[House Hearing, 106 Congress] [From the U.S. Government Publishing Office] DEPARTMENT OF EDUCATION'S STUDENT LOAN PROGRAMS: ARE TAX DOLLARS AT RISK? ======================================================================= HEARING before the SUBCOMMITTEE ON CRIMINAL JUSTICE, DRUG POLICY, AND HUMAN RESOURCES of the COMMITTEE ON GOVERNMENT REFORM HOUSE OF REPRESENTATIVES ONE HUNDRED SIXTH CONGRESS FIRST SESSION __________ JUNE 17, 1999 __________ Serial No. 106-103 __________ Printed for the use of the Committee on Government Reform __________ U.S. GOVERNMENT PRINTING OFFICE 63-517 WASHINGTON : 2000 Available via the World Wide Web: http://www.gpo.gov/congress/house http://www.house.gov/reform ______ COMMITTEE ON GOVERNMENT REFORM DAN BURTON, Indiana, Chairman BENJAMIN A. GILMAN, New York HENRY A. WAXMAN, California CONSTANCE A. MORELLA, Maryland TOM LANTOS, California CHRISTOPHER SHAYS, Connecticut ROBERT E. WISE, Jr., West Virginia ILEANA ROS-LEHTINEN, Florida MAJOR R. OWENS, New York JOHN M. McHUGH, New York EDOLPHUS TOWNS, New York STEPHEN HORN, California PAUL E. KANJORSKI, Pennsylvania JOHN L. MICA, Florida PATSY T. MINK, Hawaii THOMAS M. DAVIS, Virginia CAROLYN B. MALONEY, New York DAVID M. McINTOSH, Indiana ELEANOR HOLMES NORTON, Washington, MARK E. SOUDER, Indiana DC JOE SCARBOROUGH, Florida CHAKA FATTAH, Pennsylvania STEVEN C. LaTOURETTE, Ohio ELIJAH E. CUMMINGS, Maryland MARSHALL ``MARK'' SANFORD, South DENNIS J. KUCINICH, Ohio Carolina ROD R. BLAGOJEVICH, Illinois BOB BARR, Georgia DANNY K. DAVIS, Illinois DAN MILLER, Florida JOHN F. TIERNEY, Massachusetts ASA HUTCHINSON, Arkansas JIM TURNER, Texas LEE TERRY, Nebraska THOMAS H. ALLEN, Maine JUDY BIGGERT, Illinois HAROLD E. FORD, Jr., Tennessee GREG WALDEN, Oregon JANICE D. SCHAKOWSKY, Illinois DOUG OSE, California ------ PAUL RYAN, Wisconsin BERNARD SANDERS, Vermont JOHN T. DOOLITTLE, California (Independent) HELEN CHENOWETH, Idaho Kevin Binger, Staff Director Daniel R. Moll, Deputy Staff Director David A. Kass, Deputy Counsel and Parliamentarian Carla J. Martin, Chief Clerk Phil Schiliro, Minority Staff Director ------ Subcommittee on Criminal Justice, Drug Policy, and Human Resources JOHN L. MICA, Florida, Chairman BOB BARR, Georgia PATSY T. MINK, Hawaii BENJAMIN A. GILMAN, New York EDOLPHUS TOWNS, New York CHRISTOPHER SHAYS, Connecticut ELIJAH E. CUMMINGS, Maryland ILEANA ROS-LEHTINEN, Florida DENNIS J. KUCINICH, Ohio MARK E. SOUDER, Indiana ROD R. BLAGOJEVICH, Illinois STEVEN C. LaTOURETTE, Ohio JOHN F. TIERNEY, Massachusetts ASA HUTCHINSON, Arkansas JIM TURNER, Texas DOUG OSE, California Ex Officio DAN BURTON, Indiana HENRY A. WAXMAN, California Sharon Pinkerton, Deputy Staff Director Mason Alinger, Professional Staff Member Andrew Greeley, Clerk Cherri Branson, Minority Counsel C O N T E N T S ---------- Page Hearing held on June 17, 1999.................................... 1 Statement of: Berthoud, John, president, National Taxpayers Union; Thomas A. Butts, National Direct Student Loan Coalition; Fred J. Galloway, former director, direct loan program evaluation, Macro International, Inc.; and Steven A. McNamara, Assistant Inspector General for Audit, Office of Inspector General, Department of Education........................... 12 Smith, Marshall S., Acting Deputy Secretary, Department of Education; and Greg Woods, Chief Operating Officer, Office of Student Financial Assistance Programs, Department of Education.................................................. 126 Letters, statements, et cetera, submitted for the record by: Berthoud, John, president, National Taxpayers Union, prepared statement of............................................... 15 Butts, Thomas A., National Direct Student Loan Coalition: Information concerning loan reconciliations.............. 113 Prepared statement of.................................... 23 Cummings, Hon. Elijah E., a Representative in Congress from the State of Maryland, prepared statement of............... 9 Galloway, Fred J., former director, direct loan program evaluation, Macro International, Inc., prepared statement of......................................................... 37 Gilman, Hon. Benjamin A., a Representative in Congress from the State of New York, prepared statement of............... 47 Kucinich, Hon. Dennis J., a Representative in Congress from the State of Ohio, prepared statement of................... 161 McNamara, Steven A., Assistant Inspector General for Audit, Office of Inspector General, Department of Education, prepared statement of...................................... 52 Mica, Hon. John L., a Representative in Congress from the State of Florida: Prepared statement of.................................... 5 U.S. Department of Education's Study of Cost Issues...... 60 Mink, Hon. Patsy T., a Representative in Congress from the State of Hawaii, letter dated September 20, 1991........... 119 Smith, Marshall S., Acting Deputy Secretary, Department of Education, prepared statement of........................... 129 Woods, Greg, Chief Operating Officer, Office of Student Financial Assistance Programs, Department of Education, prepared statement of...................................... 141 DEPARTMENT OF EDUCATION'S STUDENT LOAN PROGRAMS: ARE TAX DOLLARS AT RISK? ---------- THURSDAY, JUNE 17, 1999 House of Representatives, Subcommittee on Criminal Justice, Drug Policy, and Human Resources, Committee on Government Reform, Washington, DC. The subcommittee met, pursuant to notice, at 10:10 a.m., in room 2154, Rayburn House Office Building, Hon. John L. Mica (chairman of the subcommittee) presiding. Present: Representatives Mica, Gilman, Souder, Ose, Mink, Cummings, Kucinich, and Tierney. Staff present: Sharon Pinkerton, deputy staff director; Steve Dilingham, special counsel; Andrew Greeley, clerk; Mason Alinger, professional staff member; Cherri Branson, minority counsel; and Jean Gosa, minority staff assistant. Mr. Mica. I'd like to call this meeting of the Subcommittee on Criminal Justice, Drug Policy, and Human Resources to order. We'll have other Members joining shortly, and with the consent of the minority, we're going to proceed because we have several full panels, and we don't want to keep our witnesses. We'll be able, I think, to proceed in good order as the Members arrive. I will read my opening statement, and then we'll submit others for the record, or, if the Members arrive, we will recognize them. This morning's hearing is entitled, The Department of Education's student loan programs, and it asks a question: Are Tax Dollars at Risk? Faced with staggering college costs, the American family is increasingly dependent on student aid to finance higher education. The cost of a 4-year public education has escalated to almost $12,000 annually, and private schools can cost almost twice as much, now averaging $21,000 a year. Today, more than ever, the Federal Government's role in this process must be examined to ensure that both the student and the taxpayer are being well served. As a subcommittee with oversight jurisdiction of the Department of Education, we have an important responsibility to see that the Office of Student Financial Assistance is operating with fiscal and managerial integrity. For almost 10 successive years, the General Accounting Office has labeled the Education Department's student financial aid programs as, ``a high risk for fraud, waste, abuse, and mismanagement.'' The GAO tells us that the Department lacks the ability to provide basic information about whether a student is enrolled, even after a student loan is awarded and thousands of dollars in student aid have been given. In other words, many students who are not eligible could be, and often are, receiving funds. This kind of poor management not only hurts the taxpayer, but it ultimately takes away from funding from other eligible students. In an attempt to remedy some of these problems, the 1998 Higher Education Act reauthorized a bipartisan agreement that included some much-needed reforms for managing our student aid programs. Congress created the first Federal sector performance-based organization [PBO], this was in the 1998 law, to accomplish some clear goals and try to make the operations of the student loan program more efficient. The goals outlined in that statute are clear, let me cite some of them: to improve service, reduce costs, integrate systems, and improve data accuracy and program integrity. We're here today to assess the PBO's progress to date. It's my understanding that we have some 1,200 plus people employed, and we're not sure how many contractors. We'd like to find out how many additional folks are involved in that process, in addition to full-time employees; how many contractors. We created these PBOs to initiate some of these changes, and today, we'll hear a little bit about what's taken place. By improving service, we mean we do not want a repeat performance of the 3-month shutdown of the loan consolidation program. Systems can be integrated and reliably enhanced by consolidating the existing 12 stovepipe systems into one system with accurate and immediately retrievable data. What progress has been made on this issue? I hope we can find answers to that question today. Now, I understand that the National Student Loan Data System [NSLDS], was created to improve the quality of student financial aid data and minimize fraud and abuse in these programs. However, according to a September 1998 GAO report, almost half of the schools are not using NSLDS's on-line functions. Is this data base working effectively? We also hope to find answers to that question. We'll hear today from the Inspector General's office that the administrative costs in the Department of Education's direct loan program are 31 percent higher than private sector costs. This is bad news for the taxpayers. I'm very concerned that spending for student loan administration has jumped from $137 million a year to $401 million a year from 1992 to 2000. This is a 193 percent increase despite the fact that the Department's award workload has only increased some 28 percent. This is even more bad news for the taxpayer. Qualified personnel should be in place to ensure that the programs are not subject to waste, fraud, and abuse. Since the Department has been repeatedly criticized for a lack of systems integration, are competent people in place to fix this problem? That's another question we hope to find an answer to today. In addition to examining the Student Financial Assistance Office's progress in achieving those goals, I have some other very specific concerns. It's absolutely astounding to me that over $109 million in Pell grant over-awards were made in 1996 to students who fraudulently stated their income in order to be eligible for loans. The Higher Education Act of 1998 was supposed to fix this problem by authorizing the Department of Education to verify a student's income with the IRS. What has the Department done to implement this solution? Another question we hope to find an answer to today. As we delve into a recently released audit by the Inspector General's Office, even the most blase supporter of government bureaucracy has to be shocked by the fact that the Department has forgiven millions of dollars in loans to students on the basis of death or disability despite the fact that these students were neither dead nor disabled. In fact, in just one program that was examined, students went on to earn significant salaries after over $73 million in loans were forgiven for their supposed total and permanent disability. Some of the students, after having their loans forgiven, simply returned to school and received additional loans and grants. Perhaps the most astounding thing about this report is that over $3.8 million in loans was forgiven for students who claimed to be dead but were alive and well. In fact, some forgiven disabled and so-called deceased borrowers were discovered to be doing quite well and enjoying salaries of over $50,000 a year. But what's so unbelievable is that the Department does not even require presentation of a certified copy of a death certificate before a loan is forgiven, just a simple act like that. Once again, the taxpayer is fleeced by a loan program out of control. It really shocks, I think should shock, the conscience of every Member of Congress when we see this type of abuse within a system, particularly when there's so many of our students who are in need of financial assistance, and we have so many demands on education today. I'm also concerned about reports that there are a rapidly growing number of loans going to students who attend foreign universities and misuse the loan money. In 1998, $200 million in loans were awarded for tuition at foreign schools, and the Inspector General has been after the Department for several years to do something about these students who get their checks but never show up for school. I have a quote here from a former Assistant Inspector General in which she asserts that the Department had not moved aggressively to combat this fraud and that, in her opinion, ``the Department could do more to deal with this problem if they just made it a priority,'' and that's taken from the Chronicle of Higher Education, January 15 of this year. In addition, while I understand that the default rate has come down slightly in recent years, I'm frankly troubled that there are still about $20 billion of loans that are in default. I'm also concerned that the default rate terminology and calculation can, in fact, be very misleading. It is defined generally by the Department to refer to the repayment of loans for a 2-year period, not whether the loan goes into actual default at a later date. Congress, for the first time in history, provided a performance-based organization. It now has some 1,200 employees and contract personnel. We provided the PBO with personnel and also gave them contracting flexibility to facilitate operation of the PBO's hoped-for achievement of important educational financing goals. Today, we'll ask many questions. We'll ask in particular how the Department has used those tools to do more, and efficiently, an effective management of our student loan programs. In a time when Congress is struggling to provide funds for students who are very much alive and classrooms and teachers who don't have adequate resources, it's absolutely outrageous that our Federal education bureaucracy would waste such an incredible amount of money. [The prepared statement of Hon. John L. Mica follows:] [GRAPHIC] [TIFF OMITTED] T3517.001 [GRAPHIC] [TIFF OMITTED] T3517.002 Mr. Mica. That concludes my opening statement. I'm pleased that we've been joined by our ranking member, the distinguished lady from Hawaii, Mrs. Mink, who is indeed one of the Congress's champions in education. I recognize her at this time. Mrs. Mink. Thank you, Mr. Chairman. I apologize for being late and missing part of your opening statement. Mr. Mica. That's OK. I'll give you a copy right here. Mrs. Mink. Thank you. Creating opportunities for young people to go on to college is an enormous responsibility, not only of the Federal Government, but of the State and local agencies. It's been one of the very, very significant efforts on the part of the Federal Government to open up opportunities for higher education through loan programs which have enabled many, many students, not only the low-income students, to go on to college. It has afforded relief to many middle-income families as well, as the Congress moved to recognize that the Nation as a whole was dependent upon its ability to offer higher educational