertain.

Mr. Chairman, we need your help in finding a solution, to balance the interests of students in paying as little as possible for their loans, with the larger interest of having loans available to all who need them.

We are prepared to work with you and others to find a solution that will reduce the current borrower rates, while maintaining a return to lenders that permits innovation, offering borrower programs, and continued full access to all borrowers.

It will not be possible to accomplish these things under Vice President Gore's proposal.

In closing, I want to make some suggestions being included in the proposal. First, as reported by Treasury, the most efficient practical reference rate or index should be used in the formula, such as LIBOR or commercial paper rates.

Efficiencies produced for lenders and holders can be used to reduce the cost of programming.

Second, lenders should contribute to reducing the cost of loans. But the reduction should be based on sound economic analysis. Only a modest reduction from current lender yield can be made without jeopardizing the reliability of the program.

And third, any modified interest rate should apply to both FFEL and direct loans, as proposed by Vice President Gore. Doing so will avoid the potential disruption caused by schools opting in and out of the two loan programs, simply based upon rates.

Again, thank you for the opportunity to be here today. I would respectfully like to thank Representatives Kanjorski and Gordon who appeared on the first panel for their support on this issue. I would be pleased to answer any questions posed by the Members. Thank you.

See Appendix L for the written statement of Mr. Jon A. Veenis




Mr. Carey. Thank you, Mr. Chairman, members of the subcommittee, my name is Paul Carey. I am executive vice president of Sallie Mae.

As a national secondary market, we have a unique opportunity to observe the student loan market in all 50 states, and see the variety of market dynamics. We buy loans from over 1,200 lenders, ranging from the largest lender in the business to local banks which finance just a few loans a year.

We own loans from students who have attended over 4,000 schools. And service over five million borrowers.

I am pleased to have the opportunity to testify before the subcommittee today. We all have the same objective, to provide reliable and efficient low cost loans to student and parents.

One thing we cannot forget is the tremendous success of this unique public-private partnership that began over 30 years ago. Today, lenders in the business provide over $20 billion of capital to students, parent, and higher education institutions.

Capital is provided efficiently, with the highest level of customer service. Lenders in the business, we all compete on price. We take care of our customers. We answer phone calls of borrowers within ten seconds, 24 hours a day, seven days a week.

We allow borrowers to access their loans on the Internet, and we all strive to harness the next technology to better serve students and schools.

Schools can solve many operational issues through the use of our technology. We all transfer funds electronically to thousands of schools across America. Sallie Mae has direct data linkages to administrative systems to hundreds of college financial aid offices.

Over the past five years, Sallie Mae has invested a half a billion dollars in technology. Just in technology to better provide this level of service to our school and student customers. Other lenders in the business have made similar commitments.

The taxpayer benefits through lower cost to the government. As you probably know, over the last five years, the FFEL program has cost the government four and a half billion dollars less than the five previous years. This is a fabulous success story.

One of the greatest attributes of this program is that capital is available in any interest rate scenario, high, low, or anywhere in between. It is the result of the lender interest rate being tied to a short-term index, with a sufficient margin to cover costs, and provide adequate return. In fact, until recently, no one ever worried whether capital would be available in the student loan market.

We were heartened last week when the administration acknowledged the unworkability of the ten-year index. Everyone now agrees we have a problem. Now is the time to fix it.

Unfortunately, the most important issue that was ignored in the analysis, and often overlooked by many others, is the difference in return for loans made to students at different types of schools.

It costs the same for us or Jon or anyone else who services these loans the same. About $40 a year, regardless of the size of the loan, or where they went to school. Some students at independent private colleges borrowed $20,000 or more. A student at a public institution may only borrow $4,000.

Regional differences have a great impact, as well. In the southwest, it costs about half as much to go to a community college as the northeast.

I have shown a chart here that I hope you can see. I didn't realize the room was so large. It has a simple message. Changing, reducing returns for good programs of low cost, short duration, at risk.

The student at Hopkins, or Harvard, or Stanford, or MIT, may well get their loan at returns below today's. Students attending state schools, community colleges, or learning a trade, will not.

