Still Upside Down!

So the Department of Education thought and thought about it, the industry waited with baited breath, and here's what they came up with: Lenders can sell their loans to the Department of Ed for 100 basis points + $75.

Nope, that's not gonna get people back in the game.

Let's take a little example: a Stafford loan...the vanilla sort....say $3,500 in principle. A lender would be able to sell that loan to the DoE for (3,500 * 0.01) + 75 = $110. That's right....a lender would be able to pocket $110 for funding this loan. It seems like a lot until we compare that with the associated costs.

Let's say, on average, marketing expenses, and we're being conservative here, per loan are $50. That assumes the lender has a kick-ass marketing department -- which by the way, student lenders have very sloppy and unsophisticated marketing efforts, so this number is probably 2 or 3 times higher than our efficient $50 per loan figure. Now that the marketing department has secured the application, the lender must now process the loan, this isn't a free process: we'll presume this costs about $30 per loan. Again, we're assuming a highly efficient loan operations group -- and you guessed it, very few efficient loan operations exist in student lending. And there will be funding costs. In order for the loan to be funded, even though the DoE will ultimately be replacing the capital, those funding structures must be organized. This effort primarily utilizes investment bankers, lawyers, and commercial bankers. The costs aren't cheap; a funding structure of a modest size can cost up to half a million dollars plus ongoing maintenance fees. For simplicity sake, let's assume there's a funding cost of $20 per loan.

In our greatly simplified, and unrealistic assumed world, that comes to a per loan revenue of $110 and expenses of $100. For a total profit of $10! Or, in terms of ROI, that's a 9.1% return. Not bad? No, not too bad. But considering this is a temporary program, and you'd be doing business with the government (the Department of Education no less!), there are unquantifiable risks here that in reality shrink that 9.1% return down to a loss! The government has yo-yo'ed the FFELP program so many times, that bank transfer costs have a significant legislation/regulation risk premium built in.

It's still not worth it. And here's the main problem: the Department of Education decided on an arbitrary profit amount. The Department of Education is good for doing things like shuffling paper, issuing memo's, promoting bureaucrats. The Department of Education is not good at, in fact horrible, at modeling the market forces in a loan origination industry.

Not to mention, it's not the lack of capital that hindering the FFELP business....it's the, you guessed it, the profit incentive. It will all be quite interesting. This fix will blow up before the elections take place. At some point our elected delegates will have to admit failure.