opportunities and that financial barriers should never be the reason for persons not being able to go on to higher education. I recognize the fact, Mr. Chairman, that there are always difficulties in the administration of any program and that there will be people who will attempt to sneak out the back door or indulge in fraud or misinformation. It is the responsibility of this subcommittee, I recognize, to investigate these matters, and for that reason I commend you for opening this hearing today. Perhaps it will lead us to ways in which we might tighten up the program, insist upon greater scrutiny and greater safeguards that the Federal funds invested in these programs are not wasted. I look forward to the testimony of all the witnesses that have been called for this subcommittee hearing and must apologize, Mr. Chairman, if I have to leave in midperiod of the hearing as we are in the juvenile justice floor debate, and the chairman of my Education and the Workforce Committee has a major amendment which is coming up shortly and I need to be on the floor. But I will come back as soon as I've had my 2 minutes on the floor. Thank you very much. Mr. Mica. Thank you so much, Mrs. Mink. I recognize now the gentleman from Maryland Mr. Cummings. Mr. Cummings. Thank you very much, Mr. Chairman. I want to thank you, too, for holding this hearing. As one who has a daughter just about to enter college, I, too, am concerned about these loan programs as I am for the students at Johns Hopkins University in my district and many other colleges and, of course, the students in my district and students throughout the country. As one who came from a mother and father who never passed the first grade, but were able to send all of their children to college, their seven children, trying to find ways to make sure that students are able to have the opportunity to go to college is something that is very near and dear to my heart. I would associate my words with that of our ranking member, I think we have to look at these things very carefully. One of the things they taught us in criminal law my first year of law school, was that if there is a way to break the law, people will find it, and I think that you are always going to have some problems. The question is whether you deal with those problems effectively so that the program continues on to do the good that it does. I think that it is our responsibility to look very carefully at the program to make sure they are functioning properly. In the process of doing that, I think we must be careful to keep in mind that these programs are making it possible for people to have opportunity. The great educational scholar James Comber says that people can have will, they can have ability, but if they don't have opportunity, they're going nowhere fast. And so I hope that we'll look carefully at what we're doing here, that we will take appropriate actions where we deem them necessary, and we will strengthen the things that need to be strengthened and made better. And so I want to thank the witnesses too, for being here today, and as I have said to witnesses many times, it is your testimony that makes it possible for us to do what we do. You are the ones who are on the front line. You are the ones who are dealing with the issues. You're the ones who have to go under the scrutiny, and sometimes, I must tell you, after sitting on this committee for over 3 years, sometimes the scrutiny is one-sided, and so it is good to have you here so that you can give us both sides. I've sat in this committee where you would have thought somebody had committed an offense that was worth 10 death penalties, and by the time we'd finished, there was nothing there, and I've seen that many, many, many times. So I sit here with open ears and open heart. Thank you very much. Mr. Mica. I thank the gentleman. [The prepared statement of Hon. Elijah E. Cummings follows:] [GRAPHIC] [TIFF OMITTED] T3517.003 [GRAPHIC] [TIFF OMITTED] T3517.004 [GRAPHIC] [TIFF OMITTED] T3517.005 Mr. Mica. No further opening statements at this time. We'll turn to our first panel. Our first panel consists of Dr. John Berthoud, president of the National Taxpayers Union; Mr. Thomas A. Butts, the National Direct Student Loan Coalition; Dr. Fred J. Galloway, former director of the direct loan program evaluation, currently with Macro International, Inc.; and Mr. Steven A. McNamara, Assistant Inspector General for Audit, Office of Inspector General, Department of Education. I think you're mostly new witnesses. This is an investigations oversight panel of Congress. We do swear in our witnesses, so if you'd please stand and raise your right hands. [Witnesses sworn.] Mr. Mica. The witnesses answered in the affirmative, and I'm pleased to welcome them. Let me just tell you the ground rules first. If you have a lengthy statement, we're going to run the little clock here. We will be glad to submit this statement or additional information or reports for the record. It will be made a part of the record upon request. We ask that you summarize your remarks in about 5 minutes here, and we will begin. I first recognize Dr. John Berthoud, president of the National Taxpayers Union. Welcome, and you're recognized, sir. STATEMENTS OF JOHN BERTHOUD, PRESIDENT, NATIONAL TAXPAYERS UNION; THOMAS A. BUTTS, NATIONAL DIRECT STUDENT LOAN COALITION; FRED J. GALLOWAY, FORMER DIRECTOR, DIRECT LOAN PROGRAM EVALUATION, MACRO INTERNATIONAL, INC.; AND STEVEN A. McNAMARA, ASSISTANT INSPECTOR GENERAL FOR AUDIT, OFFICE OF INSPECTOR GENERAL, DEPARTMENT OF EDUCATION Mr. Berthoud. Mr. Chairman, distinguished members of the committee, thank you very much. It's an honor to appear before you. As you said, Mr. Chairman, I'm John Berthoud, president of the National Taxpayers Union. We are a nationwide grassroots lobbying organization of taxpayers with 300,000 members. I come before you today to state our views, and I will summarize my remarks as you requested, Mr. Chairman. To state our views on the Federal direct loan program, we believe that the evidence shows that this program has been plagued by intractable administrative problems and inefficiencies. These inefficiencies in turn cost taxpayers directly today, and in the future could lead to greater losses if there are significant defaults on the program's loans. The Federal direct loan program has been the fastest-growing Federal loan program, yet until recently there has been little attention to this program or the Department of Education's management practices. We are very grateful at the National Taxpayers Union that you are holding this hearing today to shed some light on some of the difficulties. One of the greatest problems for this program has been slipshod administration by the Department of Education. Mr. Chairman, you touched on some of the problems. I'll repeat a few others. In a March 1999 study, the Inspector General of the Department of Education found inefficiencies in both the FDLP and the Federal family education loan program. Regarding the FDLP, the Inspector General wrote, ``To approximate the effect of these inefficiencies, we compared our estimates to the Department's cost to manage the FDLP, $17 per loan, to the average cost that we estimated, based on U.S. Treasury research, the large private lenders would have incurred to manage the FDLP, $13 per loan. A significant portion of the $4 difference may be due to inefficiencies; however, some of the difference may be due to other factors.'' As you said, I believe, Mr. Chairman, this is indeed bad news for taxpayers. Beyond what the Inspector General found, there have been other troubling indications of waste. Since 1992, while student aid awards were up 28 percent, administrative spending is up about 200 percent, as your chart over here demonstrates. Two years ago, taxpayers were forced to pay $40 million in penalties because of the Department of Education's actions related to the FDLP. I think, as you indicated, the Department had to shut down the loan consolidation program from August 1997 to December 1997 because it couldn't keep up with the backlog of applications. However, these were not the first warning signs for this program. An earlier report by the Inspector General of the Department of Education found other problems. They found problems and weaknesses in other areas, including student status reporting, electronic data processing controls, loan record accuracy, timeliness of reporting, cash management reconciliation, written policies and procedures, and quality assurance systems. The record of the Department of Education in running this program is clearly not one in which the administrators or taxpayers can take pride. The question arises as to why we have these problems, and I know on the second panel you will hear from the Department of Education. They may assure you that if there have been problems, they will get better. We are not so confident of that. I think the problems, from a structural point of view, come from the fact that we are asking a bureaucracy to be something it is not, which is a bank. NTU believes that where the private sector can better fulfill a mission desired by the Congress and the President, it should be allowed to do so. In my written testimony is discussion of the benefits of using the private sector in all facets of public policy. I will note that strong use of the private sector is a central component of the reinventing government concept that Vice President Al Gore often touts. Here, I will only note that beyond greater efficiencies through heavy use of the private sector, there are lower risks to taxpayers. There's also greater satisfaction among end users of the customers of government, as was demonstrated in the Macro International study. Inefficiencies in the FDLP program lead to taxpayer costs and risks. The size of the program puts the extent of this risk in perspective. The FDLP is more than five times as large as the next biggest Federal direct loan program. Through last year it had issued more than $30 billion in loans, which is about one-third of all outstanding Federal loans. By 2004, just 5 years from now, it's projected the program will have issued more than $100 billion in student loans. Even if this program were small, there is no excuse for inefficiency, but the enormous size of the program magnifies the cost. In conclusion, Mr. Chairman, it is not surprising that the Department of Education has not done well with this program. NTU believes education policy is best set by those closest to students and most concerned with results. To maximize efficiency and service delivery, program implementation should be turned over to the private sector wherever feasible. While many are clamoring for yet more education spending on the K through 12 levels and higher, we see, as representatives of taxpayers, a huge run-up in education costs in recent years. In my testimony, you will see both numbers looking at K through 12 spending and overall Federal education spending. I think our message to you today, which is why these hearings are so important, is despite a lot of calls out there for yet more dollars to go to our education systems, the facts are clear that we have invested heavily in recent years in education. The time has come to not spend more, but to spend wiser. In light of this huge run-up, the National Taxpayers Union adamantly rejects the need for more dollars for education. Again, what we need is wiser spending. One small step in that direction would be rolling back the Department of Education's role in direct loans. As is often the case, much of what the government is doing currently could be handled more efficiently and effectively through the private sector. Thank you. Mr. Mica. Thank you for your testimony. We'll withhold questions until we finish the panel. [The prepared statement of Mr. Berthoud follows:] [GRAPHIC] [TIFF OMITTED] T3517.006 [GRAPHIC] [TIFF OMITTED] T3517.007 [GRAPHIC] [TIFF OMITTED] T3517.008 [GRAPHIC] [TIFF OMITTED] T3517.009 [GRAPHIC] [TIFF OMITTED] T3517.010 [GRAPHIC] [TIFF OMITTED] T3517.011 Mr. Mica. Our next witness is Mr. Thomas A. Butts, with the National Direct Student Loan Coalition. Welcome, and you're recognized. Mr. Butts. Thank you, Mr. Chairman. I am Thomas A. Butts, associate vice president for government relations at the University of Michigan. I was, at one time, the director of student financial aid at Michigan and have served as the Deputy Assistant Secretary in the U.S. Department of Education. I am pleased today to have the opportunity to appear before you on behalf of the National Direct Student Loan Coalition. The Coalition is composed of institutions participating in the Federal direct student loan program. Its purpose is to assure the direct loan program accomplishes its goals and mission of providing outstanding service and accountability to students, institutions, and taxpayers. The chair of the Coalition executive committee is Marian Smithson, director of financial aid at Southern Illinois University. The direct loan program was first authorized as a demonstration program as part of the 1992 reauthorization of the Higher Education Act and signed into law by President Bush. Recognizing the lower cost to the taxpayers and potential improved service to students and institutions, the direct loan program was expanded in 1993. Today, institutions have the choice of participating in either the government-guaranteed Federal family education loan or direct loan programs. Presently, more than 1,200 institutions participate in the direct loan program and originate about $11 billion per year in new loans to about 1.9 million students. The University of Michigan was among the first 105 institutions to participate in direct lending. We originate about $130 million in direct loans each year and have had a very successful experience with the program. It has helped us streamline our student aid operations and deliver loans to our students in a timely, cost-effective manner. Like other direct loan institutions, we have been able to fully integrate the loan process with all of our financial aid and business processes. While there have been bumps along the way, as anyone experienced in large system change projects would expect, the Department of Education has really done a wonderful job in meeting its responsibilities to us and to our students. I believe the Michigan experience is typical, as demonstrated by the loyalty direct loan schools have shown to the program and its mission. Direct loan institutions are also pleased by the fact that the competition that we introduced to the FFEL program has resulted in improved service to our colleagues who have chosen to say in FFEL. Although most dissatisfied institutions left FFEL for direct lending, it is good to see that satisfaction of those who remained has improved. One of the reasons those involved in direct lending thought the program would be a success is that it permitted government to leverage the best of private market principles. Capital for the program is obtained essentially through the auction of government securities in the private capital markets, and the program is administered through competitive contracts with the private sector. This stands in stark contrast with FFEL, which essentially is a corporate welfare program masquerading as free enterprise. I had to add that in light of the previous testimony. I'm sure the Department will be providing us with cost comparisons, which, when considering both administrative and subsidy costs, will show that direct lending is a good deal for taxpayers. While the direct