We wholeheartedly agree with Treasury's recommendation of thoughtfully using market-based pricing for loans. But the solution must encourage both price and service competition. We encourage examination of Representative Kanjorski's proposal to model is after the FHA and VA programs.

As I noted earlier, this is an issue that needs to be solved now. There are a variety of resolutions that would be successful, and they entail three things, I believe. Tying the loan rate to a short-term index. The 91-day T-bill has worked for 30 years through a variety of economic conditions.

Using a more efficient index, such as CP or LIBOR, makes even more sense. These would allow funding efficiencies to lenders that could be passed on to student or to the taxpayer.

Provide an adequate return to attract capital, encourage innovation, encourage investment in technology and systems, and promote competition. These are the things that make this program work today, and make it get better every year.

And finally, review proposals for a market-based system with real operational reforms. This will encourage competition, investment, and high quality service. However, these reforms should be studied carefully and prudently, not in a rush because of a pending crisis.

I appreciate the opportunity to be here today. Sallie Mae looks forward to the opportunity to work with you and the administration to develop a solution that serve the best interests of students in the higher education community. Thank you.

See Appendix M for the written statement of Mr. J. Paul Carey


Chairman McKeon. Thank you very much. This has been a very good day. I think we've had excellent testimony. You have all contributed greatly to the debate.

Ms. Adelsheimer, you have brought out a point that I concerns me. I have five children who have gone through school, one that has not graduated, but has gone to college, and one who is still in school. I think most of them have probably taken out student loans, and some of them received grants after they were married.

But what I'm really concerned about is a two-pronged problem. We are talking about cutting interest rates, so that the students can borrow more money.

I'm concerned about piling on more and more debt. I've also noticed not just here, but there's also credit made very accessible to college students. They get all kinds of offers for credit cards, for other kinds of loans.

When I'm looking at the interest rates on those, it would be interesting to look at what interest they pay on credit cards. I'm sure it's twice the rate of what we are talking about here for these.

Mr. Nassirian, you said that in the past, Congress, in a similar situation, guessed wrong, and dangers were caused from that. I have real concerns there, if we make a mistake one way or another. We're down to talking a few basis points on these kinds of things. Maybe we've gotten so focused on this, that we've forgotten what we're really trying to do. The potential for the downside of this is much greater than the potential for upside risk.

In other words, we're in a political position, if you think that we've been too favorable to banks, then we're going to get trashed. We've been there before, if you remember student lunches. All in the name of trying to do what we think is better to help people.

And politicians, we like to be liked. We have human feelings, just like everybody else. And not all of us are blessed with the wisdom of Solomon. I know one who isn't. Myself.

Mr. Steele, when I visited your organization, one of the things we talked about was how your organization is paid. There's been a lot of talk about profit, excess profit.

I've forgotten some of those numbers. But could you just refresh me a little bit. How much have you paid to service a loan over a period of years?


Mr. Steele. Well, as a participant in the program, we're really carrying out the rules and program activities under the sponsorship of the Department of Education, through the California Student Aid Commission, which is the holder of the guarantee.

In our case, the way it works is that, we hold that asset for, let's say 14 years, to use my example. We get a one time, up front 84 basis points, fee that we are allowed to take out of that proceeds of that loan.

Eight-five basis points, divided by 14 years, is roughly six basis points per year. An average loan in California means you get $30 a year to service that loan.

Now, we are the guarantor. So, we maintain the file records, et cetera, and the banks work with us, as long as it's a good loan. If it's a bad loan, the banks sell it to me, because I guaranteed it. I then have to work that loan for the life of the transaction, to recover the money for the Department of Education, ultimately, the U.S. taxpayer.


Chairman McKeon. Mr. Veenis, you said that, I forget the exact number, but the big percentage of the people you represent indicated they would drop out of the program if something is not done to fix this problem.

I have real concerns. I wish I had had more time with the Secretary when he was here. He talked a lot about borrower of last resort. Looking at 3,500 loans out of 400,000 loans, and laying it onto that.

And then, some of the problems we had this past year, with the direct lending program, where they had to shut down their loan consolidation part. I think all of us had some concerns there about how much additional loan volume they can take over and handle efficiently. We talk about lender schools.

