Bank of America and Citigroup scaling back Student Loans

Bank of America on late Thursday said it would exit the private student loan business, but continue to make loans backed by a federal loan program for students. Citi, meanwhile, said earlier this week that its subsidiary Student Loan Corp.(STU Quote - Cramer on STU - Stock Picks) would temporarily stop issuing loans at schools where profits aren't as high as they'd like.

The defections come at a time of stress for the student loan market, which has seized as investors' appetite for packaged debt has dried up in the credit crisis. Some 60 companies have exited the student loan market recently putting pressure on the remaining providers. Sallie Mae(SLM Quote - Cramer on SLM - Stock Picks), the nation's largest student loan lender, warned on Thursday that it will lose money on every federally backed loan it makes. That came a day after Sallie reported a first-quarter loss of $104 million.

BofA and Citi's decisions have a domino effect on companies that specialize in the roughly $85 billion education financing market. Some 75% of federal student loans are issued by lenders that primarily raise money by bundling those loans into securities that institutional investors had bought.

First Marblehead(FMD Quote - Cramer on FMD - Stock Picks), whose stock price has plummeted more than 90% as the credit crisis has unfolded, is losing a major source of revenue in BofA. The bank on Thursday terminated its agreement with First Marblehead, after The Education Resources Institute, or TERI , the Boston non-profit that guaranteed the loans it packaged and sold, filed for bankruptcy earlier this month.

On Friday, Student Loan reported its first-quarter earnings, which have dropped a whopping 65% from the previous year's quarter.

Sallie Mae CEO Al Lord, during a conference call Thursday, said loan demand was running at $3 billion a month, while the company has only been able to access funding of about $1 billion a month -- at record-setting costs.

The situation in the student loan market and the flood of applications at Sallie Mae has pushed the company to look to Washington for help.

The House of Representatives on Thursday overwhelmingly approved a bill to address the problems in the student loan market. With a vote of 383-27, the bipartisan legislation will direct federal financial institutions, including the Treasury Department's Federal Financing Bank, to pump liquidity into the student loan market.

It will also allow the Education Department to buy federally guaranteed student loans from lenders unable to sell them in the secondary market, and push capital to colleges through state guaranty agencies. The Senate has a similar bill pending.

However, Goldman Sachs analyst James Fotheringham is worried about the negative impact of the legislation on Sallie Mae.

"First, legislated liquidity relief may shift Sallie's mix toward less-profitable [Federal Family Education Loan Program] loans; second, potential funding to enhance the Direct Loan Program may erode Sallie's market share," he wrote Thursday. Fotheringham cut his estimates and lowered his price target for the lender.

In the near term, the stocks were buoyed by soaring equity markets. BofA was moving up 3% to $38.60. First Marblehead was jumping 9.2% to $3.68, Student Loan jumped 1% to $106.07 and Sallie Mae was up fractionally to $17.28.

Offer to Refinance or Modify Home Loans

Countrywide Financial, the nation's largest mortgage lender, said yesterday that it will offer to refinance or modify about $16 billion in home loans through the end of 2008, a move that could affect 82,000 borrowers.

Lenders have come under increasing pressure from policymakers and consumer advocates to help borrowers who are struggling to hold on to their homes. Critics say lenders have done little to stem an alarming rise in foreclosures since problems surfaced earlier this year, fueled by risky, or subprime, borrowers. They want lenders to restructure the debt in a way that makes the loans affordable.

"Lenders have been paying a lot of lip service to loan modification in particular, but we haven't seen them do a lot about it," said Guy Cecala, publisher of the trade publication Inside Mortgage Finance. "Now the largest player in the mortgage market is taking first steps, and that's something."

The lender, which is based in California, is focusing on borrowers with so-called 2/28 and 3/27 adjustable-rate mortgages, which offer low rates for the first two or three years of the loan, respectively, and then adjust to a much higher rate for the remaining 28 or 27 years.

Countrywide said its main goal is to reach at-risk borrowers who are current on these types of loans, notify them that their rate is about to reset and develop more affordable options for them if necessary.

One target group is made up of 52,000 subprime borrowers. Countrywide said it will try to refinance their loans, worth about $10 billion, into less expensive deals.

The company also plans to modify $4 billion in loans for 20,000 subprime and prime borrowers who are on time with payments but may have trouble once the higher rates kick in.

Countrywide is also sending letters and offering to cut rates for an additional 10,000 borrowers who have missed payments on $2.2 billion in loans because rates recently reset.

