Sallie Mae Not Opposed To Bankruptcy Relief For Student Loans

Originally Published on forbes.com on April 6th,2012

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Alan Collinge, founder of StudentLoanJustice.org , and Sallie Mae on the same page? Can such a thing be? Well maybe not exactly, but it may be that they are not as far apart as you think. A couple of weeks ago I heard from Martha Holler, Senior Vice President, Corporate Marketing & Communications for Sallie Mae.  Being a mere $193 billion (assets) company, they don’t have the kind of media access a famous activist like Alan Collinge has, so they wanted to talk to me about how to get their story across on the forbes.com platform.  Here is the email from Ms. Holler that got us going:

I read Alan Collinge’s blog and your comments about it with interest and would welcome the opportunity to discussstudent loan debt and recently proposed legislation. I will be in New York on April 24 with Sallie Mae President & COO Jack Remondi and SVP of Public Policy Sarah Ducich and would love to meet. Would you have 45 minutes to meet with us?

As we discussed the arrangements for the meeting,  my conscience was stricken with the notion that I was becoming guilty of impersonating a journalist.  I was afraid that this email might cause them to cancel, but I sent it anyway in the interest of full disclosure:

Actually I am located in Westborough Massachusetts but I like to get down to the city every once in a while and there is somebody else I need to meet with around then anyway.  I should be clear that I am just a contributor to forbes.com.  I work full time as a CPA.

That didn’t cause them to back out.  I thought I could use some help from a real journalist so I asked my friend Jonathan Schwartz, who runs Interlock Media, a not-for-profit corporation based in Cambridge that makes films on environmental and human rights issues to help.  Among their films is Turned Out, a powerful documentary about sexual assault in prison:

We supplemented the team with John Whalen, an Interlock intern, who was immensely helpful, not least in handling much of the driving including especially the city part.

Sallie Mae On Increasing College Costs

So there I was in Connolly’s on 45th Street sitting across from John F. “Jack” Remondi, President and Chief Operating Officer of Sallie Mae.  I started off by asking him if he really is worried that college costs might go down, which would hurt their business.  I got that from the Sallie Mae 10-K.  He kind of smiled and said that was the type of risk that they had to disclose to shareholders but he did not think it was very likely.  Then I asked him about the assertion made by Allan Collinge and others that the industry profits from student defaults.

Sallie Mae On Defaults

The argument has a certain logic to it.  The interest and principal on most of Sallie Mae’s portfolio is federally guaranteed.  If somebody goes delinquent, but then starts making some payments, many of those payments will be late fees, which is extra income to Sallie Mae beyond the interest and principal that is guaranteed.  Mr. Remondi indicated that this argument ignores costs. Before turning a loan over to the federal government for delinquency, a process that takes about a year, Sallie Mae, on average, will contact the borrower seventeen times (They are required to contact them twice).  Given the limited time and the amount of material we were covering, there was some necessary vagueness in our discussion, but Mr. Remondi was very clear on this:

When someone is delinquent, it takes work to pursue service. Sallie Mae faces five times the servicing costs as compared to servicing a current loan.If we had all current accounts, we would trade late fees for delinquent costs. Absolutely.

Given what else I’ve learned about Sallie Mae, I’m inclined to believe him.

What About Refinancing ?

Sallie Mae is at an interesting crossroads right now.  The program that generated most of its portfolio, FFELP, is not guaranteeing any new loans.  Sallie Mae expects to be making money off that portfolio for the next twenty years, though, and is buying portfolios of other institutions that hold FFELP loans.  Given its infrastructure, Sallie Mae can presumably service them more profitably.  Since it is a federal guarantee that gives the portfolios their gilt edge, it strikes me that this might not be the optimal deal for the taxpayers.  We will get the ones that stink while Sallie Mae makes money off the ones that perform.

Mr. Remondi set me straight on something that I had not understood from the 10-K.  Although many of the borrowers are paying fixed rates, the lenders are getting variable rates (roughly LIBOR +2). (There is a true-up done with payments either coming from or going to the federal government.  Currently they are going to the federal government.)  Sallie Mae when it buys the loans up, secutitizes them giving institutional investors something like LIBOR+1.  That seems like a pretty sweet deal, if you already have the servicing infrastructure in place.  My question was and still is why the taxpayers don’t do this.  Why don’t we, the taxpayers, refinance the whole FFELP portfolio ?  We are already stuck with the down side of it.  This is another thing that Sallie Mae tells its shareholders it is worried about:

For instance, during the fourth-quarter 2011, the Administration announced a Special Direct Consolidation Loan Initiative that provides a temporary incentive to borrowers who have at least one student loan owned by ED and at least one held by a FFELP lender to consolidate the FFELP lender’s loans into the DSLP program by providing a 0.25 percentage point interest rate reduction on the FFELP loans that are eligible for consolidation. We currently do not foresee the initiative having a significant impact on our FFELP Loans segment. However, the initiative is an example of how the Administration and Congress could detrimentally affect future estimated cash flows and profitability from our FFELP Loan portfolios through their actions.

