Federal Family Education Loan Program
Statutory and Regulatory Changes Could Avert Billions in Unnecessary Federal Subsidy Payments Gao ID: GAO-04-1070 September 20, 2004To encourage lenders to make student loans under the Federal Family Education Loan Program (FFELP), the federal government guarantees lenders a statutorily specified rate of return--called lender yield. Some lenders may issue tax-exempt bonds to raise capital to make or purchase loans; loans financed with such bonds issued prior to 10/1/93 are guaranteed a minimum lender yield of 9.5% (hereafter called 9.5% loans). When the interest rate paid by borrowers is less than the lender yield, the government pays lenders the difference--a subsidy called special allowance payments. In light of the upcoming reauthorization of the Higher Education Act of 1965, we examined special allowance payments for 9.5% loans.
Special allowance payments for 9.5% loans have risen dramatically in recent years, increasing from $209 million in FY 2001 to well over $600 million as of June 30, 2004. A primary reason for the increase is the sharp decline in the variable interest rates paid by borrowers relative to the minimum 9.5% lender yield. Another reason for the increase in special allowance payments is the rising dollar volume of 9.5% loans, which increased from about $11 to over $17 billion from FY 1995 to June 30, 2004. Given that current market interest rates are at or near historic lows, lenders have a financial incentive to maintain or increase their 9.5% loan volume and can do so in three ways. After paying costs, including payments to bond investors, associated with a pre 10/1/93 tax-exempt bond, lenders can use any remaining money to reinvest in more FFELP loans that, by law, are also guaranteed a minimum 9.5% yield. Lenders can issue a new bond, called a refunding bond, to repay an outstanding pre 10/1/93 tax-exempt bond that financed 9.5% loans. Consequently, the refunding bond finances the 9.5% loans and may have a later maturity date than the original bond, allowing lenders to maintain their 9.5% loan volume for a longer time. By issuing a taxable bond and using the funds obtained to purchase 9.5% loans financed by a pre-10/1/93 tax-exempt bond, lenders can significantly increase their loan volume. Lenders can use the proceeds from the sale of loans previously financed by the pre-10/1/93 tax-exempt bond to make or buy additional loans, which are also guaranteed a 9.5% yield. Under Education's regulations, loans previously financed by a pre 10/1/93 tax-exempt bond and subsequently financed by (i.e., transferred to) a taxable bond continue to be guaranteed a 9.5% yield. Some Members of Congress and the Administration have proposed making statutory changes with respect to 9.5% loans, which could save billions of dollars in future special allowance payments. An official representing a leading credit rating agency and some major lenders told us that making changes to the minimum 9.5% yield for loans made or purchased in the future should not affect lenders' ability to make required payments on outstanding tax-exempt bonds.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-04-1070, Federal Family Education Loan Program: Statutory and Regulatory Changes Could Avert Billions in Unnecessary Federal Subsidy Payments
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Report to Congressional Requesters:
United States Government Accountability Office:
GAO:
September 2004:
FEDERAL FAMILY EDUCATION LOAN PROGRAM:
Statutory and Regulatory Changes Could Avert Billions in Unnecessary
Federal Subsidy Payments:
GAO-04-1070:
GAO Highlights:
Highlights of GAO-04-1070, a report to congressional requesters
Why GAO Did This Study:
To encourage lenders to make student loans under the Federal Family
Education Loan Program (FFELP), the federal government guarantees
lenders a statutorily specified rate of return”called lender yield.
Some lenders may issue tax-exempt bonds to raise capital to make or
purchase loans; loans financed with such bonds issued prior to 10/1/93
are guaranteed a minimum lender yield of 9.5% (hereafter called 9.5%
loans). When the interest rate paid by borrowers is less than the
lender yield, the government pays lenders the difference”a subsidy
called special allowance payments. In light of the upcoming
reauthorization of the Higher Education Act of 1965, we examined
special allowance payments for 9.5% loans.
What GAO Found:
As shown below, special allowance payments for 9.5% loans have risen
dramatically in recent years, increasing from $209 million in FY 2001
to well over $600 million as of June 30, 2004. A primary reason for
the increase is the sharp decline in the variable interest rates paid
by borrowers relative to the minimum 9.5% lender yield.