loan program is only completing the 5th year of operation, it captured one-third of the student loan market in its first 3 years. Some express concern that it seems to be on hold at that level. However, any private company that introduced a new product and went from zero to one-third of market share in 3 years would be the darling of Wall Street. The last couple of years have given the Department and the institutions the opportunity to adjust to rapid expansion. Under the new performance-based organization, we are expecting substantial improvements in all aspects of program operations, including cost. We believe that the PBO authorized by the Department and being implemented will do much to improve service to direct loan institutions and students. Indeed, it should better the operation of all of the student financial aid programs. In my testimony, I further talk about some of the implementing activities of the performance-based organization. I think it is well on its way, as we'll hear, I presume, from the Department shortly, about what it is about. We are also concerned that students receive equal access to benefits provided by the taxpayers and that all students in both programs be given similar terms and conditions on their loans. That is, their interest rates, fees, and so forth should be the same. To the extent that the Congress has chosen, through a system of mandatory payments to the lenders in the FFEL program, to evidently give more than is necessary to provide a reasonable profit and cover operating expenses in order for them to determine who should get taxpayer benefits, we believe the same should obtain in the direct loan program. The direct loan program for every $100 lent is $7 cheaper than FFEL when considering all of the subsidy costs and the administrative costs of both programs. Mr. Chairman, thank you. I'd be happy to answer any questions. Mr. Mica. Thank you. We will withhold questions until we've heard from everyone. [The prepared statement of Mr. Butts follows:] [GRAPHIC] [TIFF OMITTED] T3517.012 [GRAPHIC] [TIFF OMITTED] T3517.013 [GRAPHIC] [TIFF OMITTED] T3517.014 [GRAPHIC] [TIFF OMITTED] T3517.015 [GRAPHIC] [TIFF OMITTED] T3517.016 [GRAPHIC] [TIFF OMITTED] T3517.017 [GRAPHIC] [TIFF OMITTED] T3517.018 [GRAPHIC] [TIFF OMITTED] T3517.019 [GRAPHIC] [TIFF OMITTED] T3517.020 [GRAPHIC] [TIFF OMITTED] T3517.021 Mr. Mica. We will now hear from Dr. Fred J. Galloway, former director of the direct loan program evaluation, with Macro International. You're recognized, sir. Welcome. Mr. Galloway. Thank you, Mr. Chairman. My name is Fred Galloway, and I appreciate the opportunity to appear before you today to share with you the results of the 5-year evaluation of the Federal direct loan program that I directed while at Macro International. In my remarks today, I'll be touching on three topics of interest to the subcommittee: The structure of our evaluation, the research questions that drove the evaluation, and some of the results from the evaluation. I'll begin with the structure of the evaluation and try and limit my rather lengthy remarks between to 5 and 6 minutes. The evaluation itself was a 5-year, $6.7 million project funded by the Department of Education. Its stated purpose was to evaluate the implementation and effectiveness of the direct loan program. The project began on October 1, 1993, and was scheduled to end on September 30, 1998, although final revisions to reports continue through the end of this year. In the almost 3 years I spent running the evaluation, I can assure you that all of our work was done in a completely unbiased manner, and in no way did the Department of Education ever force us to change or manipulate any of our findings. However, as you will see in a moment, they did cancel part of our contract during the 4th year of the evaluation. Now, we had four research questions that drove the evaluation: What do institutions think about direct lending; what do borrowers think about direct lending; how well has the Department of Education managed and administered the direct loan program; and what are the Federal costs of the direct loan program? I would like to spend approximately 1 minute on our answers to each of those questions to provide some context for you to help understand the program's successes and failures. We asked what institutions think about direct lending. We conducted four annual surveys of over 3,000 direct loan and FFEL institutions. We started in academic year 1994-1995 and went through 1995-1996, 1996-1997, and concluded with academic year 1997-1998. We used a mail survey methodology with the option of completing the survey over the Internet, and our response rates ranged from 75 percent in 1995-1996 to 86 percent in 1997-1998, most importantly with no evidence of nonresponse bias. We had two major findings from our four institutional surveys. First, we found that all schools, direct loan and FFEL schools, were increasingly satisfied with their respective loan programs. In fact, 81 percent in our last survey expressed their satisfaction. This is up from 68 percent in academic year 1994-1995, suggesting that, something I believe Mr. Butts said before, the competition between the two programs has seemed to improve both programs. Our second finding over the last 4 years, institutional satisfaction with the direct loan program had fallen for 3 years before rebounding last year in academic year 1997-1998. Satisfaction with the FFEL program rose through all 4 years. In fact, during the first 2 years of our surveys, we found direct loan schools were significantly more satisfied than were FFEL schools. In the last 2 years of our surveys, we found just the opposite, that FFEL schools were more satisfied than direct loan schools. Now, we also had two minor findings from our institutional survey I'd like to briefly share with you. In terms of institutional satisfaction with the Department of Education and other service providers, in all four of our surveys, we found that direct loan schools were more satisfied with the services provided by the Department than were FFEL schools. Not surprisingly, FFEL schools were significantly more satisfied with the materials and training provided by lenders and guarantors than that provided by the Department of Education. Our last finding, which is quite interesting among institutions actually participating in both programs, we found those institutions trying to do both were less satisfied with the direct loan program than all the institutions participating fully in the direct loan program, and they were less satisfied with the FFEL program than institutions participating fully in the FFEL program. For those schools trying to do both, it was a rough road to hoe. Now, our second research question, what do borrowers think about direct lending? In this case, we conducted three borrower surveys, between 2,500 and 5,000 direct loan and FFEL borrowers. These were telephone surveys using computer-assisted telephone interviewing techniques. Our response rates ranged between 64 percent for our survey of borrowers in repayment to 77 percent for our last, our 1996-1997 survey. Again, there was no evidence of nonresponse bias. Two major findings: Borrowers were extremely satisfied with their respective loan programs; 94 percent of students and 91 percent of parents expressed satisfaction during our last survey, suggesting that borrowers in both programs seemed quite satisfied with the loan programs. We also found in all of our surveys that when we asked students and parents about specific aspects of the loan programs, they were also very satisfied. We found no significant differences, however, between direct loan and FFEL borrowers. Taken together, these findings also suggest the competition between the loan programs has improved both programs. We also found two other things of interest. When we talked to borrowers in repayment, over 90 percent of them were satisfied with their contacts with the Department of Education and other service providers, so it seems things are working quite well here. Finally, and perhaps most interestingly, we found borrowers indicated a relatively low awareness of the terms and conditions of their loans. For example, only 15 percent of students and 19 percent of parents were able to recall or estimate the amount of their recent loan within 1 percent. Almost 6 out of every 10 students and almost half of all parent borrowers did not even know their loan amount within 50 percent of the actual amount. It's quite shocking. It turns out, what's even worse is borrowers have become less knowledgeable between 1994-1995 and 1996-1997. Fortunately, borrowers in repayment do seem to know a little bit more about this. I would like to turn to our third research question, which is how well has the Department of Education administered and managed the program? To answer this question, we used our survey results together with between 40 and 50 interviews a year with individuals involved in the management, administration and oversight of the direct loan program to help shape our reports. Although we produced several reports, I'd like to concentrate on the structure content of our last and most retrospective report, direct loan program administration 1993 to 1998. However, rather than discuss the successes and failures that occurred, as documented in our report, I'd like to focus on the structure of the report, which the subcommittee may find useful helping to understand the context surrounding the Department's management and administration of the program. We prepared this report in the spring of 1998. It was written largely for the new Chief Operating Officer, Greg Woods, although we didn't know who it was going to be at the time coming in to run the congressionally mandated performance- based organization. Our goal in producing the report was to provide a contextual understanding for some of the major events that occurred during the history of the program so the new chief operating officer could hit the ground running. Specifically, we developed a framework that looked at three things. We looked at the effect of external or exogenous factors on departmental decisionmaking. We looked at operating constraints common to all Federal agencies, and finally, we looked at problem areas unique to the Department. In developing this context, the two factors that the Department must take as given to their daily operations is the amount of money they have to operate the program and the level of political scrutiny that the program receives. Although to some extent, all Federal programs operated under these constraints, time and time again we were told by individuals in the Department that not having as much money as they needed to run the program, coupled with the increased level of political scrutiny that resulted from the 1994 congressional elections, forced many direct loan decisionmakers into adopting a risk- adverse posture when making key decisions. Now, in addition to these outside factors, we looked at two factors prominent in most Federal agencies that the Department also has to grapple with: contracting issues and personnel issues. It's discussed in a number of the reports by the Inspector General and the General Accounting Office. Contractual oversight issues coupled with structural weaknesses in the technical skills of many employees make running a technologically sophisticated program like direct lending a tremendously challenging task. Finally, we looked at several problem areas unique to the Department. These included such issues as organizational structure, systems problems and accountability, all of which affect the context that surrounds the management and administration of the program. In our report, we used this contextual framework to help explain some of the major events in the history of the direct loan program, like the transition of loan origination from Utica to the Montgomery, the decision to move to multiple services that was subsequently reversed, and the difficulties associated with the consolidation process that occurred in the latter part of 1997. We also looked at a host of smaller issues, and in our report we provide the historical perspective and discuss how the departmental decisionmaking was influenced by the context that the program operates within. If our report could be summed up in only one phrase, it might be that of a long-time observer of the Department who commented that the program was run better than we had thought, but not as well as was needed. Now, our last research question, which will take less than a minute to discuss, because we didn't complete it, was what were the Federal costs of the direct loan program? In this we enlisted the help of Coopers & Lybrand to help us with some of the accounting information we obtained from the Department, and Economic Systems, Inc., to build a microsimulation model for us. Together our firms were engaged in the tasks of calculating the actual cost to the Federal Government of running the two loan programs, which involved gathering such information as the administrative costs from the general ledger accounts of the Department's primary accounting system. We also looked at invoices and analysis of the major Office of SFA program systems contracts and loan data from the National Student Loan Data System. During the summer of 1997, we were hard at work estimating the Federal cost of the loan programs when our work was stopped by the Department of Education. We were told to turn over all our work documents and provide a summary of our work to date, which we did on August 15, 1997. The modification to our contract became official on September 19, 1997, and the Department reduced our contract amount by slightly more than 300,000 as a result of their cancellation of the cost component. Within less than a month, we had signed a $20,000 contract with the Office of Inspector General to provide both materials and training necessary for OIG staff to prepare our report comparing the cost of the direct loan and FFEL programs. We completed our approximately 160 hours of training by the end of January 1998 and closed the books on our contract with the OIG at that time. I'd be happy to answer questions after the final statement. Mr. Mica. We'll take the questions not in fast forward when we get back to you. [The prepared statement of Mr. Galloway follows:] [GRAPHIC] [TIFF OMITTED] T3517.022 [GRAPHIC] [TIFF OMITTED] T3517.023 [GRAPHIC] [TIFF OMITTED] T3517.024 [GRAPHIC] [TIFF OMITTED] T3517.025 [GRAPHIC] [TIFF OMITTED] T3517.026 [GRAPHIC] [TIFF OMITTED] T3517.027 [GRAPHIC] [TIFF OMITTED] T3517.028 [GRAPHIC] [TIFF OMITTED] T3517.029 [GRAPHIC] [TIFF OMITTED] T3517.030 Mr. Mica. I'm going to interrupt before we get to you, Mr. McNamara, because Mr. Gilman has joined us and may have to leave for another hearing. Mr. Gilman, I'd like to recognize you for your statement. Mr. Gilman. Thank you, Mr. Chairman. I'll be very brief. I want to commend you, Chairman Mica, for conducting this hearing, and when we see a deficit of $11 billion at the end of this year, and possibly by the year 2004 going to $100 billion, it certainly warrants a very thorough review of this whole process and possibly moving it to the private sector. I want to commend the panelists for being here to give us the benefit of their thinking, and I want you to know that many of us are very much concerned about this kind of a deficit at a time of our budgetary constraints. So I would like to ask that my opening remarks be made part of the record. I thank you for allowing me to. Mr. Mica. Without