The Privatization of Sallie Mae and Its Consequences
About This Event

Sallie Mae (the Student Loan Marketing Association) was privatized in 1996, making it the first government-sponsored enterprise (GSE) to be spun off by the federal government with a sunset on its government charter. What has been the result and what can we learn from it? In a new study for Listen to Audio


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AEI, Thomas H. Stanton has reviewed the terms of the privatization and the ensuing history of the student loan industry. Participants at this conference will consider Stanton’s paper and its analysis of how the government should and should not sever its ties with a GSE, as well as the larger implications for the student loan sector.

Thomas H. Stanton is coauthor, with Peter J. Wallison and Bert Ely, of Privatizing Fannie Mae, Freddie Mac, and the Federal Home Loan Banks: Why and How (AEI Press, 2004). Alex J. Pollock, a resident fellow at AEI and former president and chief executive officer of the Federal Home Loan Bank of Chicago; Lawrence A. Hough, chairman of Sallie Mae when it developed and prosecuted its privatization plan; Sarah Ducich, vice president for public policy at Sallie Mae; and Frederick M. Hess, resident scholar at AEI and editor of Footing the Tuition Bill: The New Student Loan Sector (AEI Press, 2007), will discuss Stanton’s presentation.

Agenda

2:45 p.m.
Registration
3:00
Introduction:
Peter J. Wallison, AEI
3:15
Presenter:
Thomas H. Stanton, Johns Hopkins University
Discussants:
Sarah Ducich, Sallie Mae
Frederick M. Hess, AEI
Lawrence A. Hough, Stuart Mill Capital, Inc.
Alex J. Pollock, AEI
Moderator:
Peter J. Wallison, AEI
5:00
Adjournment

Event Summary

May 2007

The Privatization of Sallie Mae and Its Consequences

Sallie Mae (the Student Loan Marketing Association) was privatized in 1996, making it the first government-sponsored enterprise (GSE) to be spun off by the federal government with a sunset on its government charter. What has been the result, and what can we learn from it? In a new study for AEI, Thomas H. Stanton has reviewed the terms of the privatization and the ensuing history of the student loan industry. At a May 30 AEI conference, Stanton presented his paper, and participants commented on his analysis of how the government should and should not sever its ties with a GSE, as well as the larger implications for the student loan sector.

Peter J. Wallison
AEI

Sallie Mae's privatization in 1996 is a cautionary tale. In his paper, Stanton outlines many of the advantages that Sallie received as part of its privatization, including its continued operation of a profitable GSE after privatization occurred. As a result of this and other advantages, Sallie Mae had a great deal of financial and business momentum, which led to its dominant position in the student loan market. There may come a time when Fannie Mae and Freddie Mac may seek to privatize, and Congress should carefully review the experience with Sallie Mae as an example of what mistakes can be made if a powerful GSE is dropped into the middle of an existing market. Privatizing Fannie Mae, Freddie Mac, and the Federal Home Loan Banks: Why and How (AEI Press, 2004) is careful to propose, as an integral part of the privatization, that these companies surrender the advantages they obtained as GSEs. The purpose of this conference is to consider the extent to which Sallie Mae's history as a GSE led to its market dominance in the student loan market today.

Thomas H. Stanton
Johns Hopkins University

Although Sallie Mae was privatized a decade ago, it retains several key characteristics that it had as a GSE. After privatization, Sallie Mae retained the economies of scale it achieved as a GSE, which enabled it to maintain a cost structure lower than that of other competitors and remain the dominant firm in the student loan market. Due to its position in the federal student loan market, Sallie Mae continues to depend on federal laws and regulations for much of its business, and despite its loss of government sponsorship, it is possible that the government might bail out the company in the event of a crisis in the student loan market. The great lesson from Sallie Mae's privatization is that GSEs can distort the marketplace and displace the activities of the firms they were originally created to support. Therefore, the proper way to fully privatize a GSE is to remove or otherwise offset the advantages that government gave to the firm before letting it enter the free market. Otherwise, its distorting effects on the market are likely to continue--and potentially increase--as has been the case with Sallie Mae.

Lawrence A. Hough
Stuart Mill Capital, Inc.

Contrary to Stanton's assertions that Sallie Mae distorts the student loan market, many profitable Sallie Mae competitors have developed over the past three decades. Moreover, Sallie Mae's success is due more to its talented employees than past legislative advantages. Concerning the privatization of GSEs, Stanton's argument that government must "undo the distorting effects" at the time of privatization is not a viable option. Rather, for any future GSEs that are meant to end up fully privatized, the terms of exit and business restrictions should be stipulated in the enacting charter. In addition, while Stanton criticizes Sallie Mae for entering different areas of the student loan market, the legislation that created Sallie Mae limited its advantages to the secondary market and did nothing to encourage or subsidize Sallie Mae's development of its own servicing capability. Nor did Stanton provide substantive evidence for the notion that the government might be willing to bail out Sallie Mae, which is unlikely, for if Sallie Mae ever did collapse, its competitors would assure Congress that they could fill in the gap. Finally, consolidation within the student loan market will likely continue over the next five to seven years, and in the meantime, it might be worth considering some of Stanton's recommendations, such as conducting a risk assessment of federal student loan programs and having Sallie Mae develop more effective collection techniques.