Another reason for the increase in special allowance payments is the
rising dollar volume of 9.5% loans, which increased from about $11 to
over $17 billion from FY 1995 to June 30, 2004. Given that current
market interest rates are at or near historic lows, lenders have a
financial incentive to maintain or increase their 9.5% loan volume and
can do so in three ways:
* After paying costs, including payments to bond investors, associated
with a pre 10/1/93 tax-exempt bond, lenders can use any remaining money
to reinvest in more FFELP loans that, by law, are also guaranteed a
minimum 9.5% yield.
* Lenders can issue a new bond, called a refunding bond, to repay an
outstanding pre 10/1/93 tax-exempt bond that financed 9.5% loans.
Consequently, the refunding bond finances the 9.5% loans and may have
a later maturity date than the original bond, allowing lenders to
maintain their 9.5% loan volume for a longer time.
* By issuing a taxable bond and using the funds obtained to purchase
9.5% loans financed by a pre-10/1/93 tax-exempt bond, lenders can
significantly increase their loan volume. Lenders can use the proceeds
from the sale of loans previously financed by the pre-10/1/93 tax-
exempt bond to make or buy additional loans, which are also guaranteed
a 9.5% yield. Under Education‘s regulations, loans previously financed
by a pre 10/1/93 tax-exempt bond and subsequently financed by (i.e.,
transferred to) a taxable bond continue to be guaranteed a 9.5% yield.
Some Members of Congress and the Administration have proposed making
statutory changes with respect to 9.5% loans, which could save billions
of dollars in future special allowance payments. An official
representing a leading credit rating agency and some major lenders
told us that making changes to the minimum 9.5% yield for loans made
or purchased in the future should not affect lenders‘ ability to make
required payments on outstanding tax-exempt bonds.
What GAO Recommends:
To address the issues identified in this report, Congress should
consider changing the yield for loans made or purchased in the future
with the proceeds of pre-10/1/93 tax-exempt bonds, and any associated
refunding bonds, to better reflect market interest rates.
GAO recommends that Education change its regulations so that 9.5% loans
transferred from a pre-10/1/93 tax-exempt bond no longer receive a
minimum 9.5% yield. Education agrees that special allowance payments
should be reduced, but believes it has limited options to do so. GAO
believes that Education has other options it can explore.
www.gao.gov/cgi-bin/getrpt?GAO-04-1070.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Cornelia Ashby at (202)
512-8403 or ashbyc@gao.gov.
[End of section]
Contents:
Letter:
Special Allowance Payments For 9.5 Percent Loans Have Increased More
Than Threefold Since Fiscal Year 2001:
Changes to the Minimum 9.5 Percent Yield For Future Loans Could Save
Billions and Is Unlikely to Cause Lenders to Default on Outstanding
Tax-Exempt Bonds:
Conclusions:
Matter for Congressional Consideration:
Recommendation for Executive Action:
Agency Comments:
Appendix I: Briefing Slides:
Appendix II: Comments from the Department of Education:
Appendix III: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Abbreviations:
FFELP: Federal Family Education Loan Program:
HEA: Higher Education Act:
IRC: Internal Revenue Code:
IRS: Internal Revenue Service:
SAP: special allowance payment:
United States Government Accountability Office:
Washington, DC 20548:
September 20, 2004:
The Honorable Dale E. Kildee:
Ranking Minority Member, Subcommittee on 21st Century Competitiveness:
Committee on Education and the Workforce:
House of Representatives:
The Honorable Chris Van Hollen:
House of Representatives:
Under the Federal Family Education Loan Program (FFELP), lenders--
including banks, state agencies and other nonprofit and for-profit
organizations--annually make, or originate, billions of dollars in
loans to help students and families finance postsecondary education
costs. To encourage lenders to make loans, the federal government
guarantees lenders repayment and a statutorily specified rate of
return--called lender yield--on the loans they hold. Lender yields as
well as the interest rates paid by borrowers are typically tied to, and
vary with, money market financial instruments, such as the 91-day
Treasury bill. When the interest rate paid by borrowers is less than
the guaranteed lender yield, the government pays lenders the
difference--a subsidy called special allowance payments. In exercising
its oversight of the FFELP, Congress has periodically changed the
formula for lender yields to better reflect market interest rates,
federal budget constraints, or the costs incurred by lenders to finance
loans. To finance loans, some lenders, specifically state agencies and
state-designated authorities, may issue tax-exempt bonds to raise
capital to make or purchase loans, thereby providing other lenders with
more funds to make more loans. Investors who buy these bonds receive
interest income that is exempt from federal taxation. Because these
investors do not pay taxes on their interest earnings, they are willing
to accept a lower pretax rate of return on their investment, which
lowers the financing costs for agencies and authorities issuing the
bonds. As student loan borrowers repay their loans, loan holders use
the money to repay, in turn, bond investors.