objection, so ordered. [The prepared statement of Hon. Benjamin A. Gilman follows:] [GRAPHIC] [TIFF OMITTED] T3517.031 [GRAPHIC] [TIFF OMITTED] T3517.032 [GRAPHIC] [TIFF OMITTED] T3517.033 Mr. Mica. I appreciate your patience, Mr. McNamara, you are our last witness in this panel. Steven A. McNamara, who is the Assistant Inspector General for Audit, Office of Inspector General, the Department of Education. Welcome, sir. You're recognized. Mr. McNamara. Good morning, Mr. Chairman and members of the subcommittee. Thank you for the opportunity to discuss issues and costs affecting the Federal loan programs. My name is Steven McNamara, and I am the Assistant Inspector General for Audit at the Department of Education, Office of Inspector General. Today, I am representing the Office of Inspector General because our new Inspector General, Lorraine Lewis, was just sworn in on Monday of this week. She regrets not being here today to provide our testimony, but she has not yet had sufficient time to become familiar with the details of our report entitled, Study of Cost Issues, Federal family education loan program and Federal direct loan program, which is the focus of my testimony today. Mr. Chairman, with your permission, I would like to provide a brief oral summary of my statement and submit my complete statement for the record. Mr. Mica. Without objection, the entire statement will be made part of the record. Mr. McNamara. Thank you, Mr. Chairman. Before discussing what the study did say, let me put to rest some misconceptions about what we didn't say. We did not conclude that one program is inherently cheaper than the other. We did not conclude that eliminating the direct loan program would save the government money. We did not state that the inefficiencies affect only one of the programs. And finally, we did not state that private lenders making student loans are more efficient than the government contractors serving the direct loan program. Let me say just a little bit about how we did our study, which was not an audit of either program. We obtained cost information for both programs as reported in the Department's published financial statements for fiscal years 1996 and 1997. Consistent with the Credit Reform Act, we segregated costs into two primary categories, subsidy costs and administrative costs, and we addressed them separately in our study. Subsidy costs include interest expense, loan origination fees, default costs, and other fees, and they constitute by far the majority of the direct loan and FFELP costs. The Department has limited control over subsidy costs because the economy and Congress exert the greatest influence on these costs. Administrative costs are those that the Department incurs in managing both the FFELP and the direct loan program, and they include such costs as contracting, personnel, travel, and others. The Department can largely control these administrative costs through effective management. Because the Department lacks a cost accounting system, it does not allocate administrative costs to the various financial aid programs. Consequently, we allocated administrative costs to the particular loan program in light of the activities and services actually performed. Our study reached two principle conclusions: No. 1, in any given year, either the direct loan program or the FFELP program total cost may be greater, given the effect of prevailing economic conditions on subsidy cost. Since costs may be higher or lower at any one point in time, the total cost figure for any one year does not definitively answer the question of whether FFELP or direct loans are more expensive over a longer period of time. Second, we concluded that inefficiencies likely affect the Department's administrative costs for both loan programs. We base this conclusion on cost calculations that we made in this study and reviews that we had done in previous audits. For the direct loan program, we estimated the Department's cost to administer the loan portfolio to be $17 per loan. We compared our estimate of the Department's cost to the benchmark average cost of $13 that we derived based on a Treasury study of servicing costs of large lenders. We believe that a significant part of the $4 difference may be due to inefficiencies. These inefficiencies can largely be controlled by improved access to reliable information, increased technical and contract management expertise, and compatible automated data processing systems. We do recognize, however, that some of the differences are due to such uncontrollable factors as Federal procurement policies and personnel rules. We were unable in our study to estimate what portion of the FFELP administrative costs result from inefficiencies. This was the case because we didn't have any comparable private sector entity to compare the Department's FFELP administrative costs to. I do want to be perfectly clear on one essential point. We are not taking the position that either program over an extended period of time is cheaper than the other. The intent of the study was to serve as a beginning with the expectation that the Department would refine our cost estimates as it strives to improve the management of both loan programs. We suggested four actions the Department could take to improve the administration of the loan programs: No. 1, institute an activity-based cost accounting system; two, track employees' time to the programs that they work on; three, develop models to predict borrower behavior; and four, take actions to address possible reasons for cost inefficiencies which we cited in the report. We are encouraged that the Department has begun efforts to develop a managerial cost accounting system, and the OIG is working with them as they go forward. Further, the PBO has initiated several actions to address areas where we have found inefficiencies in our past audits. Mr. Chairman, this concludes my statement, and I would be happy to respond to any questions on this issue or other work products. Mr. Mica. Thank you, Mr. McNamara. [The prepared statement of Mr. McNamara follows:] [GRAPHIC] [TIFF OMITTED] T3517.034 [GRAPHIC] [TIFF OMITTED] T3517.035 [GRAPHIC] [TIFF OMITTED] T3517.036 [GRAPHIC] [TIFF OMITTED] T3517.037 [GRAPHIC] [TIFF OMITTED] T3517.038 [GRAPHIC] [TIFF OMITTED] T3517.039 [GRAPHIC] [TIFF OMITTED] T3517.040 Mr. Mica. I'll start out real quickly. Mr. McNamara, this is the study that was produced. It says, Study of Cost Issues, Federal family education loan program. 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On page 17 it says, ``the 2-year average of the Department's FDLP administrative cost is $24 per loan. Of the $24 total, $7 is used to perform oversight and default functions, while the remaining $17 represents FDLP management costs. To assess the reasonableness of the FDLP management costs, we compared the Department's cost to manage the FDLP, $17 per loan, to the average cost that we estimated the large lenders would have incurred to manage the FDL program, $13 per loan,'' and you refer to a table and an appendix. The report goes on to say, ``Given the similarities of the two programs and results of the audits we've reviewed''--and another appendix--``we believe a significant portion of the $4 difference may be due to inefficiencies.'' Now, I'm not a rocket scientist. I didn't do extremely well in math, but the administrative costs appear to be 31 percent higher for the government program; is that correct? Mr. McNamara. Yes, Mr. Chairman, the difference between the $17 and the $13. Mr. Mica. Now, what's gotten a lot of publicity isn't something that we've uncovered here, but rather what we've watched on television. Some of it is probably sensational, but some of the reports are that we have $73 million gone astray for forgiven disability payments and $3.8 million forgiven payments for students that really didn't die. Can you explain what's going on there? Mr. McNamara. Yes, Mr. Chairman. Mr. Mica. Are those inaccurate figures? Mr. McNamara. Yes, Mr. Chairman. Mr. Mica. Tell us what the figures are. Mr. McNamara. The figures are pretty much as you described. What we found in doing an audit---- Mr. Mica. The figures are as I described: $73 million forgiven for folks who weren't disabled, $3.8 million for students that weren't dead. Mr. McNamara. Let me check that very quickly. Mr. Mica. Am I in the range? Mr. McNamara. Yes, Mr. Chairman. During the period July 1994 through December 1996, our audit determined that $216 million in student loans were discharged for death; $292 million in student loans were discharged for total and permanent disability. Nearly $77 million, or approximately 14 percent, were forgiven for these individuals who we later found appeared to have earned income. Mr. Mica. That's more, $77 million, 14 percent. Again, it's very hard for me to understand. I empathize with Mr. Cummings and the ranking member. Their concern is my concern, that these dollars should be going to students who are in need, that's the reason we set this up. But when you tell me in your testimony that we really don't have a problem, that there's not much difference, then you testify that there's a 31 percent difference, the 14 percent of those given to disability are forgiven on a wrong basis, there's something dramatically wrong with the program. Mr. McNamara. Mr. Chairman, I would point out that the numbers I'm quoting are for the FFELP program. We think the underlying cause would be the same for both, so it doesn't relate to the administrative cost of the direct loan program. Mr. Mica. I don't care if it's for the government or for the private sector. It's still just not an acceptable level, and again, I don't mean to give you a hard time, but what we're trying to do is find out--if the information is correct, and are the reports we're getting correct. Is this happening? Mr. McNamara. Yes. Mr. Mica. Thank you. Mr. Butts, you're from the University of Michigan, and you had some laudatory things to say about the direct program. That's correct? Mr. Butts. Yes. Mr. Mica. Is it true that the University of Michigan in 1995 and 1996 could not reconcile its books on this program? Mr. Butts. I'm not sure exactly what you're referring to, Mr. Chairman. Mr. Mica. Isn't one of the requirements that when you participate in the direct loan program that you reconcile your books? Mr. Butts. It's my understanding that all of our records are reconciled, and all cash has always been reconciled. Mr. Mica. Is it not also true that more than $100,000 is given out in 1 fiscal year that could be collected by your university? Mr. Butts. I'm not aware of that. Mr. Mica. I would appreciate it if you go back and check and see if 1995 and 1996 have even yet been reconciled. Mr. Galloway, you conducted this extensive--sounds like a consumer survey. How much did that cost? What was the total cost of finding out whether these folks are satisfied or not? [The information referred to follows:] [GRAPHIC] [TIFF OMITTED] T3517.092 [GRAPHIC] [TIFF OMITTED] T3517.093 Mr. Galloway. Our institutional surveys which we conducted for them, the cost varied between $215,000 and $300,000 per survey. Mr. Mica. The total amount contracted over the period of years for your activities, all of your activities? Mr. Galloway. Put together were about $6.3 million. Mr. Mica. You ended by saying that you felt that there were still problems. In fact, some of the problems you cited you said--and this is from your testimony ``structural weaknesses in the technological skills of many employees make running a technologically sophisticated program like direct lending a tremendously challenging task.'' Were you trying to say it's hard for a government bureaucracy to be a bank? Is that what you said, Mr. Berthoud? Mr. Berthoud. Yes, it is, Mr. Chairman. Mr. Mica. Is that basically what it boils down to? Mr. Galloway. That's part of it. The other part of it, there's a lot of systems requirements in running the direct loan program, and it seems a lot of people told us they really had trouble getting people with cutting-edge technical skills. Mr. Mica. You also said that given the difficulty of firing anyone in the Department I'm very familiar with that, I chaired the Civil Service Subcommitee for 4 years. Mr. Cummings was one of my ranking members. We found it was almost impossible to fire anyone in the Federal work force. Managers are forced to rely constantly on a thin layer of capable people. Now, these aren't my words. This is your testimony; is that correct? Is that one of the problems? Mr. Galloway. If I could add one word to that, I would be glad to say it's correct. Some managers--not every manager has that problem, but a lot of managers talked to us about having problems with some people who couldn't get the job done, and they kind of shove them off in a corner of the room, and they rely on the people who could get the job done. Mr. Mica. Still on the payroll, and then we tax the ones who are able to-- Mr. Galloway. It's tough for the people who have the skills because they get called on all the time. Mr. Mica. Mr. McNamara, one final question. There's also been a number of stories and reports about the problem with foreign schools, people getting loans and not attending school or something wrong with the school. What's the problem there in a nutshell? Mr. McNamara. In a nutshell, Mr. Chairman, foreign schools operate differently than schools in the United States. The check goes directly to the student, and currently there isn't any process in place to verify either before the student gets the loan or while they're in school that they actually are attending the school. Mr. Mica. So there's still no mechanism in place to check up on this? Mr. McNamara. As of this moment, no, but I'm aware the Department is in the process of setting up a website. They could tell you more about the exact status. There is no mechanism in place to prevent the student from initially getting the fraudulent loan. Mr. Mica. Thank you. I'd like to yield now to the ranking member, Mrs. Mink. Mrs. Mink. Thank you very much. Mr. McNamara, the Chair has raised some disturbing statistics about discharges from liability to repay loans on the grounds of total permanent disability or death or other reasons where the government is allowed to discharge the debts rather than by payment. Are there any safeguards in the law which--upon audits such as the one that was performed--which disclosed all of these figures allowing the government to go back and reclaim the loan payments due? Or is the discharge and waiver that's issued final and permanent even though the circumstances upon which those waivers were given turn out not to be true? Mr. McNamara. I believe if we could determine that people that applied for disability did so based on fraud, we could prosecute them criminally or civilly and attempt to---- Mrs. Mink. In the absence of fraud, is there any way in which the law would permit a recovery of the loan payments due? Mr. McNamara. The regulations would not permit us to go back and do that right now. Mrs. Mink. So if, at the date of discharge of the loan liability, the person was indeed disabled, perhaps, as indicated from these notes, collecting Social Security disability, and then subsequently was able to recover, get a job notwithstanding that disability--I mean, blind people are employed, and they do earn sufficient moneys. Persons that are disabled in many ways can go back to school, become trained in computer technology or something and become gainfully employed. Under those circumstances there's no way that the government is able to