Steve Bailey, senior managing director of loan administration at Countrywide, said the initiative will not prevent all foreclosures. But it aims to ensure that "none of our customers will suffer foreclosure solely because they had payment increases because of the rate resets." The company said it has modified 20,000 loans this year but wanted to be more aggressive as the focus on credit concerns intensified.

For months, policymakers have focused on adjustable-rate loans because they were especially popular during the housing boom with subprime borrowers, who now account for most of the foreclosures.

About 2 million of those subprime loans will reset to higher rates in the next 18 months, according First American CoreLogic, a mortgage data company. When they do, many fear, foreclosures will spike. Many subprime borrowers with adjustable-rate mortgages would not have qualified for loans under more-traditional rules.

Much attention has been focused on Countrywide because of its size. The company collects payments on about $1.4 trillion in loans and made one out of every five loans in the country in the first half of the year. It was also known for granting the kinds of nontraditional loans that have led to the current troubles.

On Capitol Hill, reaction ranged from skepticism to faint praise.

"Given Countrywide's track record, a lot of questions must be answered before they get a pat on the back," Sen. Charles E. Schumer (D-N.Y.) said in a statement. "What are the fees they will be charging borrowers to refinance or restructure their loans? Who will qualify for help? And are they putting these borrowers into safe, affordable products or another unsuitable loan?"

Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, which has jurisdiction over lenders, said he welcomes Countrywide's "late" decision to aid borrowers.

"However, this problem reaches far beyond the 82,000 borrowers they have agreed to assist," Dodd said in a statement. "Many more hardworking Americans are at risk of losing their homes unless subprime lenders quickly adopt and implement a set of standards and procedures for reaching out to them."

Reaching out to borrowers has been part of the problem. Many homeowners don't know where to turn when they run into trouble, and some are too embarrassed or intimidated to call the company that manages their loan.

"Half of distressed borrowers never bother to pick up the phone," said Greg McBride of Bankrate.com, a personal finance Web site. "So it's very likely that Countrywide's efforts are preemptive in nature, that they're trying to reach out to borrowers before they start to fall behind."

But even if borrowers contact their lenders, there may still be problems finding sustainable payment plans. Most of the 16 largest firms that collect payments on subprime loans had modified only about 1 percent of their adjustable loans that reset in January, April and July, a poll by Moody's Investors Service found.

Modifying these loans is an art, not a science, said Cecala of Inside Mortgage. Many lenders have little experience crafting changes in rates or canceling resets.

"Lenders are reluctant to do that," Cecala said. "How many would have paid if they hadn't lowered the payments?"

At this point, Cecala said, most lenders are convinced that they can recoup more money by selling a foreclosed home than they can by restructuring a loan that could later fail.

In that sense, what Countrywide is doing is "aggressive and unique," he said, and politically savvy. The company is scheduled Friday to release third-quarter earnings that show huge losses because of delinquencies and defaults. This initiative may be designed to highlight that it is addressing its problems, he said. "There's no question that the timing of this announcement is not coincidental".

Mortgages are harder to get

Wake-up call! If you're ready to buy or refinance a home, the turmoil on Wall Street may be further hurting your chances of getting a loan.

In a huge sell-off Friday, investors reacted to a mortgage industry crisis not seen in decades.

Some lenders are shutting down, laying off thousands of employees and leaving buyers in the lurch. Interest rates and the terms of loan offers are changing daily. And borrowers with tarnished credit are facing deal-killing loan terms — if they can find a loan at all.

Stock investors' wariness about the housing market spilled over Friday, driving a 281-point loss in the Dow Jones industrial average.

While poor repayment of "subprime" loans to borrowers with blemished credit is the primary concern, there are a few signs that more blue-chip borrowers are also having problems paying their mortgages.

Lenders are quickly closing the door to borrowers with low credit scores, small down payments for a new home or little equity in their current homes. Homeowners and buyers in high-cost areas such as California, Florida and the Northeast are also reeling as lenders chop "jumbo loan" programs.

"The market for virtually any loans with the slightest element of risk has effectively disappeared," John Bollman, an executive vice president at Cleveland-based National City Mortgage, wrote to his employees.

In explaining the company's latest pricing and product changes that will weed out some of these borrowers, he said, "I have been a mortgage banker for 20 years and have never seen such a severe reaction to credit risks in the market place … (and) things may even get worse before they get better."

