The Privatization of Sallie Mae and its Consequences

The Privatization of Sallie Mae andits ConsequencesThomas H. StantonAmerican Enterprise InstituteMay 30, 2007Washington, DC

Sallie Mae as a GSEEstablished 1972 to provide secondarymarket for guaranteed student loan program• Student loans small and hard to service• Sallie Mae could specialize in student loans anddevelop economies of scaleObtained substantial government benefits• More than other GSEs, e.g., authority to borrowwith explicit federal guarantee and from FFBCBO in 1979: 98% of Sallie Mae resourcessupplied by federal government2

Sallie Mae as a GSELower capital and higher leverage thancompetitorsAbility to grow much faster than competitorsSpecialization in designated market withoutfinancial diversificationDependence on political process;development of political strengthPerception that, if Sallie Mae failed,government would bail out debtholders3

Sallie Mae as a GSEFueled by itsgovernmentbenefits, Sallie Maegrew rapidlySallie Maeobligationsoutstanding:19751980198519901995$ 0.3 BN$ 2.7 BN$13.4 BN$ 39.0 BN$ 47.5 BN4

Sallie Mae as a GSE Sallie Mae developed:• Economies of scale, especially in servicing• Close ties to lenders e.g., through technology platforms andwarehousing advances• Political strength5

Sallie Mae as a GSE As a GSE, Sallie Mae remained subjectto political risk In 1993 political risk materialized• 30 bp (0.3 percent) offset fee• New Federal Direct Loan Program 1989: Sallie Mae held 27% of federalguaranteed loans outstanding; second largestcompany held 4 percent6

Privatizing Sallie Mae 1996 Sallie Mae Privatization Act• Established privatization process Holding company structure• Holding company could expand activities Long transition period to operate GSE (to2008) Generally, no affiliation of GSE and a bank ED could request lender-ofof-last-resort function Modest exit fees ($ 36 million + $ 5 million) Shareholder approval required7

Privatizing Sallie MaeHolding Company(non-GSE)Operating Company(non-GSE)Operating Company(non-GSE)Liquidating GSE8

Sallie Mae’s s TransitionThe companycontinued to grow(in a growingmarket)Total managedstudent loans ($ BN,held + ABS):1998200020022004$ 46.4$ 67.5$ 78.1$ 107.52006$ 142.19

Sallie Mae’s s TransitionThe company expanded vertically andhorizontally through acquisitions• Nellie Mae (lender: $ 2.6 BN portfolio)• Operations for USA Group (largestguaranty agency)• Noel-Levitz (enrollment managementcompany)• GRC, AMS, and AFS (debt collectors)10

Sallie Mae’s s Continuing GrowthThe company continued its expansion:Acquired Upromise (saving for college)Established Sallie Mae Bank (ILC)2006: Sallie Mae held 35% of federal guaranteedloans; second largest company held 8 percent2007: agreed to be bought by private equityinvestors + Bank of America + JP Morgan Chase11

Sallie Mae’s s Continuing GrowthCosts of continued expansion:ED IG: Sallie Mae’s s common control of servicingoperations and guaranty agencies creates conflict ofinterest:“The potential for USA Education, Inc., tomanipulate default aversion and collection activitiesis greater than it would be if a separate entityperformed default aversion activities”GAO: common control means that defaulted loanscan be more profitable than performing loans12

Sallie Mae’s s Continuing GrowthNew York State Attorney General onSallie Mae ties to schools:• Sponsoring “advisory boards” comprised of schoolfinancial aid officers, to whom Sallie Mae providedremuneration, travel and lodging fees;• Contracting with 20 schools to provide call-centercenterservices;• Providing “entertainment” to officials at schools withwhich it does loan business; and• Offering opportunity loans to “credit challenged”academically qualified students.13

Sallie Mae TodaySallie Mae is not a GSE today. Yet some parallelsare striking:• Lower capital and higher leverage than competitors• Ability to grow faster than most competitors• Specialization in designated market without financialdiversification• Dependence on political process and exercise of politicalstrength• Possibility that, if Sallie Mae failed, government might bailout the companyUnlikely that this is reflected in a borrowing advantage14

Sallie Mae Today Sallie Mae possesses:• A commanding presence (“the(dominantfranchise”) ) in the student loan market• Economies of scale, especially in servicing• Close ties to schools and lenders e.g., through technology platforms, andblandishments (e.g., opportunity pools)• Political strength15

Public Policy Implications The paper recommends reforms for thefederal student loan market• It is too late to look at the unusual marketstructure created by government and Sallie Mae’sGSE status; privatization is complete• The government should look at market issuesrelating to federal guaranteed loan programs,e.g., need to diversify program risk• The government should look at consumer issuesrelating to federal guaranteed loan programs16

Public Policy ImplicationsThere also are important lessons for theother GSEs from Sallie Mae’s s privatization• Consider beforehand the market implications ofthe privatization of a GSE• Consider, similar to acquisition of a nonprofit by afor-profit company, assessment of a fee to beused for public purposes17