 Mr. Remondi did not seem all that worried, but I don’t think he was smiling when I asked him about this.

The Big Question – What About Bankrurptcy ?

This was the most exciting thing about the interview to me, but the Sallie Mae people did not think it was that big a deal.  Ms. Ducich explained how the bankruptcy exemption for student loans evolved over time, with the last most draconian piece being added by a floor amendment.  They indicated that Sallie Mae is not opposed to bankruptcy protection for student loans, provided that it applies to all student loans and there is some sort of good faith attempt at payment for five or six years.  You should not be able to graduate and immediately declare bankruptcy.  (Calm down, Alan, I know you think those stories are apocryphal).

Alan Collinge and John Remondi Around The Campfire ?

I have this strong desire for everybody to get along.  Somebody once told me it is because I am an Aquarian.  So the image of the President of Sallie Mae and the student loan activist singing Kumbaya about bankruptcy protection is irresistible to me.  Sadly, the Sallie Mae people tell me much of what Alan says is “factually inaccurate”.  There is a lot to sort out there, which I will leave for future posts.  I hope some of those will come from Sallie Mae, who will further aid me in my ambition to become the Tom Sawyer of blogging.

You can follow me on twitter @peterreillycpa.

Supreme Court Has Taken Ammunition From IRS In Son Of Boss Cases - Time To Fix Bayonets ?

Originally Published on forbes.com on April 6th,2012

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Just so the lawyers do not think I am a moron, I suppose I should talk about what is good about the Supreme Court’sdecision in the Home Concrete case. Normally the IRS has three years to audit you after you have filed your return. If you “forget” to report a significant percentage of your gross income (25%), they get an extra three years. I think the idea is that it is easier to spot phony deductions than missing income.

When you sell something your income is only the gain from what you sold. So what happens if instead of “forgetting” to report the sale you “make a mistake” about your basis ? The IRS argued that they had six years in that case also. They issued a regulation to that effect and applied the regulation retroactively. There were numerous circuit and Tax Court decisions that either invalidated the regulation, said it could not be applied retroactively, was just fine and could be applied retroactively and I think there was one that said it wasn’t even needed, but I have not gone back and reviewed them all.

The Supreme Court said that they answered the question in 1958 and even though the language in the 1954 Code was a little different than the 1939 Code, that their decision was based on, the answer was the same. An overstatement of basis is not an omission from income. I like that clarity.  There is a lot more lawyerly procedural stuff in the decision and it is a 5/4 decision with Antonin Scalia writing his own opinion because he thinks the four he voted with were right for the wrong reasons.  So the lawyers willhave a lot of fun with it.

I did not like the decision, because it lets the clients of the Big Four get away with murder.  The taxpayers affected by these cases did not “make a mistake” about their basis. They hired Big Four firms to create basis out of thin air. What is particularly egrigous about the schemes is that they were based on one sided entries.  I called it “Debit by the Window – Credit out the Window“.  Richard Egan’s attorney talked about how some schemes used basis rather than creating losses, which was less likely to be noticed by the IRS.  If the price of EMC stock had not collapsed, there would have been no big ugly negative numbers on his return, just lower gains.  No tax shelter here – just a hard working high tech billionaire paying more taxes than most people.  So we have the Supreme Court blessing people who did a better job gaming the system than KPMG and McGladrey did for Mr. Egan, who was caught before three years were up.

Robert McKenzie commented extensively on my first piece on the casestarting out quite diplomatically by observing “Peter misses the point of the ruling”.  He actually did have a good point (which I had not missed):

It should also be noted that had the IRS prevailed in this case it would been allowed to audit most capital transactions for 6 years not 3. Every person who sold a rental property or a significant amount of stock would have been subject to an IRS financial proctolgy exam for up to 6 years. If Congress dislikes the results the results of this case it can amend the law but in so doing it will subject many of the 99% who lack to the resources to hire talented tax lawyers to IRS intrusion into their finances for more than 3 years. In my 40 years as a tax lawyer there is one certainty, every time Congress grants the IRS more power some of its agents will abuse that power.