go back then and recover the loan liability if subsequently the person became an earner, and therefore liable for taxes under IRS? Because I assume that the IRS is the one that disclosed some of these figures. Mr. McNamara. Actually, we obtained these figures by matching everyone who had received a discharge with the Social Security master earnings data base. It certainly could be the case that someone could be declared permanently disabled and then perhaps recover. The Department's regulations right now state that, and I think they're on the chart on the wall--on the board over there, basically you have to be so disabled that it's unlikely you can either return to work or go to school or that you're going to die. So it's pretty extreme. Mrs. Mink. So is there any ability, under the loan regulations that exist, for the government to go back and reclaim the loan liability? Mr. McNamara. Currently, no. Mrs. Mink. So would it be your recommendation that we correct the discrepancy or omission in the law and allow the government to go back and reopen this liability? Mr. McNamara. I think if it can be proven that there was fraud, definitely. The other question, the previous regulations dealt with that, if you were going to get a new loan, your previous loan would be reinstated. That regulation changed, I think, in 1995, that's clearly a policy question but we would support that. Mrs. Mink. Now, on the cost basis which your inspector's report indicated as a $4 difference in terms of operational costs, to what do you directly attribute the $4 difference? Mr. McNamara. We attributed that to possible inefficiencies surrounding access to the necessary information to run the programs. The Department didn't always have necessary management information. As has been mentioned earlier by other members of the panel, the Department is aware that it needs to make improvements in its technical and contracting expertise. We've met with the new PBO Chief Operating Officer, Greg Woods, on that regard, and he has brought in people that have this expertise. And finally, the last inefficiency would be basically the timely information coming in that would allow you to make the management decisions you needed to make. Mrs. Mink. How do you determine what the cost of the loan is if the basis of the determination is lack of information, lack of a cost accounting system, or lack of relevant data? How do you make an assessment on what the true cost is for the program? Mr. McNamara. We use the audited financial statements for fiscal years 1996 and 1997, so we started with a full deck. Then basically, we just allocated it down to one program or the other, and we came out with a bottom line. Mrs. Mink. So if you had the true data, it might turn out to be quite different? Mr. McNamara. We did have the true data. Mrs. Mink. You had the true data in terms of how to distribute the administrative costs to each type of loan? Mr. McNamara. Yes, ma'am. Mrs. Mink. You have confidence that the $4 difference is a true difference? Mr. McNamara. I have confidence in what the actual costs were for fiscal years 1996 and 1997. The $4 difference is derived by a projection that we made using a U.S. Treasury study that estimated the cost of a large private lender to service a similar portfolio. We used that as a benchmark, and we compared that to the actual cost. Mrs. Mink. Which is the large private vendor that was used as a benchmark? Mr. McNamara. There was no particular lender. This was a Treasury study done to try to determine how much FFELP lenders should be paid last year when there was a lot of controversy about the interest rates and what they should get. This was their approximation of what it would cost a hypothetical large lender to service loans. Mrs. Mink. The decision of the Congress to go into the direct loan program was basically to save money. As I recall the deliberations in my committee, there was an assumption that there would be a $4 billion savings in establishing a direct loan program which the universities would administer directly rather than going through the private lenders route. Has that savings panned out? Mr. McNamara. I could comment on the results of our study. The savings, I guess, would depend on what previous study you were quoting and whether they said it would cost more or less. Studies we looked at fell out on both sides. I think one of the major flaws we found in all the studies we looked at was that some of them were made before the law was passed. They were assumed to be 100 percent direct loan program, for example, and other significant changes Congress made really invalidated the assumptions of many of those studies. We know what we found, and I really couldn't compare it to the earlier studies because they didn't use the same assumptions. Mrs. Mink. What is your conclusion then in terms of whether there have been any budgetary savings overall by the transfer to a direct loan program? Mr. McNamara. We didn't make that conclusion. What our conclusion was that in any given year, and that really subsidy costs drive it, either program could cost more or less. I think there are projections available, and depending on what interest rates you use going into the future, you could project one to be more or less than the other. Mrs. Mink. I have just one final question, Mr. Berthoud, representing the National Taxpayers Union. Certainly I appreciate your comments with respect to the attention which your National Taxpayers Union directs to the cost of various programs. I just wanted, Mr. Chairman, to note that when this matter was being debated in the Congress, specifically in my committee, the author of the program was Congressman Robert Andrews, with the support of our then chairman, Mr. Ford. We have a letter from the record dated September 20, 1991, from the National Taxpayers Union endorsing the bill that Mr. Andrews introduced, H.R. 3211. The letter commends him for introducing it because it would yield taxpayers savings of $1.5 billion a year. I'd ask unanimous consent to have this inserted in the record. Mr. Mica. Without objection so ordered. Mrs. Mink. Thank you very much. [The information referred to follows:] [GRAPHIC] [TIFF OMITTED] T3517.094 Mr. Mica. I'd like to now recognize the gentleman from Indiana, Mr. Souder. Mr. Souder. I thank the chairman, and I also thank him for this hearing. This has been a difficult topic as we move through the higher education bill over in the education committee, and it's important that we continue to monitor this issue. First, I'd like to ask Dr. Berthoud in general, I was on the small business program, and every time we expanded small business lending, people said, well, this is free. We have this little portion that we can expand. Don't you see this phenomena happening across the government, that at the time we have economic good times, we're expanding all the risk of the Federal Government, and we're not really having an analysis of what this could cost the taxpayers long term? Mr. Berthoud. I think that's absolutely right. The Congress in recent years has made important steps on better accounting of its loan and direct loan and loan guarantee programs. But in many cases, with Federal and State governments loans, loan liabilities, the tremendous unfunded liabilities of the Social Security program and others, there are a lot of long-term fiscal concerns that we have. Mr. Souder. Many conservatives such as you and I, favored moving toward loans from some grants and having accountability and responsibility, but there also needs to be a balance of what amount at risk the government would have if there was a downturn. I've never seen such a projection in any forecasting. We see the total cumulative, but not the differential cost to the government if there's a recession or a growth rate of X amount. It simply isn't in our budgetary calculations. We see the large hundred billion exposed, $11 billion annually, but we don't see what that actually means in the bad debt allowance that a private company would have to be projecting, assuming an average bad debt ratio over time. We assume a fixed bad debt ratio even if the exposure increases. Mr. Butts, when the program was first conceived, was there any consideration given to that variance in the amount of bad debts and how that would be calculated in the budget? Mr. Butts. The assumptions were that the defaults should be--would be roughly similar, and that the Department of Education needed to do everything it could to reduce the default rates, and as direct lending comes on-line, it should have and maintain a loan rate. You'll note that in the last few years the overall default rate in student loans has dropped from something like 22 percent to under 10 percent now. Mr. Souder. But isn't this exactly where the administrative costs come into play, because if you have fixed overhead plus the bad debts, it's no longer a savings because we don't absorb--in other words, if all of a sudden we have a recession and the bad debts go up, we don't ask the private lenders that we have to pay their overhead. Mr. Butts. The private lenders are guaranteed 98 percent of repayment on their loans and are guaranteed an entitlement, mandatory payment from the Congress, a subsidy for every loan they make, which would appear to be more than is necessary to make a reasonable profit and to cover their overhead costs for administration. The direct loan program, it was anticipated--we're in our 5th year. We're making over $10 billion a year in new loans. And students are beginning to come into repayment, so it is only logical that the servicing costs should be increasing as that volume comes on-line. That was anticipated when the program was enacted, and the administrative funding that was put into the law anticipated those costs. If you look at the administrative costs of the program that the Department has, one of the things that we don't have is a comparison of what those real administrative costs are in the FFELP program because it's so diverse, it has never been studied. We've not had a good study of the subsidies. The Congressional Budget Office has studied those issues with the Treasury, and I have some concerns here. But the latest methodologies that I've seen from the OMB and the CBO, if you take into account the subsidy payments in both FFELP and direct lending and the administrative costs to the Department, it is roughly $7 per $100 loaned cheaper to do a direct loan than to do a FFELP loan, and if you reduce direct loan volume, taxpayer costs will increase. If you increase direct loan volume overall, they will decrease. Mr. Souder. I already have the yellow light. I want to make a couple of points. One is that, in a factual basis, we've had a loan increase since 1992 of 28 percent and an administrative increase of 212 percent. Now, there may be many different reasons, but we've heard a number today. This program was sold that it was going to save the Federal Government money. At best, the Inspector General seems defensive in his report in saying he's not saying that the private loan programs are cheaper to administer. In other words, at best you're saying it's a draw. Is that a misrepresentation of what you said, Mr. McNamara? Mr. McNamara. We didn't conclude it was a draw. We simply said we didn't draw a conclusion on the difference. Mr. Souder. In fact, you did draw a conclusion in the sense you said it could be higher under one program one year, and it could be lower under another program, which means it could go back and forth. But you did not suggest that, in fact, the way the program was sold, which is that it was going to save the government money, was a definitive conclusion. Mr. McNamara. Correct. We didn't conclude that. Mr. Souder. And that furthermore, if this was a private government audit--and we heard things, as the chairman already pointed out, structural weaknesses in the technological skills of many employees, which is because the Department of Education is not expected to be a bank; the difficulty of firing anyone in the Department, which is true because it's government; and as was also pointed out by those from Dr. Galloway and Mr. McNamara, having access to reliable information. Well, yes, government departments aren't private sector organizations that necessarily have this equipment, having qualified technical aid and contract management, because they're not a bank using compatible automated data processing systems. We have that throughout the government, and it's the danger of trying to expand and take over additional private sector things; we're not going to be able to afford all the data processing systems, including uncontrollable factors as Federal procurement. Yes, we do have personnel rules. Yes, we do have that. Furthermore, I think earlier in your testimony you said they don't have a cost accounting system. I can't imagine a private sector company this big without a cost accounting system. And then my personal favorite line of which I am very proud of is that the--from Dr. Galloway, the 1994 congressional elections, me, I was one of the people that came in, forced many direct loan decisionmakers into adopting a risk-adverse posture. I would hope so. They are loan officers. As a borrower, I don't like banks a lot of times. They only want to give you money if you deserve it, and they sit there, and unless you can prove you have plenty of money, they don't want to give you the loan. It's aggravating. As a parent with two students in college, quite frankly, I understand that in initial procedures with direct lending, it actually helped simplify, much like sometimes a public sector entity is needed, but then they back up after we've fixed some of that. The truth here is that I am concerned about the ability of the government and definitely don't believe it should be expanding, and that I hope they continue to be somewhat concerned by Congress so they adopt a risk-adverse policy, and I view that as a tremendous compliment, and I want to thank you for it. Mr. Mica. I thank the gentleman from Indiana. I don't think you were asking for a response. Mr. Cummings. Mr. Cummings. Thank you very much, Mr. Chairman. Mr. McNamara, a lot of times these hearings come about--I'm not always sure about how they come about--but a lot of times what happens, we read things in the newspaper or we hear it on the news, and the next thing you know we have a hearing. There's nothing wrong with that. One of the articles that I think probably had some impact here was a June 1, 1999, article, editorial rather, of Investors Business Daily. Are you familiar with that? Mr. McNamara. No, sir, I'm not. Mr. Cummings. They talk about your report extensively. Mr. McNamara. The cost study? Mr. Cummings. Yes. When you look at an editorial, a lot of times the editorial writer takes a lot of liberty, and I'm not sure whether--I mean, just based upon your testimony today, I question whether the writer is accurate. I just want to make sure we're clear. First of all, the editorial says that your report says, ``one program is costing taxpayers an extra $100 million a year.'' Is that accurate? Mr. McNamara. No, sir. Mr. Cummings. You never said that? Mr. McNamara. No, sir. Mr. Cummings. It also says that the Department of Education ignored your report, do you believe that to be accurate? Mr. McNamara. No, I don't believe that they have ignored it. We've had a lot of discussions with them. They also plan to adopt the methodology we use to allocate costs as they go forth to set up their accounting system, and we've had a few meetings with them so far