Tuesday, March 30, 2010

The Ballad of Sallie Mae - A cautionary tale of public subsidy and arbitrary politics

The Ballad of Sallie Mae. WSJ Editorial
A cautionary tale of public subsidy and arbitrary politics.The Wall Street Journal, page A18, Mar 30, 2010

President Obama today signs his nationalization of the college student loan market, which will put the Department of Education directly in charge of doling out cash to students and colleges. It's one more plank in the cradle-to-grave entitlement state, but this landmark is also a good moment to recount the rise and fall of Sallie Mae. It's a cautionary tale for our times about public subsidy, arbitrary politics and doing business with the government.

The story begins in another progressive heyday, 1965, when the federal government launched a program to make college "affordable" by offering a taxpayer guarantee on student loans. College has if anything become even less affordable since, as the subsidies have merely driven up the prices that colleges charge.

So in 1972, with affordability still an issue, Congress created a new government-sponsored enterprise, the Student Loan Marketing Association, or Sallie Mae. Like Fannie Mae and Freddie Mac in housing, Sallie was born with a federal charter and an implied taxpayer backstop to provide a secondary market for student loans. Sallie would go public in 1983 and, also like Fan and Fred, mint money for shareholders by enjoying a lower cost of funds than fully private lenders.

[Stock price of Sallie Mae January 2000 - March 2010 http://sg.wsj.net/public/resources/images/ED-AL245_1salli_NS_20100329194502.gif]

This free lunch gradually became a source of political concern and an inviting target under federal accounting. In 1993 President Bill Clinton claimed in his first budget that the government could save billions by cutting out the private firms and lending directly to students. But even a liberal Congress had concerns about this "single-payer" model.

That year the White House and Congress compromised and created a "public option." The government's new Direct Lending program would compete with private loan originators. Sallie would still be able to provide a secondary market for the loans made by private firms, but new fees in the law took away much of Sallie's cost-of-funds advantage.

The Clinton Administration continued to push for the end of Sallie's federal charter. But in contrast to Margaret Thatcher's campaign to convert U.K. state-owned monopolies into private competitive companies, the Clinton team wanted to turn most of the market over to its new state-owned program at the Department of Education.

A 1996 law set a 2008 deadline to make Sallie fully private. The company moved aggressively into the loan origination market and went private a few years early, in 2004. For a time, business was very good, and the leader in the student-loan market saw its stock approach $60 a share as recently as 2007.

However, liberals were perennially disappointed that the "public option" at the Department of Education, plagued by customer-service failures, had failed to win most of this business. So when Democrats took control of Congress in 2007, they also seized greater control of education financing. First they reduced the return on originating government loans, then they increased regulation of private loans, and this year they pressed their outright ban on private origination of federal loans. Today a Sallie share costs $12.67. Sallie's shares fell with the financial panic, but thanks to the Congressional squeeze they haven't rebounded like those of the big banks.

We have no special brief for Sallie or its shareholders, who presumably understood the political risks they were running. Democrats have also been shrewd in pitching their takeover as an end to public subsidy, though there will be no such thing. The reality going forward is likely to be even more subsidies, more taxpayer risk and higher tuition prices.

George Miller in the House and Tom Harkin in the Senate are on a march to all-government financing, and that includes enacting new rules in recent years to discourage even private student loans with no taxpayer risk. Sallie had a booming business in fully private loans, but expansions of the federal Stafford and PLUS programs helped drive the volume of Sallie's private business down 50% last year. The PLUS expansion was enacted in 2006, proving that Republicans have also helped to build the subsidy machine.

This week's legislation is also a way to lever up spending on federal college grants. That's because Congress is pouring the putative savings from punishing Sallie and other private companies into more Pell grants. The savings are illusory, based on government accounting rules that ignore the likelihood of higher future loan losses, but the spending will be all too real for taxpayers.

We should note that not even the Congressional Budget Office believes that CBO's analysis is correct. In an only-in-Washington farce, CBO director Douglas Elmendorf has to his credit written a series of letters explaining in detail why his official estimates are wrong, which of course Congress ignores.

Following today's signing ceremony, Sallie says it will have to fire 2,500 of its 8,600 employees, though perhaps they can look for jobs at the Department of Education. Sallie's saga is almost certainly the future of health-care insurers as liberals attempt to resurrect their "public option" once insurance premiums inevitably rise.

As for the cost of college, expect it to become even less affordable as the subsidies keep flowing. The main achievements of this new legislation will be to give more power to government, and to transfer more of the costs and risks of college financing to taxpayers. There's no such thing as a free entitlement state.