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You know how they say that getting to the bottom of a complicated problem is like peeling an onion? Well, the more we peel off the federal student loan crisis, the more tears we end up shedding.

A couple of weeks ago, Sen. Elizabeth Warren (D-Mass.) sent a letter to the acting director of the Federal Housing Finance Agency, asking for an explanation about an unusual accommodation it had granted. Apparently, the agency has allowed the Sallie Mae Corporation (SLM) — the country’s largest private student lender and loan servicing company — to borrow directly from the Federal Home Loan Bank, an entity whose role is to support residential mortgage lenders.

The Federal Home Loan Bank’s low interest rate of 0.31% is a significant perk for SLM, a company that makes big money on packaging, selling and servicing government-guaranteed Federal Family Education Loan Program (FFELP) and private student loans.

But why would a lender in the mortgage business get into the student loan business?

To give you a sense for the prospective magnitude of this issue, at the time the FFELP was discontinued in 2010, borrowers still owed roughly $487 billion of these loans. As of March 31, 2013, SLM reported that it owned $119.2 billion of these loans, of which $100.7 billion had already been securitized. The company also stated its intention to purchase even more loan debt as it becomes available from secondary sources.

That fact made me curious enough to skim through SLM’s June 12 supplement to its April 2 securitization prospectus, and a few things caught my eye.

To start, securitization agreements generally designate an official servicer for the pool of loans that underlie the subject transactions. SLM itself is that servicing company for these student loan-backed securities, which means the company stands to earn additional profits (above and beyond interest) for the loans it originated. And while there’s nothing unusual about that arrangement, the amount that SLM is charging for its efforts is noteworthy.

Are the Markups Justified?

According to the supplement, the investors agree to pay Sallie a servicing fee that tops out at 0.9% of the outstanding loan balance. Since the average duration of these loans is roughly 10 years, that 0.9% equates to an interest rate add-on of just less than 0.2% – a remarkable number because it starkly contrasts with the various Senate and House proposals that call for interest rate add-ons for borrowers of 10 to more than 20 times that value.

So, as I asked in an earlier post: Is the government in the student loan business altruistically or exploitatively?

Even after factoring in the costs of administering payment delinquencies and defaults, it’s hard to justify proposed interest rate add-ons of 2% to 4.5% within the context of a program that’s already throwing off significant profits.

Then again, perhaps the underlying intent is to use these excess revenues for deficit reduction purposes. If that’s the case, what we’re actually doing is asking the students — our children, who can neither pay their debts, nor realistically discharge them in bankruptcy — to cover expenses that have nothing to do with them!

Maybe it’s a good thing that Congress recessed without moving forward on any one of its misguided measures to address the subsidized Stafford loan-pricing matter.

Second, according to the securitization document, SLM warns investors that as the designated servicer for this pool of loans, it’s empowered to restructure or modify the contracts as the company sees fit — actions that will likely diminish investment returns. Yet, according to the borrowers who have contacted me, forbearance seems to be the only game in town — no ability to modify their own loans, and in fact no help beyond six-month payment moratoriums after which the unpaid interest is added to the outstanding loan balance. Worse, some FFELP borrowers weren’t even informed about their eligibility for the various government relief programs.

All the more reason for reforming the loan servicing process in tandem with tackling pricing and the aggregate unpaid debt.

Even More Troubling …

Last, buried deep within this beast of a document is a so-called receivables aging schedule for the soon-to-be securitized loans: a summary of past-due payments. At the time of its publication, 10.3% of the loans were 30 or more days past due, 15.9% were already in forbearance and another 18.6% were in deferment (which means the borrowers had stopped making their payments altogether).

Although it’s unclear how these three data points fit together, in its simplest form it appears as if 45% of the loans in this prospective securitization are experiencing some form of distress.

So, why would investors be willing to pay good money to buy into such a sketchy-sounding opportunity? Probably because they’re counting on you, me and other taxpayers to bail them out.

This story is an Op/Ed contribution to Credit.com and does not represent the views of the company or its affiliates.

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