Concerned that the lender yield for loans financed with tax-exempt
bonds did not adequately reflect the lower costs associated with tax-
exempt financing, Congress reduced the yield in passing the Education
Amendments of 1980. To do so, Congress reduced the special allowance
payments to be paid on loans financed with tax-exempt bonds to one-half
of that otherwise payable. At the same time, however, Congress
guaranteed that the lender yield for loans financed with tax-exempt
bonds would be no less than 9.5 percent. Several years later, in
passing the Omnibus Budget Reconciliation Act of 1993[Footnote 1],
Congress eliminated the one-half special allowance payment and minimum
9.5 percent yield provision for loans financed with tax-exempt bonds
issued on or after October 1, 1993. In so doing, Congress provided that
lenders would receive the same yield on loans, regardless of whether
tax-exempt bonds or other sources of funds had been used to finance the
loans. Due to these changes, loans that are financed with the proceeds
of tax-exempt bonds issued prior to October 1, 1993 are guaranteed a
minimum 9.5 percent yield. (These loans are hereafter called 9.5
percent loans).
Believing that changes to the law should have resulted in a decline in
special allowance payments made for 9.5 percent loans since 1993,
various news media, policy makers, and others have recently raised
questions about the extent to which the government continues to make
such payments. In light of the upcoming reauthorization of the Higher
Education Act of 1965, which authorizes the FFELP, you asked us to
examine special allowance payments for 9.5 percent loans. To conduct
our examination, we analyzed the Department of Education's (Education)
data on 9.5 percent loan volume and special allowance payments paid to
lenders from fiscal year 1986 through the third quarter of fiscal year
2004, the most current data available at the time of our review. On the
basis of our review of the documentation for these data and our
discussions with Education officials about the steps they take to
ensure the reliability and validity of these data, we determined that
the data were sufficiently reliable for the purpose of our examination.
In addition, we interviewed officials with Education; the Internal
Revenue Service; a major credit rating agency that examines and rates
the quality of student loan bonds, including those issued by several
holders of 9.5 percent loans; a leading bond counsel law firm that
provides legal advice to lenders that issue tax-exempt student loan
bonds; and 12 lenders that reported holding 9.5 percent loans in fiscal
year 2003. We gathered additional data on the amount of 9.5 percent
loans in taxable bonds from the top 10 holders of 9.5 percent loans in
fiscal year 2003. These 10 lenders held 70 percent of reported 9.5
percent loan volume in fiscal year 2003.
On August 19, 2004, we briefed your staff on the results of our work.
This report summarizes the information we shared with your staff and
transmits the slides we used to brief your staff that day. In this
report, we are also making a recommendation to the Secretary of
Education and suggesting a matter for Congress's consideration. We
conducted our work between December 2003 and August 2004 in accordance
with generally accepted government auditing standards.
Special Allowance Payments For 9.5 Percent Loans Have Increased More
Than Threefold Since Fiscal Year 2001:
Special allowance payments for 9.5 percent loans have risen
dramatically in recent years, increasing from $209 million in fiscal
year 2001, to $556 million in fiscal year 2003 and reached about $634
million at the end of the third quarter of fiscal year 2004. Two
reasons account for this increase: (1) a decline in the interest rate
paid by borrowers and (2) a rise in the dollar volume of 9.5 percent
loans. In some cases, restrictions exist on how the nonprofit, for-
profit, and state agency lenders that hold 9.5 percent loans may use
their earnings, including their special allowance payments, from 9.5
percent loans.