Well, we start getting into loan volume. Not just making the loan. Giving out the money, but also servicing it, and collecting the money, and getting it all back.

There's more to talk about than just five minutes. But again, I appreciate your being here, and I’ll turn the time over to Mr. Kildee.


Mr. Kildee. Thank you, Mr. Chairman. What it really means, in these hearings and all our discussions there has never emerged on this committee the strictly pro-banker, or the strictly pro-student group. Because we're all here to be pro-student loans.

We have to find out what is the best figure to put in there, to make sure the lenders stay in, and the borrowers get the best possible deal with the lenders there.

But I'm glad that there's a consensus that seems to be emerging that we will go to the 91-day T-bill. That's the one part of the problem.

We have to put some numbers in this bill. And we're trying to find out, as I'm sure all of us are, what should be the rates that we put in there, assuming we take the 91-day, what will the rates be. The administration said 1.7 while in school, and 2.3 in repayment. Currently it is 2.5 in school, and 3.1 in repayment.

I want to make sure the students are treated fairly, that the lenders remain in the program.


Mr. Veenis. Can I take your current time? Having had the pleasure of sitting in for the last several hours as we've talked through this issue, and the question has been asked several times, it seems that while there's a lot of very intelligent people in this room, that really, no one has the answer.

The answer is out of the marketplace. The marketplace really dictates what that rate should be.

In the absence of that, with today's current FFEL program, you have a program that provides, in my view, high quality service, as evidenced by a recent survey that was conducted, authorized by the Department of Education.

You have price competition that is demonstrated through borrower programs, and through reduction of up-front guarantee fees, and other fees. There is price competition in today's program, under the existing pricing that's in place.

We have offered as an industry and offered what we believe can continue all of those very attractive features of the guarantee program. Still offer a 15 basis point cut in both the in-school and repayment periods and still have a very vibrant FFEL program.

If you start going beyond that, you have to ask yourself, what sort of program do you want? Do you want to run like a utility, where you go to the lowest common denominator of services? Or do you want a program that schools and students seem to like?

So, we'll continue to offer that proposal, and believe that it's going to result in continued competition in the program, including price competition.


Mr. Kildee. That would be 2.3 and 2.9? Is that right?


Mr. Veenis. That is correct.


Mr. Carey. Along the lines of different industries, as Jon said, I think others have said is, if we went to something like a commercial paper program proposal, a lot of what we put out, that provides real benefits.

You're only losing out by moving from a T-bill to a real money market instrument, it’s really trading interest rate swaps. What that does is allow us to maintain our net spread, and allow for lower cost to the student. That's why we had proposed moving off of the T-bill a couple months ago.


Mr. Kildee. You proposed commercial paper, or LIBOR, or what?


Mr. Carey. Our most recent proposal is commercial paper.


Mr. Kildee. Anyone else?


Mr. Nassirian. Mr. Kildee, I guess I am copping out in giving you a straight answer. But I have to say that attempting to solve the real issue through the setting of a number is not going to be satisfactory. Let me demonstrate that.

The number was cited in terms of return on equity for CitiCorp of 16 percent. Now, if you go to a non-bank competitor, what would you say the number ought to be in the range of?

I'll read it to you. It happens to be Sallie Mae's. There used to be a 27.85 percent return on equity in 1994. It went up to 29.17 percent return on equity in 1995. Fifty percent return on equity in 1996.

But this is good. I endorse it. However, I'm simply pointing out that setting long rates is not going to be as helpful to keeping the kinds of banks as was pointed out, the efficiency that CitiCorp has.

I have to very candidly tell you, I think the Treasury analysis, and then the administration proposal, is highly tenable for people who have a 40 cent on the dollar advantage, when it comes to student lending. People who don't pay income taxes, corporate income taxes.

I think that is adequate for them. The problem is, they only hold the quarter of the total and I daresay, we probably don't want a system in which banks are pushed out, and only tax exempt entities are players.

There isn't one answer. I really would think that banks are going to be pushed out of this business. You could delay that process if you set a high rate. You will accelerate it if you set a lower rate.