to get that process started. Mr. Cummings. This article was written on June 1. The actions that you just spoke of, did some of them happen before June 1, such as maybe something happened afterwards that the writer didn't know about? I'm just curious. Mr. McNamara. I would say it's both. Mr. Cummings. Could you tell us what has happened since June 1 so I can sort of update this information in my mind? Mr. McNamara. Since June 1, and I'm doing this off the top of my head. Mr. Cummings. I understand. Do the best you can. Mr. McNamara. We obtained information from the Army Materiel Command on activity-based costing. I had my staff member that did this study review that. I know he's had some discussions and had preliminary meetings with the head of the accounting and finance group in the new PBO, and she's interested in working with us as she decides on a new managerial cost accounting system. Some of that happened before the first, and some of it has happened since the first. Mr. Cummings. Quite a bit of other things happened before the first. It was only a few days ago. Mr. McNamara. Yes, sir. Mr. Cummings. Let me ask you this. Going back to the editorial, I think you said you had four recommendations? Mr. McNamara. Yes, sir. Mr. Cummings. Can you just say them again for me real quick? Mr. McNamara. To institute a cost accounting system, a managerial cost accounting, activity-based cost accounting system was one. Mr. Cummings. Some action is being taken on that based on what you just talked about? Mr. McNamara. Yes, sir. Mr. Cummings. Go ahead. Two. Mr. McNamara. The second one was to allocate employee cost to the program that benefited. Mr. Cummings. Has there been anything happening on that? Mr. McNamara. That would probably be subsumed into the first recommendation. Mr. Cummings. I'm not an accountant, but I kind of figured that. No. 3? Mr. McNamara. Was to start studies on borrower behavior. Mr. Cummings. Tell me what you have in mind by that? What does that mean? Mr. McNamara. Well, the more you know about borrower behavior, the more you know about what might happen if you change various policies, what effect it might have on defaults and various other things. I think lenders typically do this to know that if you raise interest rates, are you going to make more loans or less loans; what affect would certain collection practices have in terms of your ability to get the loans back in, that sort of thing. Mr. Cummings. Has any action been taken on that? Mr. McNamara. I'm unaware of that. The Department would be in a better position to talk about that. Mr. Cummings. No. 4. Mr. McNamara. Recommendations. I'm almost going from memory now. Let me just refer to the fourth one. The final one was to address the inefficiencies that we pointed out from previous studies that we had done or the General Accounting Office had done. Problems with the--for instance, the information systems, trying to consolidate those, eliminate the stovepipe systems that have been discussed earlier. Mr. Cummings. Some action has been taken on that? Mr. McNamara. It's currently under way. That's why the PBO was set up. Greg Woods is working on a blueprint that I'm sure he'll tell you about. Our office has been invited, and we are working with them as they design the systems to try to make sure that internal controls are designed in at the start. Mr. Cummings. Do you feel comfortable with--having spent this time doing your investigation? Do you feel satisfied that the Department is doing their part to followup on the things that you recommended generally, and from what you do know? Mr. McNamara. From what I do know, they clearly made a beginning on the first two, and that's the cost accounting. The others, you know, they've gotten started, but it's really too early to tell. Mr. Cummings. I don't have anything else. Mr. Mica. Thank you. We'll recognize now Mr. Ose, the gentleman from California. Mr. Ose. Thank you, Mr. Chairman. Mr. Butts, I want to make sure I understand the process in the direct program. The student comes in, applies to a university or higher education facility seeking financial assistance for continuing at school, for tuition, books and the like. The institution goes through its underwriting criteria, I presume, exercises some judgment on the ability of the student to repay, and makes a loan. Once the loan is made, what happens to the loan itself? You package it and sell it to Sallie Mae? Mr. Butts. Once the university has given a student a financial aid package of Pell grants, loans, and so forth, we distribute the funds to the students with appropriate promissory notes and draw down the money from the Federal Government, as we do for all of our programs, and allocate it to the students' account wherever it is appropriately to go. The signed promissory note is sent to the Department of Education's contractor for servicing purposes. The servicer then enters it and sends a confirmation notice to the student that reminds the student that they have a loan. The government then assumes the responsibility for the billing and servicing. All the servicing of the student loans for direct loans is handled by private sector contractors to the Department of Education. Mr. Ose. That's the $13 or $17 figure we keep talking about? Mr. Butts. Yes, sir. That $17 figure, as I understand it, includes the profit paid to the contractors. I'm not sure that the other number includes that. Mr. Ose. In this process, somewhere along the way, the note is sold, or is it held by the Federal Government? Mr. Butts. It is held by the Federal Government. You see, the capital for these loans have been obtained for all practical purposes through the weekly auction in the private capital markets, similar to T-bills and at, of course, very good rates for the government because it can leverage its purchasing power in the marketplace. As the loans are repaid in direct lending, then they are simply turned to the Treasury. Mr. Ose. The actual loan is never packaged and sold? Mr. Butts. Not in the direct loan program. Mr. Ose. How about the Federal family education program, the FFELP? Mr. Butts. In the FFELP program, there are, I think, some 7,000 lenders, over 300 or so very active lenders, and a variety of secondary markets including Sallie Mae, tax exempts and so forth. Those loans can be bought and sold in the marketplace. One of the advantages, we think, of the direct loan program is that the student always knows who owns their loan and who to make the payment to. Mr. Ose. Because the institution continues to hold it, and it is serviced by the private contractor. Mr. Butts. Because the government owns the loan, and it's being serviced by one entity. Mr. Ose. Now, you would have the direct loans, so you would not be involved in the guarantee, because if the Federal Government isn't paid, they just write it off or declare them dead. Mr. Butts. At one point we were involved with the guaranteed loan program, and we dealt with every lender and secondary market in the country as a national university and dealt with--it was a very complicated process for us, which is why we changed. We think direct loans provide better service to our students; other institutions think otherwise. Clearly the marketplace is now making both programs competitive, but we think that the fact that the student in direct lending knows who owns their loan, and that doesn't change, may change repayment plans wherever possible, and has access to income- contingent repayment plans are clear advantages for the students. Mr. Ose. Mr. Chairman, I thank you for the 5 minutes. I know we have a vote, so I yield back. Mr. Mica. I want to thank all of our panelists: Mr. Berthoud from the National Taxpayers Union. Mr. Butts, we're waiting to hear back from the University of Michigan's reconciliation of accounts from 1995-1996. Dr. Galloway, we wish you many further studies and contracts. Mr. McNamara, thank you. We appreciate the new Inspector General's willingness to go forward today, even though she's not in place, but we wanted to get this matter before the subcommittee in a timely fashion. I might say, too, this is not the result of a GAO study ordered by Congress. This is a study, as I understand, that the Department authorized, and the audit results speak for themselves, but we do need your interpretation and appreciate your cooperation. We will hear from the second panel and the Department of Education in--I think we have four votes or so. We're going to have to recess the hearing until about 12:35. It will be just under an hour, which will give folks an opportunity to catch a quick bite. I apologize to our next two witnesses, but there will be a series of votes, and we can't conduct business in the interim. I thank this panel. You're excused. This meeting of the subcommittee is in recess. [Whereupon at 11:45 a.m., the subcommittee recessed to reconvene at 12:35 the same day.] Mr. Mica. I would like to call this meeting of the subcommittee back to order. We have our second panel before us: Dr. Marshall S. Smith, Acting Deputy Secretary, Department of Education; Mr. Greg Woods, Chief Operating Officer, Office of Student Financial Assistance Programs under the Department of Education. Gentlemen, this is an investigation and oversight subcommittee. Would you please stand and be sworn? [Witnesses sworn.] Mr. Mica. The witnesses answered in the affirmative. If you have lengthy statements, we'll make them part of the record by unanimous consent. Otherwise, you're recognized. The first witness is Dr. Marshall Smith, Acting Deputy Secretary, Department of Education. Welcome, and you're recognized, sir. STATEMENTS OF MARSHALL S. SMITH, ACTING DEPUTY SECRETARY, DEPARTMENT OF EDUCATION; AND GREG WOODS, CHIEF OPERATING OFFICER, OFFICE OF STUDENT FINANCIAL ASSISTANCE PROGRAMS, DEPARTMENT OF EDUCATION Mr. Smith. Thank you, Mr. Chairman, Mrs. Mink. The Department of Education administers two Stafford student loan programs. Under the FFEL, Federal family education loan program, the Federal Government subsidizes private lenders to make student loans and then guarantees those loans against defaults. Under the direct loan program, we fund student loans with Federal capital and hire private companies under performance- based contracts to deliver and service the loans. This year, the FFEL program will provide an estimated $20.4 billion in new loans for approximately 3.5 million students; and the direct loan program will provide $10.6 billion in loans to 1.9 million students. Before the direct loan program was founded in 1994, students and schools were often confused by an array of different paperwork, procedures and schedules in the FFEL program. Only 68 percent of schools expressed satisfaction with the program. Federal subsidies for FFEL lenders and guarantee agencies were too costly for taxpayers, and the program had not received a clean audit opinion at least since the Department of Education was founded in 1980. The direct loan program reduced paperwork, created a single loan account with one point of contact for each student and allowed the graduates greater flexibility in repaying the loans, including the new income contingent repayment plan. In 3 years, over 1,200 schools chose to leave the FFEL program and join direct lending. The direct loan program now originates as many loans as the largest 15 FFEL lenders together. It holds one-third of one of the largest financial markets in the world. A new and strong competitor, the direct loan program helped inspire FFEL lenders to help improve their services. As a senior FFEL executive said last year, ``Direct Loans have introduced some ways of doing business and some delivery mechanisms that made the private industry wake up a little bit. It's been good for the industry, particularly for students and schools.'' Competition does help, primarily to improve service in the FFEL program. Satisfaction with both student loan programs among schools increased from 68 percent in 1994-1995 to 81 percent in 1997-1998. Students are also satisfied. A 1998 survey found that 94 percent of all student borrowers were satisfied with their loan program. With the help of Congress and our partners, the Department strengthened the financial management of the loan programs. The national cohort default rate has been reduced from 22.4 percent 5 years ago to a record low 9.6 percent. At the same time, annual collections have increased by two-fifths, from 6.6 percent of outstanding defaults in fiscal year 1993 to 9.2 percent in fiscal year 1998. The National Student Loan Data System has helped prevent ineligible students from receiving as much as $400 million in grants and loans this year. These and other improvements helped the Department receive an unqualified opinion from its auditors on its fiscal 1997 financial statement. The subcommittee heard this morning from the Department of Education's Office of the Inspector General, which recently completed a study of direct loans and FFEL costs. We welcome the findings of the study, which I hope will help us reduce administrative costs and improve our internal accounting. However, I'm concerned that some have misunderstood the study and wrongly concluded that the direct loan program is more expensive for taxpayers than the FFEL program. The report does not compare the total cost to the taxpayer of these programs. It's that simple. Instead, the Inspector General's report compares documented direct loan administrative costs with estimates of what it might cost a large FFEL lender to manage the same loans. It does not report actual administrative costs in the FFEL program. More importantly, it does not combine the Federal administrative costs with the Federal subsidy costs. The overall Federal subsidy includes default costs, interest subsidies and other expenses that are the large majority of Federal expenses in operating the FFEL program. Adding the subsidy costs to the Federal administrative costs would present a clearer picture of the total cost to taxpayers. The table on page 8 of my written testimony does this. That table shows that using current economic assumptions, both by the CBO and by the administration, the direct loan program is substantially less expensive for taxpayers than the FFEL program. In this analysis, each FFEL loan is nearly twice as expensive for taxpayers as a comparable direct loan, according to either the administration or the CBO's estimate. As a result, direct loans are estimated to save taxpayers over $700 million this fiscal year compared to the cost of all direct loans if they were FFEL loans. In summary, the student loan programs have come a long way since the direct loan program was established in 1994. Major improvements to the program include healthy competition between the two student loan programs, creating marketplace incentives to improve service and increase customer service satisfaction. Now schools can move to the program that they believe will best serve their students. We now have lower interest rates for students who have saved $4.7 billion--since 1994. Finally, there have been over $5 billion in savings--$5 billion in savings for taxpayers since 1994 due to reduced subsides for FFEL financial institutions and the lower Federal costs for direct loans than for FFEL loans. That's $5 billion. In addition, taxpayers have saved additional billions in reduced default costs. Now the loan programs are poised for further improvements. The new performance-based organization established by Congress has greater management flexibility, accountability for results, and incentives for high