Reason Foundation

http://reason.org
http://reason.org/blog/show/sallie-mae-using-a-federal-line-of

Reason Foundation

Out of Control Policy Blog

Sallie Mae Using a Federal Line of Credit for Private Gain

Adam Millsap and Victor Nava
July 16, 2013, 10:00am

Sallie Mae appears to once again be reaping the benefits of crony capitalism. This time it's in the form of an $8.5 billion low interest line of credit from the Federal Home Loan Bank (FHLB) in Des Moines, IA.

The interest rate on this exclusive line of credit available to Sallie Mae charges only 0.23% to 0.34% in interest. Meanwhile Sallie Mae is apparently using the line of credit to initiate new student loans at interest rates up to 20 times higher than the rate the FHLB charges Sallie Mae. So far, Sallie Mae has tapped the line of credit for $2.1 billion and it is secured by $2.7 billion in loans. 

Sallie Mae is one of America's top crony capitalist organizations, as is shown in a recent Reason Foundation policy brief, and in this loan we have a prime example why.

First, Sallie Mae is receiving a low interest line of credit from a government sponsored bank that is not available to their competitors - this gives Sallie Mae a financial advantage and the profits reaped depend on this government assistance. 

Second, the reason why Sallie Mae is getting this low interest line is because of their history as a former government-sponsored enterprise. Using its political connections and strong lobbying presence, Sallie Mae worked the system to become the largest originator and holder of federally backed student loans-originating more than 4 times the amount of federally backed student loans than its competition in the last year of the Federal Family Education Loan Program's (FFELP) existence. Sallie Mae is still viewed by many as tacitly backstopped by the federal government, much in the same way Fannie Mae and Freddie Mac were from the 1980s to 2008 when they were bailed out by taxpayers.

Third, the profits Sallie Mae is collecting on this government subsidized line of credit -- earning profits on the interest rate spread between the FHLB loan and issuing new private loans -- is going into its own pockets, not being passed on to students. The recent jump in student loan interest rates testifies to this. 

Sallie Mae is leveraging its politically favored status to gain a competitive advantage and earn a profit in a system that looks capitalist but only survives in the status quo due to cronyism.. Private banks that are trying to compete with Sallie Mae in the student loan market will find it difficult to do so if Sallie Mae can continue to take advantage of such cheap capital. This is the definition of crony capitalism.

A spokesperson for the FHLB says the line of credit is meant to only support the lingering federally backed loans on Sallie Mae's portfolio. This statement was refuted by Senator Elizabeth Warren (D-MA), who recently argued that any claim that this line of credit is specifically devoted to a dwindling amount of government backed student loans contradicts Sallie Mae's own corporate filings. Sen. Warren argues that the company's 10-K disclosure acknowledges that the FHLB line of credit would be used to help fund the origination of new private student loans.

Unfortunately Sen. Warren's proposed solution is to have the government lower the interest rates on student loans even further. While this will erode Sallie Mae's profits it does nothing to solve the bigger problem of government induced distortion of student loan interest rates in higher education finance and the rampant crony capitalism between the government and Sallie Mae that accompanies it, despite the elimination of the FFELP program in 2010.

 The real solution is to eliminate federally subsidized student loans and government mandated interest rates and let private institutions decide the appropriate rates for student loans through market mechanisms. Accurate price signals are necessary in order to get the efficient amount of capital into the student loan market. Any solution that involves more government meddling will only distort the market further and likely lead to more crony capitalism down the road since Sallie Mae will retain its politically influential position with no real competition.

 For more of Reason's work on student loans click here

Also see our Policy Brief, Sallie Mae and Uncle Sam: Cronyism in Higher Education Finance here


Adam Millsap is Economic Policy Intern

Victor Nava is Research Assistant


Print This