Decline in Interest Rate Paid by Borrowers Is Primary Reason for
Increase in Special Allowance Payments:
The primary factor influencing the increase in special allowance
payments has been the sharp decline in interest rates paid by borrowers
relative to the minimum 9.5 percent government guaranteed yield for
lenders. As borrower rates have declined, the amount the government has
been required to pay to make good on its promise to lenders has
increased. To illustrate, in 2001, the borrower interest rate was 8.2
percent.[Footnote 2] Because this borrower rate is tied to the 91-day
Treasury-bill rate and the Treasury-bill rate subsequently declined,
the borrower interest rate on the same loan in 2003 was 5.4 percent.
While the borrower rate declined, the yield for a lender who used the
proceeds, or funds obtained, of a pre-October 1, 1993, tax-exempt bond
to originate or purchase the loan remained at 9.5 percent. Over this
period, the difference, or spread, between the borrower rate and the
9.5 percent lender yield increased from 1.3 percent to 4.1 percent. As
a result, the special allowance payment required to ensure a lender
yield of 9.5 percent increased for each dollar of loan volume in this
example.
Increasing 9.5 Percent Loan Volume Is Another Reason for the Increase
in Special Allowance Payments:
Another factor influencing the increase in special allowance payments
has been the rising dollar volume of 9.5 percent loans. Although the
overall volume of 9.5 percent loans has increased since fiscal year
1995, volume among lenders has varied. Most lenders experienced a
decrease in their 9.5 percent loan volume between fiscal years 1995 and
2003, but by the end of the third quarter of fiscal year 2004, some of
these lenders had sharply increased their 9.5 percent loan volume. For
example, one lenders' 9.5 percent loan volume had decreased by 46
percent between fiscal years 1995 and 2003 but then increased by 136
percent between 2003 and the end of the third quarter of fiscal year
2004, making its 9.5 percent loan volume greater than it was in 1995.
There are primarily three ways--referred to as recycling, refunding,
and transferring--that a lender can slow the decrease in, maintain, or
increase its 9.5 percent loan volume.
* First, after paying costs associated with a pre-October 1, 1993 tax-
exempt bond (such as payments of interest and principal to bond
investors), lenders can reinvest, or recycle, any remaining money
earned from 9.5 percent loans to make or purchase additional loans
that, under the law, are also guaranteed a minimum 9.5 percent lender
yield. Using this method, lenders are able to slow the decrease in,
maintain, or slightly increase their 9.5 percent loan volume.
* Second, lenders can issue a new bond, called a refunding bond, to
repay the principal, interest, and other costs of an outstanding pre-
October 1, 1993 tax-exempt bond. Based on how the HEA has been
interpreted, 9.5 percent loans originally financed with a pre-October
1, 1993 tax-exempt bond, but subsequently financed by a refunding bond,
continue to carry the government guaranteed minimum yield for lenders
of 9.5 percent. Moreover, the refunding bond may have a later maturity,
or payoff, date than the original bond. Using this method, lenders can
maintain their 9.5 percent loan volume.
* Third, under Education regulations, a lender can significantly
increase its 9.5 percent loan volume by issuing a taxable bond and
using the proceeds to purchase 9.5 percent loans financed by a pre-
October 1, 1993 tax-exempt bond. The lender then uses the cash
available from the pre-October 1, 1993 tax-exempt bond to make or buy
additional loans, which are guaranteed the minimum 9.5 percent yield.
Under regulations issued in 1992, the loans transferred to the taxable
bond continue to be guaranteed the minimum 9.5 percent lender yield, so
long as the original bond is not retired or defeased. (At the time the
regulation was promulgated, Education anticipated that interest rates
would rise, resulting in a higher lender yield for loans financed with
taxable bonds than for loans financed with tax-exempt bonds. Education
believed that if the 1992 regulation was not promulgated, lenders would
have had an incentive to transfer loans from tax-exempt bonds to
taxable bonds in order to obtain a higher yield, thus resulting in
higher special allowance payments for the government.) Among the top 10
lenders holding 9.5 percent loans, more than half of the dollar volume
of their 9.5 percent loans had been transferred to taxable bonds as of
March 31, 2004. The extent to which lenders have transferred 9.5
percent loans to taxable bonds varies considerably. For example, one
lender had none of its 9.5 percent loans in a taxable bond, while
another held 90 percent of its 9.5 percent loans in a taxable bond as
of March 31, 2004. Some lenders interviewed have been transferring 9.5
percent loans for several years, while another lender just started to
transfer 9.5 percent loans in 2004. Additionally, some lenders have
also transferred 9.5 percent loans to tax-exempt bonds issued after
October 1, 1993, thereby continuing the 9.5 percent minimum guaranteed
yield.