Mr. Kildee. Erica? Do you have anything to add on this? I know that…


Ms. Adelsheimer. Only to add that, as we said in many of the negotiations, the students do not have an interest in what index is used. We're a peacock statement, that we're probably the most efficient and reckless for using a better index. We appreciate that. We hope that it will help the lenders.

On the other hand, we are overwhelmed by debt. And the best way to break down our debt, the cost of our loans is to make a significant decrease in our rates.

Students are aware, that they have been anticipating it for not because they thought it's a win. Not because they thought this is just something that's great, but something that they fought for in the 1995 Reconciliation bill. It was said to them it would be preserved as student benefit.

So, they are really, anticipating this reduction in rates. They feel desperately that they need it and deserve it.

I just want to add one problem. When talking about preparing for testimony, I was telling all of you that I was going to testify, a little bit nervous and everything, but that I was accosted by so many stories about student loans.

Not just people that we talk to every day, people like my housemates, people at the gym, people that I run into every day, just overwhelm us with stories about their indebtedness.

I talked about a few examples in my testimony. I just want to point out quickly that, one of our students who will graduate from Yale University next semester, is going to have over $40,000 of debt, and will have over $400 in interest payments.

Now that amount is going to really impact her decision as to what she does after graduation. She's already turned down a job offer for public service, which was her top priority, and doesn't know how she's going to meet her interest payments.

There are numerous other students, like my friends at the University of North Carolina, who even has an Engineering degree from the University of California at Berkeley, and is now working towards an MBA. Even though he didn't take out loans for undergraduate studies, and his masters degree was clearly paid for by his employer.

Yet, when he's finished, he will have a total loan debt of over $100,000. His monthly payments will exceed his rent payments.

Now Liz has to not think about having a career in rural North Carolina medicine, or possibly urban inner city medicine. But also that they can't invest in a car purchase. They can't even think about a house purchase. They have to delay child bearing. And they even are not able to go home and visit their family during the holidays, because they have to pay their loan repayments.

So, it has huge, significant impacts on millions of students. I’m nervous enough, not because I'm testifying in front of Congress, although that makes me nervous, too, but because it's so important for students that this become a reality. That we see some type of significant decorrelation in the interest rate.


Mr. Kildee. Just one comment. Up here we wish, I know I wish, that we could resolve this where both the lender and borrower both would be happy. I suspect we'll probably write something where both the lender and borrower will be somewhat unhappy. That's not, an envious position to be in. But we're trying to keep both borrowers and lenders in the program and I appreciate your testimony.

Thank you, Mr. Chairman.


Chairman McKeon. Thank you. Just one more thing, Erica. You said, having a lower interest rate would be the best thing. I just might recommend that that's not really the best thing. If you save up a few basis points over a period. I save some money.

I would encourage you, when students call, to use all the passion you feel on this issue to get them to borrow less. If instead of $40,000 they only borrow $39,000, they would save more than if we just eliminated interest rates.

So, I think there needs to be some emphasis and direction. I know because of my children. If it's so easy to borrow the money , they borrow it.

I had a friend come to me the other day, and I've told this story before. His oldest daughter is going to school now. He's a very well to do physician. He didn't need the money.

That day he said it was so easy to borrow money, he borrowed it. It's a direct loan. He's not trying to pay it back, because he doesn't want to pay the interest, and they can't tell him who to pay it back to, or how to pay it back.


Ms. Adelsheimer. Right.


Chairman McKeon. Mr. Goodling?


Mr. Goodling. I want to repeat what I said earlier, when Mr. Gruber was here, because I wanted Mr. Andrews and Mr. Petri to hear it, particularly. Because he indicated that the HEAL program was a success, and it was a disaster. I wanted to make sure that both sides of my aisle understood that it was a disaster, not a success.

Ms. Adelsheimer I hope we can get the U.S. Student Association to help us in attacking this from another angle. I happen to believe that there is no excuse under the sun for the cost of education to rise three, and four, and five times faster than inflation. I would hope we can enlist your support in helping us to do something about that.

Also, I agree with you, we're not here to protect every lender. At the same time, I want to make sure that there are sufficient lenders here, so that there's competition, so that students have access.

