Wednesday, May 20, 2009
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Q&A: ALBERT LORD AND JOHN REMONDI
Sallie Mae Seeks Truce
Student Loan Giant Accepts The Inevitability Of Reform And Makes A Counter To Obama's Proposal
Of President Obama's three top domestic priorities -- health care, energy and education -- his education proposal is getting the latest start on Capitol Hill. The House Education and Labor Committee is kicking off the debate on Thursday with a hearing on Obama's proposal to end the subsidized private student loan program in favor of government-run direct lending, with private loan companies reduced to service contractors. That change would save an estimated $94 billion over 10 years, which Obama would redirect to Pell Grants for needy students.
Reston, Va.-based Sallie Mae, the largest private student lender, has offered an alternative proposal that its top executives say would save just as much, if not more, while preserving competition for student loan business -- by making the government the main financier of student loans, while letting private companies originate and service loans. The government has in effect been the main financier for a year anyway, since the nation's private-sector credit markets dried up and Congress passed the Ensuring Continued Access to Student Loans Act in May 2008.
With lawmakers worried about rising unemployment at home, Sallie Mae also points out that private lending companies account for 35,000 jobs in 47 states and the District of Columbia. Sallie Mae itself has 8,000 employees and recently announced the return of another 2,000 jobs that the company had previously outsourced overseas. In an interview with National Journal's Brian Friel, Sallie Mae CEO Albert Lord and CFO John Remondi made their case -- and explained why the 37-year-old subsidized private student lending program is destined for change no matter what happens in the coming months. Edited excerpts follow. See the archives for previous Insider Interviews.
NJ: You've talked about seeing the writing on the wall for the student loan program as it has been structured, particularly since Congress cut lender subsidies in the 2007 College Cost Reduction And Access Act.
Lord: I've seen something coming for 25 years. Virtually every couple years -- and certainly every time the Congress reauthorizes the student loan program and the higher education act -- yields come down. Congress can debate among itself what the right number is and then later decide they maybe didn't cut it enough. And so, some number of years later, they'll cut it again. [Since] the legislation was passed in September [2007], essentially they've gone past zero. It's going to be very difficult to make a satisfactory return. When I think about returns, I think about returns that will allow the public investors to invest in the company and achieve a satisfactory return. For the same reasons that in some periods the [subsidy] rate was -- it's hard for me to say it was too high, but it was high, it attracted a lot of players -- the same process that made it too high also made it too low. There was no real market balance in that process.
Remondi: For years, we were the beneficiaries of what was going on in the capital markets as credit spreads went down almost in a consistent way, year after year after year. [But] Congress adjusted the special allowance spreads that lenders could retain on the loans down with that margin, and made the biggest change in 2007. Unfortunately, that was also the point in time where the capital markets swung the other way and credit spreads started to rise.
Just to put some numbers to paper here, back in 2007 the typical life-of-loan financing cost for Sallie Mae on a federal student loan asset was about 10 basis points over [the interbank borrowing rate]. That spread went, in the fall of 2008 after Lehman [Brothers collapsed], to over 300 basis points over [the interbank rate]. Now it's probably around 200. It really just created a washout. Had ECASLA not been passed and start to provide the foundation for government funding, there would have been a significant access problem for students this year. It would have happened earlier than other asset classes because unlike car loans or credit card loans or mortgages, for which lenders could push some of those costs on to borrowers, you can't do that in federal student loan programs.
NJ: If the president's proposal were to pass, what would be the effect on students and on Sallie Mae?
Lord: A worst-case situation for us would be that we did not participate in the origination of the asset.
Remondi: We would just become a pure government contractor without ability to add value to the process.
Lord: Our view is there's enormous execution risk in trying to go from where we are to 100 percent direct lending. We also believe it is unnecessary. If someone sticks $94 billion under the president's nose, or anybody else's nose, they're going to say "let's get it." What we're suggesting and have been asked to formulate by certain members of Congress was an alternative. When Congress created ECASLA, it created a foundation for a system that will deliver at least as much savings or more savings than the direct lending program would promise and do it with people who have been doing it for 35 years -- ourselves, Citibank, Chase, Bank of America and others.
Remondi: [With direct lending], competition and the value of competition disappears. We think the federal loan programs today and the products and services that are there -- whether it's ourselves, Citibank, Bank of America, or direct lending that's offering them -- [are there] because we're all competing for the same piece of business. The beneficiaries are students and schools.
NJ: Talk about your discussions with Congress on this.
Lord: This story is not a complicated story. The president has put a really fascinating proposal on the table with this $94 billion in Pell Grants. We've suggested that we can generate that same $94 billion without the execution risk. Oftentimes, a lot of rhetoric will surround this whole debate and it gets into issues that have absolutely nothing to do with the $94 billion or Pell Grants. It gets a little sloppy. I would say the meetings -- we've had quite a few meetings -- every meeting I've had has been very constructive. I would not call the economics of the student loan business particularly well understood. It's only three parts: It's the cost of funds, default prevention and operating expenses. Those are the three elements, and whoever can generate the lowest number for the taxpayer ought be the winner.
Remondi: We're trying to construct a better student loan program for students, schools and taxpayers. ECASLA started this process. The president's proposal builds off that and really is the foundation of how to get there. The government can borrow so cheaply, there isn't a benefit of competition in that aspect. When we look at the other pieces of it, though, it boils down to when you have competitors you have better products.
NJ: Another thing you've talked about is the effect on jobs and the fact that Washington [where direct lending is run] is not in a recession the way the rest of the country is.
Lord: It's not.
NJ: Talk about the effect on jobs around the country.
Lord: We made an announcement recently that we're bringing a couple thousand jobs back [to the U.S.].... We took 600 of those positions and we started moving them into Wilkes-Barre, Pa., which has double-digit unemployment. But we've got double-digit unemployment in almost every community in which we operate, with the exception of Reston. I've been getting calls from local political officials wondering where those other 1,400 jobs are going.... The fact is we will have 10,000 employees -- and not all 10,000 jobs are at risk, that is for sure, but some fair number of them are.... We don't have to hire anybody in Washington, D.C., or anyplace else for that matter. We can do the job.... If I were the president and I saw this $94 billion, and I knew I had Sallie Mae out there, he can pocket that money without risk, or he can take risk. But we can deliver the savings, of that I am sure, and our 10,000 experienced employees make it a certainty.
NJ: Under your proposal, who loses? The $94 billion has to come from somewhere.
Remondi: It comes principally from the funding difference.... If we perpetuated the historical system where companies like Sallie Mae went to the capital markets to borrow, we're borrowing today at [the interbank rate] plus 200 [points]. That is in today's marketplace about 2.75 percent. The equivalent government funding cost is about 17 basis points, or 0.17 percent. That's where the savings comes from.... As proof of that, the CBO score of ECASLA in the first year produced about $11 billion worth of savings [in 2009]. It's actually a little bit more than what the president's proposal would save on 100 percent lending.
Lord: In a lot of ways people think it's incredibly complicated, but when you cut it back to the three basic functions of raising money, preventing defaults and trying to operate efficiently, it gets fairly simple. Our proposal works because we're using the world's most effective borrower, and that's the U.S. government, and we think it works because you're using a company that's been around for 35 years, has skin in the game on the default side, has learned how to not just collect defaults but prevent them. And in 35 years, you learn how to operate a company pretty efficiently.