As a result of recycling, refunding, and transferring, the overall
dollar volume of 9.5 percent loans has increased from about $11 billion
in fiscal year 1995 to over $17 billion at the end of the third quarter
of fiscal year 2004. While the dollar volume of 9.5 percent loans
presently accounts for only about 8 percent of all outstanding FFELP
loan volume, these loans account for 78 percent of all special
allowance payments made to FFELP lenders thus far in fiscal year 2004.
Earnings on Tax-Exempt Bonds that Finance 9.5 percent Loans May be Used
for Borrower Benefits:
Under the Internal Revenue Code (IRC), earnings on loans financed by
tax-exempt bonds are limited.[Footnote 3] Lenders can reduce their
earnings on loans financed with tax-exempt bonds, and avoid exceeding
IRC limitations, by providing benefits to borrowers. Some lenders
reported that they have used, or plan to use, earnings in excess of IRC
limits to provide interest rate reductions or loan cancellation for
borrowers. In contrast to tax-exempt bonds, earnings on taxable bonds
are not limited. As a result, lenders have discretion in how they use
their earnings from taxable bonds that have financed 9.5 percent loans.
Changes to the Minimum 9.5 Percent Yield For Loans Made or Purchased in
the Future Could Save Billions and Is Unlikely to Cause Lenders to
Default on Outstanding Tax-Exempt Bonds:
Changing law and regulations with respect to 9.5 percent loans made or
purchased in the future could reduce the amount of special allowance
payments required to be paid by the government without compromising
lenders' ability to meet their obligations under their outstanding tax-
exempt bonds. The Administration and some members of Congress have, in
fact, already put forth proposals to make such changes. The
Administration has proposed limiting the extent to which lenders can
receive the substantially higher special allowance payments on 9.5
percent loans in the future and estimates savings of $4.9 billion over
fiscal years 2005 through 2014 by doing so. Proposed legislation
introduced in the 108th Congress also seeks to revise the law
pertaining to 9.5 percent loans in order to reduce special allowance
payments and change lender yields to reflect current market interest
rates.[Footnote 4]
Changing current regulations that allow lenders to transfer 9.5 percent
loans to taxable bonds and retain the minimum 9.5 percent yield could
also significantly reduce potential special allowance payments in the
future. While Education officials told us that they had considered
revising the department's regulations, they believed that Congress
could effect such a change by law more quickly and easily. Education
officials told us that promulgating new FFELP regulations would likely
be difficult and time-consuming, in light of the HEA's requirement that
the department engage in negotiated rule making in promulgating FFELP
regulations. Negotiated rule making requires the department to convene
a committee that would include FFELP industry representatives, such as
lenders, and attempt to reach consensus among committee members on
proposed regulations. Given the interest of lenders who hold 9.5
percent loans, reaching consensus on new regulations would likely prove
to be very difficult, according to Education officials. However, the
inability to reach consensus does not invalidate the negotiation of
rules.[Footnote 5] Moreover, regulations are not subject to the
negotiated rulemaking requirement if the Secretary determines that
applying this requirement would be 'impracticable, unnecessary, or
contrary to the public interest.' Representatives from a major credit
rating agency as well as some lenders who hold 9.5 percent loans told
us that eliminating the minimum 9.5 percent yield for loans made or
purchased in the future should not affect lenders' ability to meet
their obligations under, and make required payments on, their
outstanding tax-exempt bonds, nor should it have long-term negative
effects in the student loan bond market.
Conclusions:
Unlike other loans for which the lender yield varies with current
market interest rates, the lender yield for loans financed with pre-
October 1, 1993 tax-exempt bonds are guaranteed a minimum yield of 9.5
percent. Given that current market interest rates are at or near
historic lows, lenders have a significant financial incentive to slow
the decrease in, maintain, or increase the volume of loans that yield
such a relatively high rate of return unavailable on other FFELP loans.