Sarah Ducich
Sallie Mae

Stanton's argument that Sallie Mae retains GSE attributes and consequently distorts the student loan market relies on thin research and does not reflect reality. Out of hundreds of analyst reports on Sallie Mae, Stanton relies on only one Wall Street analyst report, citing it five times. He also quotes from unnamed sources and fails to acknowledge that his work was paid for by a group of Sallie Mae's competitors. Nor did he make any attempt to verify the accuracy of his work by contacting Sallie Mae prior to the publication of his paper. Since 2000, Salle Mae's share of the student loan market has actually declined from 30 to 27 percent, and many new competitors have entered the market. In addition, from 1999 to 2006, Sallie Mae has diversified its revenue sources considerably, reducing its share of revenue from Federal Family Education Loan Program (FFELP) loans from 87 to 43 percent. Mr. Stanton also inaccurately presents Sallie Mae's default management activities and grossly overstates Sallie Mae's lobbying presence. Finally, the most flawed part of the analysis was the notion that the government might bail out Sallie Mae in the case of a crisis. Not only is there no market evidence for this idea, which Stanton acknowledges, but his call for federal intervention specifically targeting Sallie Mae is reckless--based purely on his own guesswork. Furthermore, while absolutely no evidence exists that the government would even contemplate bailing out a completely private Sallie Mae, the company has expressed support for legislation to make it explicit that there be no federal bailout under any scenario.
 
Frederick M. Hess
AEI

While certain panelists have considered the privatization of Sallie Mae in terms of its status as a former GSE, it is also helpful to view it in the broader context of higher education finance. First, although the costs of college have risen faster than inflation, given the projected return on a college education, student debt is neither unmanageable nor unreasonable for most graduates. Second, the conditions that prompted the creation of Sallie Mae in the 1970s no longer exist. When Congress chartered Sallie Mae as one of several initiatives to help students obtain college loans, the general assumption was that banks would not lend to students because the borrowers were risky, having little collateral; the market was small; and the loans were meager and expensive to service. Now that these conditions no longer exist, it would be appropriate to reconsider Sallie Mae's proper function in higher education financing. Third, recent investigations by New York attorney general Andrew Cuomo into corruption by financial aid officers demonstrates the need for greater transparency in the industry, as well as clarification of ambiguous regulation that governs the marketing of student loans. Finally, since the circumstances surrounding higher education financing can and do change over time, when considering the merits of the federal government's direct loan program, it is important to think not only of how the program is beneficial in the short run, but also if it is necessary in the long run. Long-run analysis is especially important, given that government provision of a service has the potential to stifle innovation and reduce quality.

Alex J. Pollock
AEI

Sallie Mae is no longer a GSE. It is, however, a "government-sponsored business" (GSB), meaning it operates within an industry backed and structured almost completely by the federal government. A major difference between the two is that the government implicitly guarantees the liabilities of GSEs, whereas the government guarantees the assets of GSBs. Some commentators have criticized Sallie Mae for being too highly leveraged, with a tangible capital ratio of 2.6 percent. However, given that 85 percent of Sallie Mae's loans are guaranteed by the federal government, this leverage appears reasonable. Concerning broader GSE policy, a GSE should never have a perpetual charter. Congress should periodically reexamine the need for a GSE. In addition, the executives of a GSE have a fiduciary duty to its shareholders to extract the maximum value from its government sponsorship, so when a GSE is privatized, Congress should ensure that taxpayers are compensated for how the enterprise has benefited from these privileges. Finally, in the student loan industry, it might be worth considering whether colleges should have a stake in the performance of student loans, since colleges currently view loans purely as income and do not have an interest in ensuring that they do not default.

AEI research assistant Daniel Geary prepared this summary.

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AEI Participants

 

Frederick M.
Hess
  • An educator, political scientist and author, Frederick M. Hess studies K-12 and higher education issues. His books include "Cage-Busting Leadership," "Breakthrough Leadership in the Digital Age," "The Same Thing Over and Over," "Education Unbound," "Common Sense School Reform," "Revolution at the Margins," and "Spinning Wheels." He is also the author of the popular Education Week blog, "Rick Hess Straight Up." Hess's work has appeared in scholarly and popular outlets such as Teachers College Record, Harvard Education Review, Social Science Quarterly, Urban Affairs Review, American Politics Quarterly, The Chronicle of Higher Education, Phi Delta Kappan, Educational Leadership, U.S. News & World Report, National Affairs, the Washington Post, the New York Times, The Wall Street Journal, the Atlantic and National Review. He has edited widely cited volumes on the Common Core, the role of for-profits in education, education philanthropy, school costs and productivity, the impact of education research, and No Child Left Behind.  Hess serves as executive editor of Education Next, as lead faculty member for the Rice Education Entrepreneurship Program, and on the review boards for the Broad Prize in Urban Education and the Broad Prize for Public Charter Schools. He also serves on the boards of directors of the National Association of Charter School Authorizers and 4.0 SCHOOLS. A former high school social studies teacher, he teaches or has taught at the University of Virginia, the University of Pennsylvania, Georgetown University, Rice University and Harvard University. He holds an M.A. and Ph.D. in Government, as well as an M.Ed. in Teaching and Curriculum, from Harvard University.


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    Follow Frederick M. Hess on Twitter.

  • Email: rhess@aei.org
  • Assistant Info

    Name: Sarah DuPre
    Phone: 202-862-7160
    Email: Sarah.DuPre@aei.org

 

Alex J.
Pollock
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.


    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.


    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.


    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.


  • Phone: 202.862.7190
    Email: apollock@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: (202) 419-5212
    Email: emily.rapp@aei.org

 

Peter J.
Wallison
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