Could Refinancing All Student Loans Be A Free Lunch For The Taxpayers ?

Originally published on forbes.com on May 2, 2012

Before I met with John Remondi, President and COO of Sallie Mae, I combed through Sallie's 10-K to see what they were worried about. One thing they say they are worried about is that the cost of college will go down. That would be bad for their business. When I asked Mr. Remondi about that he kind of smiled and said that was the type of thing they had to mention to their shareholders, but he didn't really think it was all that likely. Then there is this other thing they are worried about:

For instance, during the fourth-quarter 2011, the Administration announced a Special Direct Consolidation Loan Initiative that provides a temporary incentive to borrowers who have at least one student loan owned by ED and at least one held by a FFELP lender to consolidate the FFELP lender’s loans into the DSLP program by providing a 0.25 percentage point interest rate reduction on the FFELP loans that are eligible for consolidation. We currently do not foresee the initiative having a significant impact on our FFELP Loans segment. However, the initiative is an example of how the Administration and Congress could detrimentally affect future estimated cash flows and profitability from our FFELP Loan portfolios through their actions.

The FFELP program was one of those public private partnerships. The federal government guaranteed most of the interest and principal, but it was financial institutions making the loans. President Obama thought that the piece going to the financial institutions was really a waste of money, since they were not taking any risk. There are no new FFELP loans being made, but the exisiting loans will be around for a long time. Sallie Mae is transitioning to making non-guaranteed loans, but they expect to be making money off the FFELP loans for the next 20 years.

They are even buying more of them from other institutions.  It does not require a lot of capital for them to do that.  The federal guaranty makes the portfolios gilt edged.  Sallie can securitize the loans with instituional investors getting something like LIBOR +1, while Salle gets LIBOR +2.  Doesn't seem like that much of a spread but it can add up.

As I noted, the consolidation program outlined above worries them a little.  Well, here is what I am thinking.  Maybe we the taxpayers need to encourage our President and his likely opponent to propose a program that would worry Sallie a lot.  It is our guaranty that makes the debts of those kids (and many of them are not kids anymore) a valuable financial asset, that the capital markets can play with for the next 20 years.  Why don't we just offer to refinance the whole lot at a reasonable rate ?  That includes the loans that are not performing that well.  We are already stuck with the downside on them because of the guaranty.  If we want to be nice guys, we could do things like put in bankruptcy protection for the really desperate.  But even, if we want to be hardnosed about, it is the taxpayers who are at risk that should be making the profits on the loans for the next twenty years.

It is too bad that we don't have a Presidential candidate that can think like a venture capitalist and make that kind of move on behalf of the American people.