This incentive will remain even if market interest rates gradually rise
in the future. Ironically, moreover, an Education regulation over 10
years old and originally intended to limit the government's exposure to
increased special allowance payments has today presented lenders with
an extraordinary opportunity to generate additional loans that earn a
9.5 percent yield. As we have shown, lenders are taking advantage of
these opportunities. Industry experts acknowledge that the government
could take action to eliminate the 9.5 percent yield for loans made or
purchased in the future without compromising the ability of lenders to
meet their obligations with respect to their pre-October 1, 1993 tax-
exempt bonds. Without government action, the taxpayers remained exposed
to additional special allowance payments that can easily and rapidly
escalate into the billions of dollars.
Matter for Congressional Consideration:
In light of the rapid increase in special allowance payments for loans
guaranteed a minimum 9.5 percent yield and the continuing financial
incentive for lenders to originate or purchase additional loans that
qualify for a guaranteed yield of 9.5 percent, Congress should consider
amending the HEA to address the issues identified by this report, but
particularly to change the yield for loans made or purchased in the
future with the proceeds of pre-October 1, 1993 tax-exempt bonds, and
any associated refunding bonds, to more closely reflect these loans'
financing costs and current market interest rates.
Recommendation for Executive Action:
Given that lenders are increasing the volume of 9.5 percent loans based
on Education regulations that allow lenders to transfer 9.5 percent
loans to taxable bonds and tax-exempt bonds issued after October 1,
1993 while retaining the special allowance payment provisions
applicable to loans financed with pre-October 1, 1993 tax-exempt bonds,
and the resulting increased costs for taxpayers, we recommend that the
Secretary of Education promulgate regulations to discontinue the
payment of the special allowance applicable to loans financed with pre-
October 1, 1993 tax-exempt bonds that are subsequently transferred to
taxable bonds or tax-exempt bonds issued on or after October 1, 1993.
Agency Comments:
We provided a draft of this report to Education for review and comment.
In commenting on our report, Education agreed that special allowance
payments for 9.5 percent loans should be scaled back considerably and
that, as noted in our report, such a proposal was included in the
President's fiscal year 2005 budget.[Footnote 6] Education also stated
that it had considered changing its regulation or its interpretation of
the regulation last year, but believed at that time that the HEA would
be reauthorized and amended to address the issues discussed in our
report before any proposed regulation or regulatory interpretation it
might undertake could become effective. Education stated this was the
case because of certain requirements contained in the HEA and other
laws, including a requirement that it engage in negotiated rule making.
Education also commented on the statutory exception to the general
requirement that it engage in negotiated rule making, which we
highlighted in our report. As mentioned in our report, the Secretary
need not subject a rule making to the negotiated rule making process if
the Secretary determines that the process would be "impracticable,
unnecessary, or contrary to the public interest." In its comments,
Education stated that the courts have construed this exception only to
cover routine determinations that are insignificant in nature and
impact, inconsequential to industry and to the public, or which raise
issues of public safety. While we believe that it is Education's
responsibility to interpret the law as it relates to its own programs,
on the basis of our review of the case law, we disagree with
Education's characterization of the case law concerning the scope of
the exception in the Administrative Procedure Act. Specifically, it
does not fully address the courts' treatment of the "public interest"
prong of the three-pronged exception noted above.
The federal courts have interpreted the three-pronged exception in many
cases involving a wide variety of factual situations. Education's
characterization of the case law describes the courts' discussion of
the first two prongs, "impracticable" or "unnecessary," but does not
fully address the potential applicability of the third prong, which, if
met, would independently justify use of the exception. In fact, in the
case cited by Education in its comments, Utility Solid Waste Activities
Group v. E.P.A., 236 F.3d 749 (D.C. Cir. 2001), the court briefly
explains the "public interest exception" by pointing to a situation
where announcement of the rule in advance would "enable the sort of
financial manipulation the rule sought to prevent." Id. at 755; see
also, Attorney General's Manual on the Administrative Procedure Act,
pp. 30-31. Thus, it is clear that the applicability of the "public
interest" exception turns neither on the insignificance of the rule nor
on whether it raises issues of public safety. See also Nader v.
Sawhill, 514 F.2d 1064 (D.C. Cir. 1975). Moreover, in reviewing
challenges to an agency's use of an exception, the Court of Appeals for
the District of Columbia has stated that it will review the "totality
of the circumstances," including the complexity of the statute and
congressionally imposed time frames. See Methodist Hosp. of Sacramento
v. Shalala, 38 F.3d 1225 (D.C. Cir. 1994); Petry v. Block, 737 F.2d
1193 (D.C. Cir. 1984).