Sam Molinaro, chief financial officer for investment bank Bear Stearns, which has suffered huge losses investing in risky mortgage loans, said the upheaval in the mortgage market is on the same scale as the fallout from the tech-stock bubble in 2000 and the stock market collapse in the 1980s. (Market jitters, below, left.)

Part of the cause is that in June, the Federal Reserve issued guidance for lenders offering adjustable-rate mortgages. Since then, most of the large lenders, including Countrywide and Wells Fargo, have eliminated ARMs that had low "teaser" rates that were fixed for the first two or three years, then began to rise — often above what the homeowner could afford.

While everyone agrees these more prudent lending standards should ensure future borrowers can afford to keep their homes over the life of the loan, many homeowners who got those loans in the past few years are now having grave problems refinancing as their interest rate rises.

Patrick Jones, a 49-year-old baker in the Denver area, bought his home three years ago and has paid his mortgage on time every month.

This month, his adjustable-rate loan reset for the first time, to $1,800, up $450. Loan terms in the current market mean that he can't get relief if he were to refinance.

"Now, I'm just barely making it," he says. "I used to have a steak once or twice a week; now, I'm going to have hot dogs and beans. We used to go to the movies, but we're giving that up."

E-mail alerts about tighter loan standards and higher interest rates from lenders nationwide flooded the in-boxes of employees, mortgage brokers and real estate agents late last week.

"Today alone, I had interest rate changes to loan products from nearly every lender I work with," Pava Leyrer, president of Heritage National Mortgage in Grandville, Mich., said Friday.

Lenders are changing their terms and criteria for borrowers so fast, she said, she can no longer make promises. "A loan may look like it should go through, but until I get all the documents and get to the closing table and have the funds, I don't know."

One would-be home buyer was ready to sign the final documents last week, only to find the lender couldn't come up with the money. Fidelity National Title in Bloomfield Hills, Mich., sent an urgent e-mail about it to all of its brokers, saying: "Our office has just been notified that a purchase closing, being held in our office right now, will not fund as a result of ABC's (American Brokers Conduit) inability to fund ANY loans until further notice."

American Home Mortgage Investment, based in Melville, N.Y., which owns ABC, fired more than 6,000 employees last week and stopped taking loan applications. NovaStar Mortgage of Kansas City, Mo., said Friday it "is temporarily suspending approval and funding activity." And Accredited Home Lenders from San Diego said it may have to stop making loans and seek bankruptcy protection.

Michael Strauss, American Home's CEO, issued a statement explaining that investors' appetite for mortgage-backed securities and the national housing market "have deteriorated to the point that we have no realistic alternative."

Those sentiments, which sparked the mass selling on Wall Street Friday, will likely weigh on the Federal Reserve board, which meets Tuesday to set short-term interest rates. While most economists do not expect the Fed this week to cut interest rates, several, including those at investment bank UBS, are now forecasting that the Fed will begin lowering rates in the next six months.

Student Loan companies struggling against Credit Crisis

Education Secretary Margaret Spellings sent lenders a letter on Wednesday stating that the government will purchase some of the loans, freeing capital. That way, the companies will have more money to issue new loans.

Student loan companies, squeezed by the credit crisis, are getting some help from the federal government.

"Many lenders today do not have access to funds at a cost that justifies originating new loans," Spellings wrote. "Our plan is designed to provide viability in the marketplace for lenders who step up and make loans in this difficult environment."

The administration also has agreed to invest in pools of loans, something the private market traditionally does but which has become less common due to the crisis in the financial markets. That's also a step that should make more capital available to lenders.

Sallie Mae Chairman and CEO Albert Lord said the plan would keep the industry leader in the federal student loan program. "Sallie Mae will continue lending without breaking stride," Lord said in a call with college officials.

Lenders, including Sallie Mae, had been saying they needed more federal help to continue serving college students under the federal student loan program. The credit crunch pushed up the cost of capital. Cuts Congress made to lenders' subsidies last year also reduced lenders' profit margins.

Under the plan Spellings outlined, the government will pay face value for the loans, plus accrued interest and the cost of fees lenders incur when originating loans. Lenders would also get a payment of $75 per loan to defray estimated administrative costs.

One thing that still must be firmed up is how the loans sold to the government will be serviced. The letter says that the department will determine servicing arrangements based on things like cost and students' best interests.

The banks want to continue servicing the loans they originate in part to maintain relationships with existing customers, said Harrison Wadsworth, a lobbyist for the Consumer Bankers Association. He said continuity in service would be helpful to students. Sallie Mae executives agreed.