Because, as I said earlier, I know who will be first to be chopped off a chopping block, if it's a matter of fact, we get down to the point where we have few involved in the whole process. The creaming will take place. And people who really need, and really need help, will get nothing.

I want to next thank Mr. Nassirian. I understand you've been very helpful, trying to help the staff muddle through this mess. One of the questions I would have for you is realizing July 1 is around the corner, how have you been counseling those that you represent?

I would assume that they're all on edge, and pretty nervous?


Mr. Nassirian. Mr. Chairman, thank you for the kind words. And with regard to counseling our constituents, I think it's sort of fair to characterize our side of this process as attempting to sort of not go too public with expressions of anxiety, precisely because we felt that the Chairman had instructed us so well. We're clearly engaged in the process of negotiating with our colleagues on the student lending side of the process.

I have had very little by way of field contact with regard to expressions of anxiety. There have been a number of meetings by friends within the loan community to institutions, and offhanded, those have, in fact, triggered phone calls from the aid directors, for example, at that level.

But I represent institutional presidents. And we have basically told them we are in the process of working the complexity out. And that there will be a settlement, as I'm certain there will be.

We really and truly believe that the subcommittee and full committee are our best ally in all of this. We know that you are attempting to make good public policy on this. And therefore, we are generally substantially more comfortable in waiting for the solution.

This makes your job so much harder. Because if, perhaps if I was really uncomfortable, I'd be rushing out to do something else. But precisely we feel you are our ally in this, we believe it's going to be settled in a mutually dissatisfactory, but not too unhappy a way. Thank you.


Mr. Goodling. Thank you. Mr. Steele, according to the Bank Rate Monitor, the national average rate for a home equity line of credit is 8.62 and for a 30-year fixed mortgage is seven percent.

With the government guaranteeing these loans, how close can we get to that seven percent? And what is the difference? If we can't get that close, what is the difference?


Mr. Steele. Well, I have two colleagues who are in the market as bankers.


Mr. Goodling. I'm sorry. I was addressing that to Mr. Veenis in the first place.


Mr. Steele. Okay.


Mr. Goodling. I made a mistake. I wasn't going to let him off the hook, and I wasn't trying to put you on the hook.


Mr. Veenis. I'm a student loan banker, so I'm not as well versed in the mortgage banking market as I should be.

It seems to me that you're looking at two fundamentally different loan types. And if you believe in somewhat rational economic pricing, lower risk loans are going to carry lower rates.

And I think within that context that causes mortgage loans to be lower cost than what student loans are. And to be brief, the default, delinquency loss on mortgage loans is substantially lower than it is on student loans. And so, you have a much reduced servicing cost because of that.

You have these delinquencies because they're making loans to borrowers. Who at the time the loan is obtained have income. They go into repayment right away. They tend to be fairly stable. They know where they're at.

Student loans, you make loans to borrowers that are not going to have an income for several years. The loan doesn't go into repayment for several years. And once the student leaves school, understandably so, a period of time before they begin repayment it really drives up the cost of servicing.

The other is purely size. We're talking an average loan, a student of about $3,000. Maybe a mortgage loan is $133,000. And so, the cost of servicing, because of the different loan sizes, also drives the servicing costs down significantly.

Those two factors cause mortgage loans to be mortgage loans to be lower priced than student loans.


Mr. Goodling. Thank you. Mr. Carey, I don't have any questions. But I have a fellow up here who says that you're a great golfer, and he plays golf with you. All I can do is offer you my condolences. It certainly must be a terrible, terrible problem for you in playing golf with him.


Mr. Carey. Well, this interest rate issue has ruined my golf game. But I do thank you for mentioning the HEAL program. Fortunately or unfortunately, I've been in this business for about 17 years. I remember the HEAL program. And that was not a positive program at all. Somebody would buy the business this year, and somebody else would buy it next year. And it was not centrally located. The schools went crazy.

That shouldn't be the model for our market-based program. There are better models than that.


Mr. Goodling. Thank you.


Chairman McKeon. Thank you. Mr. Andrews?