Determining whether the unique circumstances present here support the
agency's use of an exception is beyond the scope of our report and is a
matter, in the first instance, for Education. Nevertheless, we
continue to believe that Education should consider all of its options
in effecting the desired policy change as we recommend in the report.
This could include, for example, determining whether Education could
use less formal guidance, as it has in the past, to clarify or alter
its position; whether a full consideration of all the facts and
circumstances as well as all the applicable case law would support use
of an exception to the negotiated rule making requirement; whether an
interim final rule could be issued to take effect immediately; or
whether negotiated rule making could be accomplished on an expedited
basis. Given Education's position that it is essentially unable to
implement regulations until July 1, 2006, more than 21 months away, we
think it is important that Education fully explore all of its options,
consistent with applicable law. Education's written comments appear in
appendix II.
We are sending copies of this report to the Secretary of Education,
appropriate congressional committees, and other interested parties. In
addition, the report will be available at no charge on GAO's Web site
at http://www.gao.gov.
If you or your staff have any questions about this report, please
contact me at (202) 512-8403 or Jeff Appel, Assistant Director, at
(202) 512-9915. You may also reach us by e-mail at ashbyc@gao.gov or
appelc@gao.gov. Other contacts and staff acknowledgments are listed in
appendix III.
Signed by:
Cornelia M. Ashby Director, Education, Workforce, and Income Security
Issues:
[End of section]
Appendix I: Briefing Slides:
[See PDF for image]
[End of slide presentation]
[End of section]
Appendix II: Comments from the Department of Education:
UNITED STATES DEPARTMENT OF EDUCATION:
OFFICE OF POSTSECONDARY EDUCATION:
THE ASSISTANT SECRETARY:
Ms. Cornelia M. Ashby:
Director, Education, Workforce, and Income Security Issues:
United States Government Accountability Office:
Washington, DC 20548:
Dear Ms. Ashby:
Thank you for providing the Department of Education (the Department)
with a draft copy of the U.S. Government Accountability Office's
(GAO's) report entitled, "Federal Family Education Loan Program:
Statutory and Regulatory Changes Could Avert Billions in Unnecessary
Federal Subsidy Payments" (GAO-04-1070). We have reviewed the draft and
have the following comments.
This study reports the recent increases in the Department's special
allowance payments to lenders and other loan holders on student loans
financed with tax-exempt securities, i.e. "9.5 percent loans," and
describes three strategies employed by such lenders and loan holders to
maintain and even increase their 9.5 percent loan portfolios. The
report recommends the Department change, through rulemaking, its
current interpretation of the provision in the Higher Education Act of
1965, as amended (HEA), that governs eligibility for the special
subsidy for 9.5 percent loans.
In general, under the Department's regulations, loans that are eligible
for the special 9.5 percent subsidy retain that eligibility as long as
the tax-exempt bond whose proceeds were used to make or purchase the
loans remains open. In other words, absent a change in the law, unless
and until the original financing instrument is retired or defeased, the
loans it supports qualify for the special subsidy.
The Department believes that these special allowance payments should be
scaled back considerably, and, as you noted, the President proposed
this in his fiscal year 2005 budget request. Last year the Department
considered undertaking the process to issue new regulations or to
reverse the Clinton Administration's regulatory interpretation.
However, we quickly realized that doing so would have resulted in the
new policy becoming effective no sooner than July 2005-long after we
expected the HEA to be amended to address the issue. This is so because
of certain requirements in the HEA and other applicable laws.
Section 492 of the HEA[NOTE 1] requires the Secretary to obtain public
involvement in the development of proposed regulations for any program
authorized under Title IV of the
HEA, and to develop such proposed regulations by means of a negotiated
rulemaking process. Changes of regulatory interpretation, like new
legislative rules, require rulemaking under the Administrative
Procedure Act (APA), [NOTE 2] as interpreted by the United States Court
of Appeals for the D.C. Circuit. [NOTE 3] Therefore, the Department
believes negotiated rulemaking is required for changes of regulatory
interpretation, like changes to the 1996 interpretation at issue here,
just as it is required for new legislative rules.