The help provided to lenders is supposed to be cost neutral to the government, so it's possible the terms of the offer to lenders may shift before being finalized. The help is only being offered for loans made for the 2008-09 school year.

"Lenders need to evaluate what the department has put on the table and figure out what it means to them," Wadsworth said. "I think it's definitely a positive development though, overall, in terms of trying to make sure loans are going to be available this fall."

So far dozens of lenders have left the federal student loan program, though where that has happened other lenders have stepped in or students have turned to a smaller program in which the Education Department makes loans directly to students.

Students are starting to put together financing plans for the fall semester.

"We want students to be able to concentrate on their studies rather than worry about disruptions in the student loan market and whether they will be able to obtain federal loans to help pay for school," Spellings said in a statement.

California Democratic Rep. George Miller, chairman of the House education committee, said the Bush administration's plan was sensible. "Our goal is to ensure that students and families continue to have uninterrupted access to the federal college loans for which they are eligible," he said in a statement.

Spellings also said the Education Department was working to ensure the smaller program, under which the agency makes loans directly to students, can handle any increase in volume.

In addition, Spellings said the department was taking steps to ensure a contingency plan under which guarantee agencies, nonprofits that traditionally back student loans issued by banks, would be able to provide loans directly to students if needed.

Should we rely on schools preferred list of lenders for Student Loans

Historically, the vast majority have. But the widening college-loan scandal has raised questions about how lenders get on those lists. Was it because they offered the best deals for students? Or did they offer the best deals to schools and, in some cases, financial aid officers?

Some schools have accepted payments from lenders for placing their names on, at the top of or exclusively on their preferred-lender list for private loans.

Last week, after an investigation by New York Attorney General Andrew Cuomo's office, six schools agreed to return payments they had received for steering students to lenders, including Citibank of New York and Education Finance Partners of San Francisco. The money will be credited to students who had taken out private loans that generated those payments. The average refund will be $500 at the University of Pennsylvania and $60 at New York University.

Later in the week, Cuomo requested information from the University of Southern California, University of Texas and Columbia University about senior financial aid officers who owned stock in the former parent company of Student Loan Xpress. The company is, or was until recently, a preferred lender at all three schools. The three officers have been put on leave pending internal investigations.

On Thursday, it was revealed that Matteo Fontana, a senior official in the U.S. Department of Education, also owned stock in the former parent of Student Loan Xpress. Matteo oversees private-sector lenders that participate in the government's Federal Family Education Loan Program. He was placed on leave Friday.

Although most financial aid officers are dedicated people who do their best for students, these revelations highlight the importance of looking outside your school before choosing a loan.

The best way to borrow money for college is with a government-guaranteed Stafford loan (for undergraduate students), Plus loan (for parents) or Grad Plus loan (for graduate students). Unless your school participates in the government's direct-lending program, you can choose any qualified private-sector lender for these loans.

For private or alternative loans, which are more expensive because they are not guaranteed, students can choose any lender, no matter what school they attend.

To narrow the options, most schools publish lists of preferred lenders for both government and private loans. They typically feature half a dozen lenders, but they might have only one. Students should always ask if the school is getting any type of payment or service from lenders on the list.

To get a loan, schools must certify that you are qualified. By law, schools can't refuse to certify a loan, nor can they cause "unreasonable delays," because you choose a nonpreferred lender. That said, many schools strongly discourage students from choosing a nonpreferred lender.

On its Web site, Wheaton College in Illinois says, "Parents who borrow from one of our preferred lenders experience fewer problems and delays than those who choose other lenders. The terms of federal PLUS loans are set by the government and there is little variation between lenders. Because of this, it is very unlikely that a parent would owe less or be better served by borrowing from a local bank rather than one of our larger preferred lenders."

The University of North Carolina at Chapel Hill tells students on a form that if they choose a lender other than the school's sole preferred lender for Stafford loans, "there will be a six-week delay in the processing of your loan application" because it must be processed manually.

No official from either school was available for comment Friday.

Most schools say they recommend lenders based strictly on price and service. Some schools say they can get a special deal from preferred lenders because their alumni have stellar repayment rates. If you run into problems with a loan, you might get better service -- from the lender or your school -- if you use a preferred lender.

Despite the negative publicity, "the financial office in the vast majority of cases should be trusted and relied on as one source" of information, says Kevin Walker, president of Simple Tuition, an online college loan referral service.

But your search shouldn't end there.

