In Loco Parentis

The student loan industry has been exposed as a backwater of corruption and insider dealing. Paid vacations to the Caribbean and private stock offerings have made quid pro quo a moniker for the student lending industry. Prompted by the year-long crusade against this $85 billion per year industry led by New York State Attorney General Andrew M. Cuomo, the Department of Education issued new rules last week to prevent such illicit practices. While these federal regulations will help curb financial abuses by lenders and universities, they are not as stringent as many state statutes, and offer far too many loopholes for lenders to exploit.

Cuomo’s investigation revealed many practices in the student loan industry that are at best questionable and at worst illegal. Most alarmingly, it found evidence of huge kickbacks for university officials who granted firms “preferred lender” status, thereby directing captive audiences—and millions of dollars—to a single company. The bribery involved in this subjective designation led to the firing of an Education Department official and three senior financial aid officers at different universities last April. The four had owned—and made enormous profits from—shares of Education Lending Group, a preferred student lender for their respective employers.

The new Education Department regulations will ameliorate this anticompetitive state of affairs, but only to an extent. Among other things, regulations will prevent these educational oligopolies by imposing a minimum of three “preferred lenders” for universities. This is a step in the right direction. Enforcing a baseline level of competition will drive down loan interest rates that were artificially inflated by guaranteed business for lenders.

Despite the benefit of such regulations, they weaken many state regulations. After securing millions in settlements from corporations like Citibank and Sallie Mae, the federal lender, Cuomo was able to persuade dozens of universities and student lending firms—even some outside New York—to adhere to a “code of conduct.” This state-regulated code prohibited schools and lenders from sharing revenues, mandated disclosure of university-lender relationships, restricted how “preferred lenders” should be chosen, and banned gifts from lenders to university officials. Since the Education Department explicitly stipulated that their new federal law will supersede state law, Cuomo’s strict code of conduct may be nullified. Indeed, many lenders support the Education Department’s regulation because it is weaker and pushed for the federal supremacy clause so that they could avoid Cuomo’s code while making it seem like they were proactively reforming themselves.

The discrepancy in federal and state regulation would not be such a problem if there was not a strong possibility that student lenders would actively seek loopholes and adhere to the lowest standards of the law. As corporations serving financially inexperienced students and non-profit universities, one might assume that lenders are altruistic to some extent—or at least that universities would assume responsibility as an impartial judge of lenders. However, the recent scandals prove that regulators still have reason to doubt private interests. If such unsavory business practices persist, students will only find refuge behind stricter federal regulations aligned with Cuomo’s “code of conduct.”

Though federal regulation is crucial for correcting this market distortion, truly impartial university financial advice would ensure fair lending practices. Bribes, or to put it euphemistically, incentives, require two actors: the giver and the receiver. Lenders are at fault for offering such inappropriate gifts and incentives to university officials, but unscrupulous university officials bear just as much blame for accepting these gifts. As administrators of educational institutions that not only teach, but also care for their students, financial aid officials are acting in loco parentis. They should be giving the same unbiased financial advice that a parent would give to her child, particularly because many students have little experience with financial planning when they take out their first student loan.

University officials have violated this fiduciary responsibility and should not be given the opportunity to violate it again. Now that financial aid offices are reforming their procedures for naming “preferred lenders,” we suggest that they eliminate “preferred lenders” altogether. University officials have proven that they cannot be trusted to act in the best interest of students; therefore, they should instead direct students to third-party loan comparison companies. It is in these companies’ interests to provide impartial comparison data, because they survive by offering quality information, rather than by offering loans directly. If universities pay for loan comparisons while still helping students to navigate the maze of paperwork required for loans, they can fulfill their responsibility to their students while minimizing the potential for corruption.

Corporate scandal has been the sustenance of the New York Attorney General’s office for almost a decade. Federal regulations are an effective way of eliminating such scandal in the future, if they are tough and appropriately directed. To prevent further sordid deals between student lenders and universities, we hope that regulators will enact stricter laws and that universities will reform their lending procedures to foster impartiality. Addressing the problem from the perspective of both a lender and a university in this way will create a safer lending environment for college students nationwide.