Mr. Andrews. Thank you. I want to thank all of the panelists for their ongoing participation in this effort. As Mr. Kildee said, and Mr. McKeon said, we should sincerely try to find the right answer to this. And I hope that everyone will work with the administration, as we try to find the answer.

For the Student Association, I'm interested in with permission of the Chairman, entering some of those stories you made reference to in the record. It's important that we do get beyond the statistics, the numbers we hear about in order to hear people's concerns. I think that'd be a good way to do it, and the Chairman would agree, as a supplement to your testimony.

And also, Mr. Chairman, what I ask you to consider, is requesting help for us to sort through some of the analytical aides that we've encountered today, that we ask the Congressional Budget Office, if they would be willing to consider analyzing the Treasury Department study and its insight into this.

With your permission, perhaps we could make that request.


Chairman McKeon. The CBO is one of our biggest problems right now. Because for years, they have given one type of analysis. And now we're faced with this problem, they've also changed the way they analyzed it. That's a fairly complicated problem. We have already asked them to score this by the old method.


Mr. Andrews. Thank you. The point of my request is that they have a historical perspective on this.

I wanted to say to Mr. Veenis, there are actually Members of Congress, on both sides, who are interested in technical data, who are trying to sort this out. And we appreciate you coming with this data.

I read your analysis that you made reference to. And I want to ask you a question about it, if I could. Feel free to supplement the answer in writing.

The Ernst and Young analysis on page two contends that let me back up a second. It's your conclusion, the analysis' conclusion, that the Treasury Department study is flawed, because it understates the lender expectation as to what they're going to make off this program.

And the basis of that conclusion is on page two of the Ernst and Young report, where they said, they think that given the risks associated with student lending, a more realistic pre-tax return on equity is in the range of 45 to 30 percent. They seem to think that is the range.

Now, that would seem to me to mean a post-tax return of 15 to 18 percent, somewhere in that general sum. We heard testimony earlier today that one study indicates that the typical post-tax return, I think the phrase is the average post-tax return, excuse me, would be 11 percent.

This is not a rhetorical question. This is a sincere one. I'm having a hard time reconciling that lenders expect a post-tax return of 15 to 18 percent.

Another report, which says that they’re getting a post, tax return of 11 percent.

If that's true, it's counter-intuitive that so many people stayed in the program. Are those numbers wrong, or what?


Mr. Veenis. Again, I'm not certain which report you're citing. What the 11 percent is?


Mr. Andrews. I'm asking a question based on Mr. Gray's testimony earlier. He was talking about loans having returns roughly 11 percent. I assume that's post-tax.


Mr. Veenis. I would agree that it's probably post-tax. If you'd flip to page 12 of the Ernst and Young report, what we've tried to do is to factor in some of the additional costs that they may have, legally, that they have not included.

To do that, you have a weighted return on assets of 0.77. You have an estimated return on equity before tax of 25 percent. After tax, a 40 percent tax bracket, probably 16? Something like that?


Mr. Andrews. Between 15 and 18?


Mr. Veenis. Yes.


Mr. Andrews. Again, it's not a rhetorical question. Explain to me why the realistic expectation is an after-tax return of 15 to 18 percent? And there's a lot of evidence to suggest that11 percent is more appropriate.


Mr. Veenis. We may get into an argument about who has better numbers than the other.


Mr. Andrews. Eleven percent is wrong? More than eleven?


Mr. Veenis. I believe that the Ernst and Young study has a 16 percent after-tax return, I believe after-tax is more realistic.


Mr. Andrews. So, your position is that a 16 percent post-tax return is typical of the industry?


Mr. Veenis. Yes, sir. Of banks. Again, there are different companies, so there may be, but I also submit that that is based upon anecdotal evidence on current lenders. Because there's only two companies probably, student loan data. So, it's hard to get a real handle on exactly what Mr. Gray was referring to.


Mr. Andrews. Just a final question and this is, again, this is no one's position. I'm sort of emphasizing two points we've heard today.

We've heard a very, very qualified person, I assume his position is to advise people with money to invest, and apparently has done so very, very well. Very successful. Testified that the post-tax return on equity to banks is 15 percent, roughly.