A student who graduates with the typical $20,000 in debt and pays it off in 10 years can save about $1,000 on average by shopping around, says Mark Kantrowitz, publisher of FinAid (www.finaid.org).

Comparing college loans is a daunting task.

The government sets the maximum rate and fees on Stafford and Plus loans. The maximum today is 6.8 percent fixed for Stafford and either 7.9 percent or 8.5 percent fixed for Plus loans. Starting July 1, the maximum up-front fees will be 2.5 percent of the loan amount for Stafford loans and 4 percent for Plus loans.

Many private-sector lenders will discount rates and fees, although the rate discounts usually require students to sign up for direct payments from their checking accounts and to make a minimum number of on-time payments. You can lose the rate discount if you make even one late payment, which is easy to do when you're fresh out of school and moving around.

For this reason, it's often better to choose a fee waiver or discount over a rate discount, unless you plan to pay off your loan immediately or are certain you'll never make a late payment.

Comparing private or alternative loans is vastly more difficult than comparing government-backed loans because the rates and fees vary widely. Virtually all private college loans are variable rate and are tied to different indexes.

Unfortunately, lenders are not required to follow a standard format when they calculate the annual percentage rate on a college loan, as they must with a home mortgage or credit card loan. As a result, comparing APRs is not a useful tool for college loans.

Kantrowitz says he will introduce a calculator on FinAid in the next few weeks that will let students compare college loans on an apples-to-apples basis.

After checking out your school's preferred lenders, check out offers from competing lenders.

At www.simpletuition.com, you can compare rates and terms from more than 20 lenders. Like most loan sites, it collects a fee from lenders that appear on the site, but it will at least provide a good comparison to your school's preferred lenders.

MyRichUncle is a newer company that provides no-strings-attached discounts on Stafford and Plus loans.

FinAid has an extensive list of lenders, including discounts.

Some states provide low-cost loan options for state residents no matter where they go to school and for out-of-state residents attending an in-state school, public or private.

If you have just received your financial aid package for next year, do not feel pressured to choose a lender now. "Most schools don't start certifying loan applications until June or July," says Kalman Chany, president of Campus Consultants.

You can submit a loan application at any time during the school year.

What families should be focusing on now is how much debt they should take on.

Over four years of college, dependent undergraduates can take out up to roughly $19,000 in Stafford loans and their payments will be roughly $200-plus a month, Chany says.

For most students, that's reasonable, he says. If their parents are not willing to help out, students should think long and hard before going into additional debt.

"If they were thinking about taking out private loans to go to school, I would say you should think seriously about going to a cheaper school" or a school that provides more financial aid, Chany says.

Kantrowitz offers this rule of thumb: "If you are borrowing more than your starting salary, you will find it difficult to make the payments."

Once you have determined how much you can borrow, shop around for the best loan.

"It's like anything else. The more cars you buy, the more dealers you visit, the more likely you are going to make a good deal," says Paul Wrubel, co-founder of TuitionCoach. "Use all the tools at hand. Keep your ear to the pavement, ask the colleges what their preferred lenders are, check them out. Ask them point blank, is there any kind of rebate to the colleges for recommending you?"

South Carolina Student Loan

To compare rates, fill out applications with more than one lender. But don't cast too wide a net. Each new application can reduce your credit score by five points, says Kantrowitz, who figures more than five new applications would damage your credit score enough to cause a lender to charge a higher interest rate. "Credit bureaus view a lot of loan inquiries as evidence that you're trying to load up on debt," says Robert Shireman, executive director of nonprofit Project on Student Debt, who recommends applying to three or four lenders within a few days.

Which are likely to offer the best rates? Ask your school's financial aid office whether it has negotiated any special deals. Then check with state-affiliated nonprofits, such as South Carolina Student Loan Corp. The credit crisis has driven several lenders to suspend at least some student loan operations. But those still offering private loans tend to offer competitive rates and fees.

Students without a co-signer may want to consider a private loan that does not depend on credit scores. One of the few such offerings, MyRichUncle's (UNCL) PrePrime product, uses criteria including a student's college and GPA (or high school records) to assess the risk of a default. Another way to scout for relative bargains: Look for lenders that offer low rates to applicants with unblemished credit. Then zero in on those with narrow spreads between their best and worst rates. "If the spread is narrow and the lender's best rate is attractive, it increases your odds of getting a good deal," says Kantrowitz.