The Department's experience with the negotiated rulemaking process for
the Title IV programs dates to 1994. In the development phase the
issues to be regulated, and therefore negotiated, require the advice of
and recommendations from individuals and representatives of the groups
involved in the federal student aid programs, such as students, legal
assistance organizations that represent students, institutions of
higher education, guaranty agencies, lenders, secondary markets, loan
servicers, guaranty agency servicers, and collection agencies.
Participants in the negotiation phase are chosen by the Secretary from
individuals nominated by the aforementioned groups and must include
both representatives of such groups from Washington, D.C. and industry
participants. To the extent possible, the Secretary selects individuals
reflecting the diversity in the industry, representing both large and
small participants, as well as individuals serving local areas and
national markets. At the conclusion of the negotiation phase, the
Secretary publishes the Notice of Proposed Rulemaking and accepts
public comment. After considering public comment, the Secretary issues
the final rule.
As the draft report notes, the Secretary may choose not to subject
Title IV rulemaking (or Title IV change of regulatory interpretation)
to the negotiated rulemaking process if the Secretary determines that
the process, with respect to the particular regulations (or changes of
regulatory interpretation) that are preferred, would be impracticable,
unnecessary, or contrary to the public interest, within the meaning of
the APA. [NOTE 4] That standard appears in the APA as an exemption
applicable to all federal agencies that are otherwise required to
conduct rulemaking. However, the draft report neglects to note that the
courts have generally construed the standard only to cover routine
determinations that are insignificant in nature and impact,
inconsequential to industry and to the public, or which raise issues of
public safety. [NOTE 5] The standard is not met here to exempt this
issue from rulemaking, including negotiated rulemaking, because the
issue would involve a policy decision to change a current
interpretation of regulations issued under Title IV of the HEA that
would greatly affect the student loan industry. Moreover, it is
obviously not a matter of public safety.
Additionally, the Department is bound to follow the "Master Calendar"
provisions of section 482(c) of the HEA. [NOTE 6] These provisions
provide that, with certain exceptions not applicable here, any
regulatory changes initiated by the Secretary affecting Title IV
programs that have not been published in final form by November 1,
prior to the start of
the award year on the following July l, cannot become effective until
the beginning of the second award year after such November 1 date.
Therefore, if final regulations are not published by November 1, 2004,
then they cannot take effect before July 1, 2006.
We look forward to working with the Congress to address this important
reform that will enable the government to modernize the Federal student
aid programs to help millions of students and families realize their
dreams through higher education.
I appreciate your examination of this important issue and the
opportunity to comment on the draft report.
Sincerely,
Signed by:
Sally L. Stroup:
NOTES:
[1] 20 U.S.C. 1098a.
[2] 5 U.S.C. 551 etseq.
[3] See, e.g., Paralyzed Veterans of America v. D.C Arena, 117 F.3d 579
(D.C. Cir. 1997)
[4] 5 U.S.C. 553(B)(3)(B).).
[5] See, e.g., Utility Solid Waste Activities Group v. E.P.A., 236 F.3d
749, 754-55 (D.C. Cir. 2001). 20 U.S.C.. 1089(c).
[End of section]
Appendix III: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Jeff Appel, Assistant Director (202) 512-9915 Andrea Romich Sykes,
Analyst-in-Charge (202) 512-9660:
Staff Acknowledgments:
In addition to those named above, the following people made significant
contributions to this report: Cynthia Decker, Margaret Armen, Richard
Burkard, Jason Kelly, Rebecca Christie, and Jeff Weinstein.
FOOTNOTES
[1] Public Law 103-66, secs. 4105 and 4111, 107 Stat. 312 (1993)
[2] Statutory formulas used to calculate borrower rates are based on
several factors, including when the loan was disbursed and loan type.
The borrower rates used for this example are for Stafford loans
disbursed after July 1, 1998 and are now in repayment.
[3] Special allowance payments may or may not be included in the
calculation of excess earnings for Internal Revenue Service purposes
depending on when a tax-exempt bond, or any associated refunding bond,
was issued.
[4] See, for example, the College Quality, Affordability, and Diversity
Improvement Act of 2003 (S. 1793) and the College Access and
Opportunity Act (H.R. 4283).
[5] See, U. S. Group Loan Servicing Inc. v. Riley, 82 F. 3d 708 (7th
Cir 1996).
[6] A similar proposal was made in the prior Administration's fiscal
year 2001 budget.
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