performance. We supported this law and have been pleased to implement it quickly and enthusiastically. The first Chief Operating Officer for Student Aid, Greg Woods, has hit the ground running. He has the right experience, including being the CEO of a software company and 5 years at the Reinventing Government initiative, to make the PBO a success. After Mr. Woods describes his plans for improving the administration of student aid, I'd be happy to answer any questions you may have. Thank you, Mr. Chairman. Mr. Mica. Thank you. [The prepared statement of Mr. Smith follows:] [GRAPHIC] [TIFF OMITTED] T3517.095 [GRAPHIC] [TIFF OMITTED] T3517.096 [GRAPHIC] [TIFF OMITTED] T3517.097 [GRAPHIC] [TIFF OMITTED] T3517.098 [GRAPHIC] [TIFF OMITTED] T3517.099 [GRAPHIC] [TIFF OMITTED] T3517.100 [GRAPHIC] [TIFF OMITTED] T3517.101 [GRAPHIC] [TIFF OMITTED] T3517.102 [GRAPHIC] [TIFF OMITTED] T3517.103 [GRAPHIC] [TIFF OMITTED] T3517.104 Mr. Mica. I'd like to recognize Mr. Greg Woods, Chief Operating Officer, Office of Student Financial Assistance Programs. Mr. Woods. Mr. Chairman, committee members, thank you very much. I'll focus on the improvements we're making in the PBO in the overall delivery of student financial assistance; and, with your permission, I will submit a written record. Mr. Mica. Without objection, that will be made part of the record. Thank you. Mr. Woods. I'll summarize it briefly here. Six months ago, I became the first Chief Operating Officer of the government's first performance-based organization. Congress created that performance-based organization to focus on the operational aspects of student aid, as distinguished from its policymaking functions, the whole idea to make the thing run more like a business. That's my background. I'd been a success in business, and I bring that point of view to this job. My specific mandates in the legislation are to improve customer service and to reduce cost and, as a way of doing both, to integrate and streamline the computer systems. I view my ultimate customer here as the student who needs financial help to get an education, but the aid is delivered in the system. That system includes partnerships with schools and the financial community. The overall cost of getting aid to the student includes everything that our delivery partners and we spend on that entire process. That means my job, as I view it, is to do whatever I can to make both these programs, the direct loan program and the FFEL program, efficient and effective, to make them both excellent values for the student and the taxpayers and to make them both excellent investments for America. The natural competition between the two programs I view is a good thing and a powerful tool to that end. The Secretary has already spoken to the advantages that competition has introduced into this arena and that competition continues. On the other hand, OSFA and these commercial lenders are partners with a common goal. That is, we're helping to put America through school. So we're trying to constantly collaborate with these partners to improve service and cut costs in the entire system. Our overall goal in the PBO is service that equals the best in business. To get to that level of performance, we're in the process of changing absolutely everything that goes on in this organization. We're reorganizing the Office of Student Financial Assistance along the lines of private sector corporations to focus in channels on the people that we deal with, a channel for students, a channel for schools, and a channel for our financial partners. We're instituting a financial management system to get the kind of cost data that the IG referred to as necessary to do proper cost estimates and to manage this business day in and day out. We have a Customer Service Task Force that's been in consultation with our partners listening to students, listening to partners, listening to our own employees; and, next month, we'll publish a report with about 200 ideas on ways to improve service delivery in our organization. We have a new acquisition strategy. We are in the process of renegotiating all of our contracts for our computer systems into performance contracts with goals that would tie to my own as the Chief Operating Officer of the organization. With the help of the schools community, technical centers like Highway One and financial powerhouses like the Bank of America, we've been preparing a Modernization Blueprint that will go after the reengineering of our stovepipe computer systems. And in September, I'll deliver to the Congress a 5- year performance plan that will have an aggressive set of goals for improving service and lowering cost. In fact, everything we're doing goes back to the PBO mandates from Congress to improve service to the students and to cut costs, whether they be FFEL or direct loan costs. Thank you very much. I would be happy to assist the Secretary now in answering any questions that you might have. Mr. Mica. Thank you. [The prepared statement of Mr. Woods follows:] [GRAPHIC] [TIFF OMITTED] T3517.105 [GRAPHIC] [TIFF OMITTED] T3517.106 [GRAPHIC] [TIFF OMITTED] T3517.107 [GRAPHIC] [TIFF OMITTED] T3517.108 [GRAPHIC] [TIFF OMITTED] T3517.109 [GRAPHIC] [TIFF OMITTED] T3517.110 [GRAPHIC] [TIFF OMITTED] T3517.111 [GRAPHIC] [TIFF OMITTED] T3517.112 [GRAPHIC] [TIFF OMITTED] T3517.113 [GRAPHIC] [TIFF OMITTED] T3517.114 [GRAPHIC] [TIFF OMITTED] T3517.115 Mr. Mica. I have questions for both of you. We'll try to cover this pretty quickly here. First of all, we've seen the audit, the report, and there are a number of criticisms. There were some items that we had a report--was it Mr. McNamara who cited that corrections are being instituted, some corrections he was aware of, some he was not? Specifically, what has brought this hearing to such a peak are questions about disability and people having their payment waived and then coming back on the system and being reeligible. Could you tell us, first of all, what's being done to correct that? Mr. Woods. Absolutely. One thing I'd like to make sure is understood here, this is an example of the Department identifying a problem and trying to get after it on its own. The study that the IG did here was at the request of the Department. The Department was concerned about fraud and other disability programs and was concerned about trends in the rise in its disability claims and asked the IG to look into it. The results of the study confirmed those fears, as you've indicated, in the worst way. We have things in process already with our partners here. Note that this problem exists within the FFEL program primarily. That's where the difficulties have been found because more of the loans in the FFEL program are into the repayment status. And we're working with the guaranty agencies on new procedures here, looking again at commercial practices. We can require certified certificates. That's something we haven't done. It's common practice in the insurance industry. We can require doctors' identification numbers and phone numbers. We can go into training programs with the guarantors and their people who are reviewing these applications for disability so that they're better informed about what to look for. The other thing I'd like to state here is that we, in fact, believe we can go after and recover this money. Where we find that there were mistakes made in processing, we can reinstitute these loans and collect on them. Mr. Mica. Well, Dr. Smith, in the record, page 8, I believe it is--there's a chart. It says, new loans after disability discharge, and it shows 1994-1995 pretty much stable and then 1995 just shoots off the charts. It's my understanding that the Department changed the regulations in 1995 to make it easier for students who have gotten loans forgiven to get new loans. Has that policy been changed back or are we still operating under the policy that had this sort of shoot off the charts? Mr. Smith. At this moment we're still operating under the policy. The regulation will be under review. It is now under review. All these regulations have to go through something called negotiated rulemaking. It's the congressional intent for all of our regulations. So we have to bring people together in order to change things, and we intend to look at that. I intend to talk with the Secretary soon about this, and we'll be moving. Mr. Mica. We just heard reports coming out in a month after this hearing or so with a lot of suggestions, but to get things done and--you know, we have to focus on the big enchiladas here. Certainly, this is the biggest area, we have identified the program. Your audit which--I congratulate you for taking that step, but now our job in oversight is making certain that there's a change in action and a change in policy. So we're going to have to followup on this, and we need a change in the policy. We've also satisfied the PBO with I'm told more than 1,000 folks; is that correct? Mr. Woods. The staffing level---- Mr. Mica. Tell me what our staffing level is. We've ramped that up pretty dramatically, and our administrative costs I guess have risen 200 percent in 6 or 7 years. Mr. Woods. I'd be delighted to address that. Actually, the staffing level in the PBO is relatively stable at 1,200 people. These people were involved in the loan---- Mr. Mica. That's a third of the Department of Education. Mr. Woods. It's a third of the Department of Education--a quarter. Mr. Mica. I'm sorry, 25 percent approximately; and when did they come on? Mr. Woods. This staff? Mr. Mica. Yes. Mr. Woods. The staff was increased over the past few years with the direct loan program, but that staffing increase number I don't have for you here today. It's nothing like the kind of percent that's shown on this chart. The indication in the chart is that we've dramatically increased the cost without an increase in workload, and I'd like to dispel that idea. That's just not the case at all. What we've been doing in the direct loan program for several years now is issuing on the order of $10 billion a year in loans. So each year a loan is put out, that adds to the workload. It doesn't go away after the first year. Now we're actually entering a period of time where as the loans go into servicing, the workload increases. The servicing is a much more expensive proposition than simply issuing them. They're not being serviced to that extent while they're in school. So our workload has actually increased dramatically over this time. Mr. Mica. We're told that one of the biggest problems with the PBO is that there's no chief information systems officer. Is that still the case? Mr. Woods. We have an excellent man who's been leading the information systems work there for some time. We've been able to add a couple of experts, for example, in privacy and security to support that. And, of course, this is my background. I'm certainly fully qualified to carry that work out and make decisions in that area. So compared to where we were 6 months ago, we're probably dramatically stronger. Mr. Mica. Two other areas, there's been great concern expressed about both in this panel and in the public arena, and that's payments for students who claim to be dead and are very much alive and then the problem with our foreign student loans. Could you address both of those for me? Mr. Woods. The death and disability claims is what we referred to earlier and the changes we're making there with death certificates and training and those improvements as well as the policy issue you addressed to the Secretary. Mr. Mica. Specifically, though, are you now requiring the death certificate? Mr. Woods. Yes. We're---- Mr. Mica. Is that in place? Mr. Woods. We have notified the guarantors that we intend to do this. Mr. Mica. But it's not in place? Mr. Woods. No, sir. They are already looking at changing their policies. Where we stand with each of the guarantors I couldn't tell you today. I would be happy to answer that detailed question for the record. Mr. Mica. Is that a policy question that Dr. Smith would have to address that becomes---- Mr. Woods. We don't believe that change is a regulatory change, so we believe we can proceed administratively to deal with this. The community is very eager to work with us on this. Mr. Mica. But it's still not in place. It's a request at this point? Mr. Woods. That would be accurate. Mr. Mica. Dr. Smith, did you want to respond? Mr. Smith. Well, it's just that Mr. Woods has to work with a variety of guaranty agencies out there and explain to them exactly what they need to do and they need to look it over and see how quickly they can put their changes into practice. I think that's the delay in this process. It's not as though they're going to get a choice. They will have to carry out the policy. Mr. Mica. That would be a variety, I guess, of participants. What about the direct loan program where you can make a decision. Has that been made? Mr. Woods. That decision has been made. Mr. Mica. And is taking place? Mr. Woods. Yes, sir. Mr. Mica. The other item was the foreign student problem. Mr. Woods. Right. The foreign schools issue I don't believe is a schools issue per se. Several years back, the Department undertook a review and went through a recertification on schools and a number of schools dropped out of the program--in fact, over 400. We have about 450 foreign schools currently involved in the direct loan program. The cases that were found seemed to be cases that were involved with students, and 18 cases is what we're talking about here. Eighteen cases of fraud identified where students are being pursued for that, a relatively small number. The other point I'd make about the foreign schools program is that the overall default rate, which has been much at issue here this morning and this afternoon, that default rate is 5.5 percent, which is better than the national average. So while we're concerned about fraud any time we find it, I just want that to be in perspective. We also think we've instituted some practices here that will improve the performance going forward. We're notifying schools, for example, when loans are issued to students who are alleged to be enrolled there. That will get the schools involved as a checkpoint on whether that student is actually there and eligible for funding. Mr. Mica. Dr. Smith, did you want to respond? Mr. Smith. No, that's fine. Mr. Mica. You said that one of the things you wanted to do was study borrower behavior. Could you elaborate a little bit more on that? Mr. Woods. My private sector experience was that it's very important to be focused on the customer and to think in terms of what the private sector talks about as customer segmentation. Different parts of the population have obvious different needs. Small business is different than big business, seniors different than juniors. In our case, students in 4-year, 2-year and proprietary schools have different needs and, as we find, much different default rates among those institutions. We think that by understanding behaviors in these customer segments and the needs of those populations, we can intervene earlier, and thereby reduce the cost in terms of default and produce a better situation for that borrower in terms of services. That's what we are interested in. Mr. Mica. One other quick question before I get to the ranking member, I did not ask you. I asked you about the number of employees with the PBO. Do we have any way of assessing the contract employees or employees that are involved through contract? Mr. Woods. We certainly could get you an accurate number if you'd like. I believe that number, at a peak during the