Shares of student lending firms, including Lincoln’s Nelnet, fell sharply Monday after President Bush proposed to cut lenders’ subsidies by 0.5 of a percentage point and give more money to education grants for financially needy students.

Some student-loan advocates at nonprofit organizations hailed Bush’s proposal as final recognition the guaranteed student loan program is a virtual handout to commercial student lending companies.

But SLM Corp., also known as Sallie Mae, whose stock was down about 9 percent,  called the proposal “harmful” and said it would lead to reduced competition because private-sector lenders serve about 80 percent of all student borrowers.

“Students and families will have less choice and more expensive loans, and taxpayers will carry the burden and cost of higher student loan defaults,” according to a statement from SLM in Reston, Va.

Shares of SLM fell $4.09, or 8.8 percent, to $42.37 in trading on the New York Stock Exchange after earlier hitting a 52-week low of $42.05.

Stock in Student Loan Corp., of Stamford, Conn., and Nelnet also dropped sharply.  

Nelnet’s stock dropped $2.65,  9.6 percent, to $25.05, just above its 52-week low on three times its normal volume.    

Nelnet spokesman Ben Kiser said: “Over the last decade, the (Federal Family Education Loan) Program) has proven itself in the marketplace. In fact, the budget proposal mentions the benefits competition between lenders provides students and schools. We need to make sure that the proposed budget cuts do not hinder the competition that adds real value to students and schools.”

Investors’ worries about the impact on lenders may be justified, Prudential Equity Group analyst Charles A. Gabriel said.

“We fear that the ‘lame duck’ Bush administration — now hunkered down over Iraq, committed to a balanced budget, and facing a newly Democratic Congress in its last two years — may be doing the equivalent of ‘throwing the student loan industry under the bus,“’ Gabriel said in a research note.

The Consumer Bankers Association also denounced the proposal in the White House’s fiscal 2008 Education Department budget request, warning that the reductions may cause many lenders to reconsider participating in the Federal Family Education Loans program.

“Driving away banks from this program will leave students with either a government monopoly or an oligopoly of loan providers,” said Joe Belew, president of the association.

Under the Bush administration plan, the government would pay lenders $13.5 billion less over the next five years, the Wall Street Journal reported.

Another $3.3 billion would be saved by reducing subsidies to student loan guaranty agencies and another $3.2 billion would be saved by eliminating the Federal Perkins Loan revolving funds entirely.

The bulk of those student loan savings under Bush’s plan would be used to gradually increase the Pell Grant maximum to $5,400.   Pell Grants  are direct government grants based on financial need. 

Michael Dannenberg, director of the New America Foundation’s education budget project,  called Bush’s proposal overdue. 

“The president’s budget makes clear the growing consensus the student loan is rife with unnecessary lender subsidies,” Dannenberg said.  “(It) does not mean the viability of the industry is compromised.  

“It is such an astonishingly lucrative business to be in.  The student loan industry has a ‘can’t miss’ business model, a virtual guarantee against risk and a government guarantee of profit. 

“This is not what I think of when I think of capitalism,” Dannenberg said.

Counting the spending increase on Pell Grants, overall changes to student aid programs would save the government an estimated $2.9 billion over the next five years, the Wall Street Journal reported.

Bush’s proposal is substantially more ambitious in saving money than one being pursued in Congress, in which lawmakers also reduced lender guarantees, but cut the lender rate subsidy by just 0.1 of a percentage point. 

The House bill would use the savings to offset the cost of cutting Stafford student loan interest rates to 3.4 percent from 6.8 percent over the next five years.

Bush opposes that plan, arguing that “student debt loads have soared in recent years, and it is not clear that encouraging more loans is a wise course,” according to a statement released by his Office of Management and Budget.

The Senate is expected to consider a similar student-loan interest-rate cut, but the sponsor, Sen. Edward Kennedy, (D-Mass.) would prefer to offset the cost of the rate cut by pushing students into direct student loan programs, in theory generating savings for the program by cutting out private lenders as middlemen.

Kennedy has been active in exposing another subsidy used by some lenders,  most prominently, Nelnet, which recently  reached a settlement with the U.S. Department of Education that will allow it to keep $278 million in disputed profits from that more controversial loan subsidy.

The settlement came after a report issued by the Education Department’s Office of Inspector General last fall concluded Nelnet got the $278 million improperly and should repay it.

The company says that, overall, it has earned about $322 million from the subsidy.

Nelnet’s experience showed how poorly designed the student loan program is, Dannenberg said.

Journal Star reporter Richard Piersol and the Associated Press contributed to this report.

How the student loan subsidy works: Lenders that participate in the Federal Family Education Loan program are guaranteed to collect an interest rate equal to a commercial debt rate set quarterly, plus 2.34 percentage points. 

 

Right now, that equals 7.72 percent.  

President Bush’s proposal would reduce the 2.34 percentage points, to 1.84 percentage points. 

The undergraduate student  borrower pays a rate set annually for what are called Stafford loans, which are guaranteed by the government to the lender against default. 

 Now, for new Stafford loans, that is 6.8 percent.

The government pays the difference between the guaranteed rate for the lender and what the student pays.