Amid the credit crunch, lenders are triming the discounts they offer on fees and rates. But borrowers who agree to make payments while in school may still qualify for a lower rate. Finally, given a choice between two loans with the same overall interest rate, favor those pegged to the London Interbank Offered Rate (LIBOR) that banks charge each other over the prime rate U.S. banks give their most creditworthy customers. (Your lender will disclose which index serves as the basis for your loan.) For years, the gap between prime, now 5.25%, and three-month LIBOR, now 2.92%, has grown. If the trend continues, "over the long term, a loan based on LIBOR will be less expensive," says Kantrowitz. With rates rising on these already costly loans, every bit of savings counts.

Private Loans for the coming Academic Year

Families often turn to private loans to bridge the gap between the cost of college and the maximum $5,500 a year undergraduates can borrow in federally backed student loans. But the credit crunch means those seeking private loans for the coming academic year are likely to encounter problems, from higher interest rates to lenders that balk at making loans to any but the most creditworthy. "It's more important than ever for families to plan in advance," says Kevin Walker, CEO of Simple Tuition, which runs a Web site that lets borrowers compare offerings from lenders that pay it for placement.

What's a good strategy? Before deciding to take out a private loan, carefully consider the alternatives. With variable rates now ranging from 6% to 16% and fees as high as 11.5%, private student loans are typically more expensive than federally backed Stafford Loans for students. These carry a maximum fixed interest rate of 6.8%, while PLUS Loans for parents charge 8.5%. Stafford Loans limit undergraduate borrowing to $3,500 for freshman year, $4,500 for sophomore year, and $5,500 annually thereafter, but PLUS loans allow parents to borrow up to the full cost of attendance.

Some states also offer bargain-rate loans to those who live or attend college within their borders. Examples include the Massachusetts Educational Financing Authority's MEFA Undergraduate Loan and the New Jersey Higher Education Student Assistance Authority's NJCLASS loan. "Private loans should be a last resort," says Kalman Chany, author of Paying for College Without Going Broke (Princeton Review; $20).

Still, many families gravitate to private loans, in part because they leave the student, not the parent, on the hook for repayment. Moreover, those unable to qualify for federal loans, including foreign students and those with grade point averages below 2.0, may have no choice but to use private loans, says Mark Kantrowitz, publisher of financial aid Web site FinAid.org.

When loan shopping, don't simply pick the lender advertising the lowest rate. Because interest rates depend mainly on a borrower's credit score, the percentage an individual pays may well be higher. Even students with relatively sound credit typically come out ahead by asking a relative or a friend with a more established credit history to co-sign a loan's promissory note. (Co-signers are responsible for repayment should the student default.)

Federal Home Loan Bank of San Francisco

The Federal Deposit Insurance Corp. took over IndyMac, the Pasadena, Calif., company that ran out of funding to sustain its large mortgage business. Of its $31 billion of liabilities, about a third were loans from the Federal Home Loan Bank of San Francisco and $19 billion were deposits - an unusually low percentage of deposit funding for a bank or thrift.

The loans from the Federal Home Loan Bank were secured by mortgages, assets now seized by the FDIC. But Home Loan Banks have a statutory right to be first to get their hands on the collateral, and observers said the FDIC is likely to keep or pay down the loans rather than hand over mortgages, which means the Home Loan Bank of San Francisco will feel little of IndyMac's failure.

Because the FDIC has always honored Home Loan advances, "the Federal Home Loan Banks have never lost money," even in the savings and loan crisis, said Bert Ely, an independent consultant and president of Ely & Co.

That, in turn, means the Home Loan Banks can continue to lend to regional banks. In fact, the failure of IndyMac may illustrate just how robust a source of funds Home Loan Banks are, said Joseph Ficalora, the chairman of New York Community Bancorp Inc.

High School Seniors have Received Financial Aid

The investigation comes as high school seniors have received financial aid offers and are in the process of deciding which school they'll attend this fall. Steven Roy Goodman, a college counselor in Washington, D.C., says two families have told him they're more closely scrutinizing communications from schools, "because in their minds, if the financial aid office can't be truthful, then how is the rest of the university to be trusted?"

Students who have already taken out loans are also wondering whether they got the best deal available. Padmini Iyer, a Columbia University senior from New Delhi, says there "is a lot of awareness" at Columbia about the allegations.

Iyer didn't use one of Columbia's preferred lenders. But she says that if she needed to borrow more, "I'd be 10 times more careful."

James Boyle, president of College Parents of America, says he's received a handful of e-mails from parents about the investigation. He says he believes the probe will lead to a "more consumer approach to student loans, with the student and their family driving the process, as opposed to schools and their preferred lenders."