year, might run to 3,000 employees if you totaled it up for all the peak periods. The reason I say peak is because our business is cyclical. When we're consolidating loans, we ramp up in that area. We don't maintain that staff level. As soon as we don't need the people, these part-time people under contract are reduced. The same thing with our student eligibility application. We ramp up and tail off in order to minimize the cost. So that's the way we're managing that contract work force. There was conversation here about the practice of involving the private sector, using private sector firms to handle the loan programs. The truth is that this organization is well on the path to contracting out these service functions and processing functions. We have experts for phone service, experts for computer processing, experts for transforming paper into electronic images, and contractors who ramp up and down to meet the particular business cyclical needs. Mr. Mica. Let me yield now to Mrs. Mink, if I may. Mrs. Mink. Thank you very much, Mr. Chairman. I served on the Education and Workforce Committee when it was known as the Education and Labor Committee, and as I recall, the initiation of the whole idea of direct loans, it was something that was generated by Congressman Robert Andrews and supported by the chairman, William D. Ford of Michigan. Those were the two individuals most responsible for the initiation and creation of this program. After a number of discussions and debates and meetings with the administration, the administration came on board and supported the program. Is my memory correct on that? Mr. Smith. I think that's right, Mrs. Mink. I believe that a direct loan program existed in the prior Congress as well, a small direct loan program. Congressman Petri as well as, I believe, Congressman Andrews and, of course, the chairman were all involved in that. And then I believe there was discussion early in Mr. Clinton's administration, and there was a decision to move with a larger program rather than just the pilot. Mrs. Mink. Yes. What I wanted to note with reference to this history is that--to dispute or dismiss the assumption that this was a grab on the part of the Federal Government for the administration, supervision and management of a program. Rather, as I recall, it was an initiation by the Congress at a time when everyone was looking for ways in which to reduce the deficit and balance the budget. And because of the high interest that the private sector banks and financial institutions were charging for the management of this program, there was this idea that maybe the Federal Government, even though you realize you have to put on more manpower and personnel and create a whole new system, that it could be done with a cost savings. Now, in your statement, Dr. Smith, you say substantial savings have occurred for the taxpayers. Can you elaborate on that? The testimony we heard this morning seemed not to conclude that that has, in fact, occurred; and since that was the genesis of this whole idea, I'm very anxious to really get to the bottom as to whether we, in fact, have enjoyed any savings. Mr. Smith. Mrs. Mink, we estimate and the Congressional Budget Office estimates that the savings have been considerable. As I mentioned, we can estimate them at about $700 million this year if all of the direct lending students were, in fact, in the FFEL program. Now, there have been a lot of other savings as well to the taxpayers and to the students, and they've come about in two ways. One is the way I just mentioned. That is, that the direct lending program, because it doesn't have to pay huge subsidies to private lenders, turns out to be a cost saver under most economic assumptions. As you recall, the IG said he wasn't sure. There are certain economic assumptions one can make about the interest rates and so on where it might not be a cost saver but, by and large, and certainly over the last 6 years, the life of this program, it has clearly been a cost saver. We estimate that the cost savings to the taxpayer have been roughly $5 billion since 1994. We can supply more detail on that if you'd like, but it is from a couple of things. One is from the direct lending program having one-third of the business. The other is the reduction in some of the subsidies that have gone to the private sector. The private sector, as you know, continues to make a reasonable profit on this, a fair profit. Mrs. Mink. What is the percentage surcharge now on the loans that the private sector charges the student or the program? Mr. Smith. The interest rates? Mrs. Mink. Yes. The surcharge for managing the program. Mr. Smith. To the Federal Government? We do it in terms of subsidies. The private sector gets an origination form of fee, which is about 4 percent. They also then charge interest rates to the students, and they get to keep whatever profits on those interest rates. In effect, they have to give some money back. By and large, what you have is a system where the Federal Government guarantees the private sector payments and then pays them a reasonable subsidy in order to provide loans for students. It has worked reasonably well over the last 4 or 5 years. I think here is where the other real savings comes in. There's competition between the two programs, which I believe resulted in savings to students and much better service to students and has gotten the two sectors competitive. The private sector, the FFEL program, for example, has become quite competitive in the reduction of some of the origination fees and in some of the other costs to students. So I think we've got a very healthy, competitive system now that has saved students a large amount of money and saved taxpayers a large amount of money. Adding them together, it's almost $10 billion over the last 6 years. Mrs. Mink. About a third of the loans currently expected are about one-third in the direct loan and the balance in the private sector; is that correct? Mr. Smith. That's correct. Mrs. Mink. That's a balance you expect to maintain over the long haul? Mr. Smith. That's certainly what we expect to maintain over the foreseeable future, that's right. And it is, as I said, a competitive market; and we're working to maintain that. Mrs. Mink. The direct loan program was initiated when? When was the first loan issued? Mr. Smith. I believe in 1994. Mrs. Mink. Now, has there been, since the initiation of the direct loan programs, any experience with collections and defaults and determinations of waivers and discharges of debt and so forth with respect to the direct loan program? Mr. Smith. Well, there's been some but not very much to make a real generalization. Mrs. Mink. It hasn't been in existence that long to experience---- Mr. Smith. That's right. In fact, the numbers are very low right now. The percentages are low. I wouldn't count on that as being something that will hold up in the future. We see no reason that this will behave any differently than the FFEL program. Mrs. Mink. The reason for my question, the reports that generated the call of these hearings with respect to the discharges for disability and the erroneous notion of students being dead and having their debt discharged emanate not from the direct loan program but from the existing private sector loan program. Mr. Smith. I believe that's true. It's probably true for 98 to 99 percent of the cases, if not 100 percent. Mrs. Mink. So the management of the private sector loans to which this problem is attributed is a responsibility of the private sector? Or is it the responsibility of the Federal Government to institute control so that it doesn't occur? Mr. Smith. I believe it's a shared responsibility. These are fiscal---- Mrs. Mink. Who recommends the waiver of the collection? Is that the private sector that recommends it or is it the Federal Government that recommends it? Mr. Woods. The process would have the private sector agency processing the paperwork. As the chairman indicated earlier, there are regulations that the Department issues that cover this practice and then---- Mrs. Mink. Who makes the final decision? Mr. Woods. At that instant in time on the piece of paper, the private organization would make that determination, but we have required certain things of them. Once they've gone through that, they're perfectly within their rights to make that call. Mrs. Mink. If they sign off and say this is discharged because of disability, in the end it's the taxpayer that loses because it's unable to collect. Mr. Woods. That's correct. Mrs. Mink. What is the process then that the Federal Government has set up to look at these discharges to make sure they're all valid? Is there someone in the Department that does that? Mr. Woods. We have not had a review function specifically focused on this issue. We have an active review program that looks at the overall practice, makes site visits, program reviews for these guarantors. And naturally those reviews in the future, any one of them that we make, would focus on this issue. But we haven't got a medical examiner or a medical reviewer at the Department level for this function. Mrs. Mink. Can you say with some assurance that, with respect to the new program, the direct loan, that you have this in hand and that these sorts of misdeterminations would not occur under the government-managed program? Mr. Woods. I wouldn't want to assure you that there would be zero, but I know we can reduce this number dramatically by instituting the kind of practices that are followed in other Federal agencies and in other retirement programs in making these determinations. Those are available to us, and we'll be able to institute those. Mrs. Mink. Mr. Chairman, I'm at the end of my questioning; I just simply want to say that I'm very much reassured by the testimony of the two witnesses from the Department that the direct loan program is being well administered. The questions that we raised have now been brought to their attention, and I have confidence that they'll be able to correct it. I say this not as an early supporter of the direct loan program. I have to make a public confession that I had great misgivings about the creation of this huge bureaucracy to manage a program that I considered so vital. At that point in our early deliberations, it seemed to me that it was an undertaking that was going to challenge our witnesses and our abilities. But I'm pleased to hear today that it's progressing along, and I commend the Department for initiating the audit to look at yourselves and come up with safeguards to make sure that this program will continue to be managed well and that the taxpayers' dollars will indeed be saved by it. Thank you, Mr. Chairman. Mr. Mica. Thank you. I appreciate the comments of the gentlelady and the ranking member. I wish I could be as confident in the bureaucracy we've created to oversee this program. Quite frankly, I do have some concerns, as I said even during their testimony, that they had commented that corrections are on the way. I think I've sat and heard that before and then some of the mechanisms and resources that we've provided for them, including PBO, which have been put in place at great expense, still have not produced the results we hoped for. We now have 24 percent of the entire Department of Education, as far as personnel, involved in the program, and costs are escalating for administration, so I have some concerns. Not to mention that we have some great loopholes in forgiveness of payments for people who are ineligible and, in fact, by their own report and these are not insignificant amounts. Again those corrections are not in place. Some policy changes are not in place, and we need those in place. Some of the administrative corrections are not in place by their own general audit. We still have some serious personnel deficits and problems that need to be addressed to make this whole program work. I have additional questions regarding the differential between the administrative costs that have been presented, not by me but by the audit, and I think we'll have some very specific questions in writing so that we can get a written response. Additionally, I have specific questions which I didn't get to about loan consolidation costs. In closing, maybe I could just ask a quick question. The information that our subcommittee obtained said that loan consolidation costs of the direct loan program greatly exceed those of the guaranteed loan program. For example, I guess you have indicated that the direct loan consolidations in 1998 cost $12.9 million for 107,000 loans or $121 per consolidation. In 1999 you reported $21.8 million for 194,000 consolidations equaling a little bit less than cost, bigger volume, $112 per consolidation. However, we're told that these figures may, in the private sector, be about half the amount, far less than the consolidation loans that are done by you. In fact, I guess the consolidation problem got so bad, and this has been testified to, that in August 1997, the Department had to close down the direct loan consolidation program. What's being done to correct this situation? And, in fact, is it still costing almost twice as much for loan consolidation by the Department? Mr. Smith. Mr. Chairman, we're going to have to check your figures. The $110 figure is actually the maximum figure, the underperformance-based contract. They're expected to hit a target of, I believe it's 65 days, or whatever the industry standard is. If they come in earlier than that with a consolidated loan that is faster for the student, they get an increase in that payment. If they come in later, they can deduct it from their amount of money. The average amount of money here is $70 per loan. For a regular loan, we charge--it costs us, in terms of paying the consolidator, considerably less for certain other kinds of loans. So there's a real mixture of loans, and I believe what-- the figure you're using is actually the figure for the maximum amount that could be paid rather than the amount that on average is actually paid. But we will get you those figures. I also believe that the numbers for 1998 were not quite right, but we'll also get you those. Mr. Mica. Again, we're using figures that have been supplied by the Department or figures that have been taken from the audit studies. So we have some very specific, lengthy questions. And I know that you have a limited time schedule; and you've been most patient, Dr. Smith. We appreciate your testimony today. Mrs. Mink, why don't we, by unanimous consent, submit the balance of the questions to the Department for response in writing? Mrs. Mink. Fine with me. Mr. Mica. And we'll leave the record open for 30 days to give you extra time to respond. Again, I think we've raised some important issues here. It's not our job just to be bad guys. Mrs. Mink practices in trying to be one of the nicest Members in Congress, and she's a wonderful ranking member, but we have a responsibility to conduct oversight of these programs. Your audit helped trigger some of the reports about continuing problems, and they certainly need to be addressed by our panel. Working with you we hope we can get this program in order and make it work efficiently and take whatever legislative steps are necessary. We hope that we'll get response from the policy and operational end. There being no further business to come before the subcommittee at this time, this meeting is adjourned. Thank you. [Whereupon, at 1:20 p.m., the subcommittee was adjourned.] [The prepared statement of Hon. Dennis J. Kucinich follows:] [GRAPHIC] [TIFF OMITTED] T3517.116