How a Little Student Loan Deal Could Spell Big Trouble for Borrowers

The Reuters headline is big and bold: “Wells Fargo to sell $8.5 billion of federal student loans to Navient.”

If you’re thinking, “It’s hard to get all worked up over an $8 billion deal when there’s more than $1.2 trillion-worth of loans out there,” think again.

The contracts that Wells Fargo Corporation is selling to Navient represent loans that were made under the now-defunct Federal Family Education Loan program. FFELs are government-guaranteed student loans that were originated by a network of banks and other private-sector lenders. Approximately $300 billion are currently outstanding, of which Navient is reportedly the single largest owner/administrator.

Government-guaranteed consumer debts—whether they take the form of residential mortgages or education loans—make for very appealing investments to yield-hungry but risk-averse investors. That’s because for all the reckless, politically-motivated bluster, everyone knows that when push comes to shove, the U.S. government always honors its financial obligations.

Navient should have little trouble financing this acquisition, probably the same way it and its former corporate parent, Sallie Mae, have financed much of their previous FFEL purchases: securitization. In this case, though, that task will be a tad less difficult to accomplish, thanks to the financing facility that Wells Fargo is setting up to help complete the sale.

So why should a deal that amounts to decimal dust in the scheme of things attract more than passing attention?

Well, ever since the feds terminated the costly FFEL program in 2010, the government has been lending money on a direct basis to college students and to their parents, to the tune of some $600 billion that now resides on the DOE’s balance sheet.

Given the recent shift in the balance of power to more conservative mindsets, it’s a safe bet that pressure will be brought to bear on the department to shrink the size of that balance sheet by selling all or part of its education-loan portfolio. The money the government borrowed to fund that activity in the first place would then be repaid from the proceeds.

The political benefit is obvious.

Loan sales worth $600 billion will generate enough cash to retire roughly the same amount of government borrowings. Therefore, the party that pulls that off can rightly claim to have engineered a substantial reduction in the national debt. (Of course, that doesn’t account for the forgone value of the deficit-reducing profits that this lending program continues to generate, but that’s a discussion for another day.)

If the DOE does indeed end up feeling compelled to lighten its load—which is likely because of the consistently high demand for Federal Direct Loans—what form would the transactions take and to whom would the contracts be sold? Hint: Look to the Wells Fargo-Navient deal for direction.

And therein lies the problem.

What About the Borrowers?

The reason why so many loan-servicing companies are the subject of consumer ire and regulatory action is because these firms first attend to the interests of their benefactors—the lenders and investors that originate and own the loans—before those of financially distressed borrowers in need of assistance or the taxpayers who are left holding the bag when they end up defaulting.

So when lawmakers talk about reducing the deficit and if downsizing the DOE’s portfolio becomes an integral component of their plan for accomplishing that, it’s important they use the size of a prospective deal to good advantage.

Loan originators that negotiate their own financing transactions are in the best position to bargain for terms that can reasonably satisfy everyone’s interests. In this instance, the DOE would get to pay off its debts, investors would earn a fair rate of return with little downside risk (thanks to the government’s backstop) and distressed borrowers would gain unfettered access to the relief they need. (Of course, the financial-services industry stands to make a fortune in investment banking fees for putting that all together, but that too is another matter for another day.)

The point is this: That “little” deal between Wells Fargo and Navient is a harbinger of things to come. Sometime soon, a mass of Federal Direct Loans is going to find its way into the private sector. When that happens, let’s hope that lawmakers will have already devised a plan that does right by borrowers and taxpayers alike.

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

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Mitchell D. Weiss is an experienced financial services industry executive and entrepreneur. He is an Executive in Residence at the University of Hartford, a member of its business school’s board and co-founder of the university’s Center for Personal Financial Responsibility. His books include Life Happens: A Practical Course on Personal Finance from College to Career and Business Happens: A Practical Guide to Entrepreneurial Finance for Small Businesses and Professional Practices—both of which are now undergraduate courses that Mitch teaches at the university and elsewhere.