The Bush administration killed a proposal to clamp down on the student loan industry six years ago following allegations that companies sought to shower universities with financial favors to help generate business, according to documents and interviews with government officials.
The proposed policy, which Education Department officials drafted near the end of the Clinton presidency and circulated at the start of the Bush administration, represented an early, significant but ultimately abortive government response to a problem that this year has grown into a major controversy.
Now, as the $85 billion-a-year student loan industry faces an array of investigations into questionable business practices that some officials believe could have been curtailed by the 2001 proposal, the Education Department has embarked on a new effort to set rules for the industry to prevent conflicts of interest and other abuses. If approved, the rules would be implemented in summer 2008, a few months before Bush leaves the White House.
The abandonment of the 2001 proposal underscores what some consumer advocates and Democratic lawmakers believe is lax federal oversight of the financial aid system by a department they say is too cozy with the industry. More than a dozen senior department officials either previously worked in the student loan business or found high-paying jobs in the sector after they left the agency.
"The Department of Education has been run as a wholly owned subsidiary of the loan industry under this administration," said Barmak Nassirian, a longtime advocate for industry reform at the American Association of Collegiate Registrars and Admissions Officers. "They are running the federal loan program for the profit of their friends and not for the benefit of students and taxpayers."
Chad Colby, a department spokesman, said he was not aware of the 2001 proposal but noted that a task force was created last week to consider new rules. The department also defended its hiring of loan industry veterans, saying their expertise was invaluable, and pointed to a 2005 decision by the Government Accountability Office to remove federal student financial aid from a list of "high-risk" programs.
"The U.S. Department of Education takes its role as steward of federal financial aid very seriously," Education Secretary Margaret Spellings, who took office in 2005, said in a statement last week.
No one has been charged with any crime in the investigations led by the New York state attorney general's office and other agencies, but in recent weeks there have been a series of revelations about conflicts of interest and financial links among universities, lenders and government officials. Some Bush administration appointees have said they were unaware of the extent of these controversial practices.
But the 2001 policy draft shows that Education Department officials knew of the issue and that at least some saw a need to act. In addition, some industry executives had sought guidelines on what would qualify as prohibited payments, or "inducements," from lenders to financial aid directors, according to current and former department officials. Several of them spoke on condition of anonymity because of the sensitivity of the matter.
"We have been asked to provide guidance on whether certain practices of [private] lenders and guaranty agencies are considered to be prohibited inducements," according to the 2001 draft obtained by The Washington Post. "We are particularly concerned with allegations that some lenders and guaranty agencies have attempted to hide or disguise an impermissible offer."
Such allegations began to draw increasing attention from the department as early as 1999, according to officials.
Although investigators have found several cases in which lenders made payments to schools that steered business their way, it has not been established that those practices violate federal prohibitions on quid pro quo arrangements. The 2001 proposal addressed that challenge by saying the department would presume that a violation has occurred if a lender offers "something of value" to a school at which it has at least 20 percent of the school's loan volume.
The draft policy, known as "subregulatory guidance," was outlined in a letter by John Reeves, a Clinton-era appointee who served as general manager in a unit of the Office of Federal Student Aid and stayed on for part of the Bush administration. The office's chief operating officer, Greg Woods, another Clinton-era appointee, briefed industry groups on the proposal, according to two people who met with him. But Bush appointees quashed the rules.
"We were like, 'No, we're not going to drop a bomb on the lending community with these wacko ideas,' " said Jeffrey R. Andrade, a senior Education Department official at the time who now works for a loan company.
Reeves declined to be interviewed yesterday; Woods died after leaving the government.
Not everyone agrees that the rules would have had a significant impact.
"People who wanted to work around the rules would have found loopholes, unfortunately," said John Dean, special counsel to the Consumer Bankers Association, which represents lenders and took no position on the proposal.
But Andrade, a former deputy assistant secretary in the Office of Postsecondary Education, said the 2001 proposal was "very draconian," so much so that half the schools in the country would have been found in violation of the policy. The department decided to encourage the financial aid community to draft its own voluntary standards, an effort that ultimately collapsed.
It wasn't long before the department's inspector general issued the first of several reports criticizing a lack of oversight from the agency's Office of Federal Student Aid. A 2003 report to Sally L. Stroup, then assistant secretary for postsecondary education and a former lending agency executive, said the office "has never performed reviews of lenders for the specific purpose of reviewing compliance" with federal anti-inducement rules.
A 2006 audit sent to Theresa S. Shaw, the office's chief operating officer and a former Sallie Mae executive, said the agency's unit responsible for overseeing the lending industry "did not provide adequate oversight and consistently enforce" federal rules. Instead, the audit said, the division "emphasized partnership over compliance in dealing with guaranty agencies, lenders, and servicers."
Stroup said the department had considered issuing new anti-inducement rules in 2005, but agency lawyers objected, saying they would not be enforceable if they weren't made through a formal process. The agency decided to postpone the start of that process until last year.
"Of course, in hindsight, that wasn't such a great decision," said Stroup, now a top Republican aide on the House education committee.
The formal process that began last year considered rules similar to the 2001 proposal, but it broke down last month. Spellings then formed a task force to propose rules to take effect next summer.
Congressional Democrats and the department also are now investigating potential conflicts of interest among agency employees. One official, Matteo Fontana, a former Sallie Mae employee, was suspended early last month after revelations that he held more than $100,000 of stock in a student loan company while overseeing the industry.