The investigation could also strengthen support for the federal "direct lending" program, which has been championed by Sen. Edward Kennedy, D-Mass., chairman of the Health, Education, Labor and Pensions Committee. Kennedy argues that the direct lending program is less costly for the federal government and free of conflicts of interest.

Direct lending schools don't have preferred lender lists. Students who attend those schools have only one option: borrowing directly from the federal government.

Critics of the direct lending program say that it's anti-competitive and that private lenders provide better service and benefits than the government. But Craig Munier, director of financial aid for the University of Nebraska, a direct-lending school, says the program allows his office to provide loans "ethically and without conflicts of interest."

Munier, who's chairman of the National Direct Student Loan Coalition, says his office still receives an occasional tin of cookies from a private lender. He says he removes the lender's name and puts the cookies out for students, or ships them to a homeless shelter.

University of Virginia recommends Bank of America

In a fierce contest to control the student loan market, the nation’s banks and lenders have for years waged a successful campaign to limit a federal program that was intended to make borrowing less costly by having the government provide loans directly to students.

The companies have offered money to universities to pull out of the federal direct loan program, which was championed by the Clinton administration. They went to court to keep the direct program from becoming more competitive. And they benefited from oversight so lax that the Education Department’s assistant inspector general in 2003 called for tightened regulation of lender dealings with universities.

At Indiana University in 2004, for example, Sallie Mae, the nation’s largest student lender, offered $3 million that the university could use for “opportunity loans” to some students if it left the direct loan program. Indiana left the direct loan program but said the $3 million was not the reason; Sallie Mae currently administers their loan program.

Bank of America, which won the University of Virginia’s student loan business, said in its 2002 proposal that certain possible incentives had “the potential to violate” federal law. The bank, which said such a discussion was normal in the bidding process, suggested that it discuss the issues with university officials “during the oral presentation phase of the process.”

All of this has helped give private lenders clear dominance of the $69 billion federal student loan industry. The lenders, who defend these practices, say they are winning business primarily because they offer lower interest rates than the government and often lower fees.

Advocates of the direct loan program say that it has been held back from offering more competitive rates and benefits, and that a very small percentage of students can take advantage of the private rivals’ advertised rates and incentives. They argue that private lenders cost the government vast amounts of money because they are subsidized and guaranteed against default.

President Bush’s budget reports that in 2006 for every $100 lent by private lenders, the cost to the government of subsidies, defaults and other items was $13.81, while the same amount lent through the direct loan program cost the government $3.85. The battle for dominance in the loan market has escalated as tuitions have soared and students have borrowed more. This is the context for many of the payments to universities and financial aid officials that have come to light as a result of recent investigations into student loan practices.

“What has happened is unbridled competition meets lack of oversight,” said Terry W. Hartle, senior vice president at the American Council on Education.

Part of what is generating the competition is that the government runs two loan programs — and universities usually choose to participate in one or the other.

Until the 1990s, the primary program was the federal guaranteed loan program under which private lenders like Citibank, Sallie Mae or Bank of America made the loans to students. They were given a helping hand from the government, which paid subsidies to the lenders and guaranteed them against default.

Bill Clinton campaigned for president on the notion of expanding the federal government’s role as student loan guarantor into a more central position as the direct lender. The idea was that this would prove cheaper and simpler for students and be less costly for taxpayers because borrowers would pay interest to the federal government instead of to the lenders.

The program went into effect in 1994. The Democrats expected it to become dominant. But unwilling to be muscled aside, private lenders began offering schools and students a variety of benefits like scholarship money and lower interest rates and fees.

Tom Joyce, a spokesman for Sallie Mae, said, “The private sector program has better prices, better product selection, better service and better technology.”

For a few years after direct lending went into effect, it grew quickly. But as student loan volume has risen, climbing above $85 billion in 2005-6 from just over $30 billion 10 years earlier, the government’s share as a direct lender has declined, and now amounts to less than a quarter of the total.

“When direct lending was created, the initial assumption was that the bank-based program would be quickly overwhelmed by the government program,” Mr. Hartle said. No one counted on the strength of the reaction from the lending industry, he and others said.

The Education Department fought back. Richard W. Riley, then the secretary of education, tried to make the direct lending program more competitive in 1999 and 2000 by reducing origination fees and interest rates. The private lenders sued, saying Mr. Riley had no authority to do this because these rates were set by Congress under the loan legislation. (Last year, lawmakers set the interest rate on new Stafford loans, one of the most popular federally guaranteed loans, at 6.8 percent; many private lenders offer to reduce that rate for borrowers who make payments on time or meet other goals.)