Mr. Veenis. I would take exception to that, also.


Mr. Andrews. Okay. Then you we hear you, clearly as an expert on student lending, tell us that your expectation is the average post tax return is 16 percent, which means that CBO is currently doing better than other kinds of bank estimates.


Mr. Veenis. I would cite also, and again, I don't want to refute Mr. Gray's testimony, but more talk to what our data suggests. And that is, we go to the bottom of page two, and the footnote.

I think that is indicative of my company. Norwest Corporation, last year, a return on equity of 22 percent. If you look at the footnote, which is Goldman Sachs, they say over the last five years, that the average has been between 12 and 21.9, and only one is 15.9 percent.

So, I think the return on equity expectations in the marketplace, among banking companies, is higher than reported.


Mr. Andrews. I appreciate that. I don't expect you to assume someone else's numbers. I assume the calculation was on the back of the envelope.

If the underlying market yields these present rates of return, some players in the private sector program are far below other financial asset reporters, I wonder if that's really true, based on what we've heard.


Chairman McKeon. Mr. Fattah?


Mr. Fattah. Thank you, Mr. Chairman. I want to thank the panel. Mr. Veenis, I wanted to pursue a couple matters with you.

The Chairman, Mr. Goodling, said that on a home equity loan for eight and a half percent, you get a mortgage for 30 years. And he says, what if on the government guarantee on the student, we get close to seven percent? And you responded, well, they are different types of loan circumstances.

I want to pursue this just for one minute, and hopefully get a concise response from you. One, the federal government is guaranteeing 98 percent repayment on a student loan. What is the level of guarantee on a home equity loan?


Mr. Veenis. I can't tell you. I'm not going to explain it. But let me ask.


Mr. Fattah. No. No. The point is, take my word for it, that the student loan has with it a guarantee unlike any other loan. So that an interest rate charge point, which is protected against risk, and also by the return on equity, there's no explanation that is plausible, even as a consensus, that a student should somehow be difficult to arrive at, at seven percent, given the other loan's to me, and to, I think, many, many other people.

But I want to pursue you said that you're representing community bankers to that, and the American Banker's Association. Is that what you said?


Mr. Veenis. Consumer Banker's Association and American Banker's Association.


Mr. Fattah. Okay. I wonder if you could submit at some point, or if you can answer now, the percent of your members whom actually service loans my impression of this is, of the student loans being provided by your members, what percent do the originators service. Do you have a general idea of that?


Mr. Veenis. I don't have that data.


Mr. Fattah. Would you agree that in most cases, they originate through the servicing, in terms of the community bankers, and the members of the association?


Mr. Veenis. From a number of member perspectives, yes. From a volume perspective, it's significantly different.


Mr. Fattah. Well, let me ask you like this, then. Can you tell me what percent of your member's overall portfolio, are student loans?


Mr. Veenis. If you took total bank assets, in comparison with student loans?


Mr. Fattah. All of the loans in the portfolio, business loans, mortgage loans, personal loans, and so on, what percent of your members would be student loans?


Mr. Veenis. I don't have that data, but we can provide it.


Mr. Fattah. If you could provide that, it would be helpful. Because in many, many instances, the reason why the banker is involved in student loans is because their customer, who is viewing with them a whole range of other matters, expects their banker to be involved in trying the system through a student loan process, but has never been for a normal, full service, consumer lender, a significant part of their business.

And that part is of the reason why the government provides the guarantee, to solicit, and to entice people to be in a fairly good situation to provide this as a community service. Not as a significant profit incentive for their lending activities.

CitiCorp and CitiBank lowered their rate 25 basis points. Also through your own testimony, you said that a number of banks, not many, but some had left the program. Could you give me some sense of how to reconcile those two things?

Especially in addition to your own comment that you believe that we could lower, response to Chairman McKeon's question, that we could lower the 15 basis points now, and continue to essentially do business.


Mr. Veenis. Well, yes. I can. What I said was, we had offered on the table a 15 basis points that can provide the current program has continue to provide the current services in the current program.