In response to the lawsuit, the Education Department argued that the public and private loan programs had the power to offer the same terms and conditions, and added that better loan terms would make loans more affordable and thus reduce defaults, benefiting taxpayers.

With the Bush administration more sympathetic to the private market, the lenders withdrew the lawsuit last year, and the direct loan program has offered some of the incentives used by its private rivals.

Katherine McLane, a spokeswoman for Education Secretary Margaret Spellings, said both federal loan programs were “a vital source of funds for student aid.” Ms. McLane said that “through these two programs we have improved students’ and families’ choices by increasing competition, upgrading customer service and lowering costs.”

The Bush administration took virtually no action as lenders offered special pools of money if universities would leave the direct loan program. Lenders, by law, are barred from offering inducements to gain loan applications. But what is an inducement is not entirely clear.

A review by the Education Department’s office of the inspector general in 2003 — prompted by an accusation that Sallie Mae was offering illegal inducements — found that the department had brought only one public action, a case involving Sallie Mae and a college of podiatric medicine in 1995, which an administrative law judge later struck down.

The assistant inspector general, Cathy H. Lewis, who conducted the examination, also noted that the Education Department had not given any updated opinions about what kind of inducements were barred since 1995, even though the competition for loan business had escalated sharply since then. Ms. Lewis expressed concern about “bargaining practices between schools and lenders.” She referred to both the guaranteed loan program and private loans, which like any consumer loan lack government backing. Students increasingly rely on private loans because of limits on borrowing through the federal program.

She wrote that the practices “should be addressed through statutory and regulatory changes or further department guidance.”

Ms. McLane said in an e-mail message that the department had offered no guidance to lenders because it believed it had “no authority over the private loan instruments and market and therefore no guidance could be provided.”

She said the department had begun examining whether there should be new regulations in December.

Republicans in Congress have issued a continuing stream of criticisms about the direct lending program and tried to restrict it in a variety of ways.

Just last year, they voted to give lawmakers the power to cut the budget of the Education Department office that oversees the student loan program — a looming if indirect threat to direct lending. They also made it more difficult for many borrowers with multiple loans to combine them into a single, larger direct loan, effectively making it harder for students to refinance their debts.

“The federal government should be in the business of student loans as the lender of last resort when private lenders can’t offer competitive opportunities,” said Senator Michael B. Enzi, a Wyoming Republican who is the former chairman of the Education Committee.

In the absence of any crackdown on inducements, banks and other lenders showered universities with incentives to leave the direct lending program.

Sallie Mae, for example, offered Pace University in New York City $4 million in loans for students who would not have otherwise qualified if it left the direct loan program, the university said. Pace turned the offer down, a spokesman said. But it did eventually leave the program.

Colleges in the direct lending program were increasingly concerned about its future in the face of growing Republican opposition.

Yvonne Hubbard, director of Student Financial Services at the University of Virginia, said that was one factor that prompted the school to leave the program, along with the better deals being offered by the private lenders.

The university invited lender proposals in 2002 and chose Bank of America for a five-year term. It was in this process that the bank warned that some services under discussion had “the potential to violate” regulations against inducements.

Ms. Hubbard said she had no memory of what that language might have referred to, and a Bank of America spokesman, Joe Miller, said that it was not unusual to use this language in responding to a request to bid for a contract.

Bank of America is the only lender the University of Virginia recommends. The bank handles about 95 percent of the federal student loans at the university. Under the agreement, students who take out subsidized loans through the bank pay no origination or guarantor fees.

Ms. Hubbard said that the university tried to make clear to families that they were free to borrow from anyone but that it also offered this advice: “Take the terms we have negotiated with Bank of America and use this as your baseline, and try get your vendor to at least match it. It’s a good deal.”

Along with the partisan battle over the lending programs has come a fierce argument over their relative costs to taxpayers. Lenders vehemently argue that the direct loan program is in fact more expensive.

With Democrats now in control of Congress, Senator Edward M. Kennedy, Democrat of Massachusetts, and Representative George Miller, Democrat of California, with some bipartisan support, are pushing legislation intended to bolster the direct loan program.

Many Republicans are determined to defend private lenders. “I don’t want a few problems to be the excuse for the Democrats to put the federal government in charge of all student lending in the United States,” said Representative Ric Keller of Florida, the ranking Republican on the higher education subcommittee.

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