I also said that that ceiling would continue to allow price competition. There may be competitors in this business the largest, that may have better economies of scale, and better ability, in terms of servicing costs, to drive the price down lower.

That's what competition is about. We think that that will continue to spur competition in the marketplace.


Mr. Fattah. And you also cautioned that if we wanted to move a market based solution, that we should do so cautiously.


Mr. Veenis. Yes.


Mr. Fattah. But you're willing to think that there is, within this 15 basis point cut, there could still be market solutions. And I'm interested in, when you suggest caution, in terms of some of the proposals, like the auction proposal, and other proposals, it would seem to work fairly well, in terms of provision of other loans.

In terms of your members, their view on that, as to whether we should test that in a pilot, or we should cautiously, hold additional hearings, and more studies.


Mr. Veenis. We're only a few weeks away from the start of the 1998-99 processing season. To switch from a program that's currently the structure, to a total auctioning concept, I think is extremely dangerous.

Now, we're willing to explore, and continue the dialogue, about how we can inject more market pricing into the existing program. But I think, again, we ought to do so cautiously, so that we don't disrupt access for the existing lending season.


Mr. Fattah. I appreciate that. I also appreciate your testimony today. And I want to thank all of you. I just want to make one last point, that's been mentioned by everyone that there's a sense of urgency in this.

This was written into the law years ago. So, we all knew that this was coming. So that prices that we're talking about, in many respects, it's not prices at all. In the sense that we've known that it was going to happen. Congress passed this law, which would kick in the ten-year, long-term interest rate.

So, I hope that as the committee goes forward, that we would, as we think through what we go by this crisis that has been in the making for a very long time, that we don't put it off even longer, looking at some of the real solutions to this.

Because, as the Chairman said, if we'd be guessing at interest rates, I mean, since none of us has a crystal ball, it's almost impossible for us to get it right. Thank you very much.


Mr. Veenis. I just want to make a point, because I think it's been expressed, and I hope responded to. The 98 percent guarantee takes care of credit risk. It doesn't take care of one's servicing risk. I can tell you, there are a lot of people with a lot of regulations.


Mr. Fattah. …that's why you service their loan Mr. Veenis and it doesn't deal with the legislative risk. There's a lot of risk, but it doesn't deal with credit risk.


Mr. Fattah. But if 90 percent of the loans that are originated by your members are not serviced by your members, and suggesting that servicing risk is somehow part of the cost, is something that I think we would all…

That's why I might ask that you would supply that information on the percent of the originating loans from your members that are serviced by your members.


Mr. Veenis. We will.


Chairman McKeon. Mr. Fattah, we have recognized this coming crisis. We have been working on this now for a long time. It's kind of bubbling to the surface, and more people are becoming aware of it. But we have been working with these people, to try to come up with some kind of compromise, Mr. Kildee and myself, for several months.

It's just that nothing has happened in the way of a solution. And as the week goes by, and the month goes by, it becomes more of a crisis. Because there are students now, even though, I think Mr. Veenis said that we're coming into the season, these students, many of them in their senior year, many now in their junior year, are having to make decision, and plan out a debt.

They’ve already sent in their applications. They've already taken the tests. If they're not already accepted now for school in the fall, they have a problem.

So, it is a crisis, and it has to be solved. The problem is, the Treasury Department came out a couple months ago, and said they would finally give us a report on this looming crisis. The administration has been hard to defend this report and to even come to the table and talk about this problem, because I think many of us have felt that they would just as soon see it not be fixed, and drive everything into direct lending.

So, I mean, this is a crisis. It is a problem. And I appreciate the work that all the members here on the panel have done, because they have been working on this now for quite a while.

We need to get it fixed. Our plan is to have a number in the full committee mark-up. Now, my credibility may not be very good, because I told you we were going to do that a few weeks ago. Believe me, it will be in there. We are moving forward. We've already pushed much further out than we can on this envelope. Now this problem has to be fixed.

Again, I thank you for being here today. For making the efforts of your appearance. And I appreciate all of your input. If you want to keep giving us things, we will use it. But we're going to make a decision soon.

Thank you very much.

[Whereupon, the hearing was adjourned at 3:20 p.m., subject to call of the chair.]