Actually it would be not most capital transactions.  It would be large, relative to gross income, capital transactions where there was significant reported basis relative to proceeds.  At any rate if the IRS had prevailed it would have been worrisome for people who were not trying to get away with anything.  Three years should really be enough for somebody who is confused about their basis in all those AT&T subsidiaries or had to reconstruct the record on improvements they made to a vacation home they sold.

Robert Wood in his piece noted:

Robert McKenzie, tax lawyer with Chicago’s Arnstein & Lehr LLP said four clients of his firm with similar issues would likely reap tax savings approaching $40 million. Indeed, some reports say the case calls into question up to $1 billion in tax revenues. The IRS was hoping to collect this huge amount in about 30 related cases involving “Son of Boss” tax shelters.

Mr. McKenzie’s clients were probably people who got confused about their basis in AT&T stock or sold vacation homes and had to estimate how much they had put in improvements not people who had collectively reaped $200,000,ooo in capital gains and hired the Big Four to rig up transactions that would fly below the radar and allow them to pay nothing – except big fees.  If they were my clients, I would be glad about it too.  In a little e-mail exchange about the case he noted “Everybody benefits when the courts restrain the IRS from making its own rules.”    I don’t know about everybody, but it is true you do have these situations where basis documentation is on the sketchy side and it is comforting to know that you can rest easy after three years.

There is still that billion dollars though.  Does the IRS have to retreat from trying to fix what Jack Townsend calls a “raid on the fisc” now that the Supreme Court has taken away their ammunition?  It almost feels like Joshua Chamberlain on Little Round Top:

Jack questions why the IRS bothered trying to extend the scope of the six year statute to apply to these cases, when they had, and in some of the cases may still have, another weapon available – an unlimited statute for fraud:

But there is a glaring candidate for the presence of fraud in these cases.  In most, if not all, a condition of the hokey but foggy tax opinions that were rendered was that the taxpayer personally represent to the opinion writerthat the taxpayer had a profit motive apart from the tax benefits for entering the transaction(s) which generated the imagined tax benefits.  In truth, there was little economic substance in these deals and the taxpayer was really motivated by the hokey tax savings.  So, the taxpayer was not really telling the truth in many — probably most, if not all — of these shelters when the taxpayer made that representation about his or her profit motive.  Without that untruth, the hokey tax opinion would not have been uttered and the hokey shelter claims would not have been made and the fisc would not have been raided.  So the question has to be asked why the IRS did not pursue civil fraud in at least some of these cases — to get the unlimited statute and a civil penalty more fitting to the egregious conduct being punished.

Would using the unlimited statute for fraud give the Service the advantage of moving down the hill ? It might, because instead of a 40% penalty, there is a 75% penalty.  As I have often, said I usually root for the taxpayers, but this one is an exception.  I really hope that the Son of Boss swat team has just heard somebody say “Fix Bayonets” and that all winning this case had done for the Son of Boss guys is add another 35% to the penalty.

You can follow me on twitter @peterreillycpa.

News Flash to Obama On Student Loans: It Is Not The Interest Rates...It Is The Sticker Price

Originally Published on forbes.com on April 26th,2012

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I asked Alan Collinge for a follow-up to explain more thoroughly why he thinks President Obama’s focus on the interest rate on Stafford loans is a distraction from more substantive issues. Here is what he has to say. 

I have been impressed with the authenticity of President Obama to this point.  On most issues he convinces me that he is both knowledgeable, and concerned. One would assume that his own personal history would inspire wisdom and passion about the student loans, the  critical issues, and so forth.  Listening to his recent stump speeches oninterest rates for student loans, however, indicates that he clearly does not get it.

First of all, the current legislation that is sucking all of the air out of the room is just not very impressive, because it is not the interest rates that are compelling citizens to take up residence in public spaces across the country- it is the sticker price on colleges, and the predatory foundations of the lending system that stand behind them.

Secondly, the legislation in question only affects a small portion of loans, namely, undergraduate, subsidized Stafford loans.  Moreover, thecurrent interest rate is 3.4%, and keeping this fixed as opposed to allowing it to double to 6.8% really does not impact the borrower’s bottom line very much. Most importantly, this legislation does absolutely nothing to control the (nearly) hyperinflation that has gripped academia for years and decades.  This is not to say this is unneeded legislation.  It is needed.  But if President Obama thinks that he can phone this one in, and be done with thestudent loan issue for a while, he had better think again.

The way to affect college pricing meaningfully is to freeze, or even lower the federal lending limits on federal student loans.  This will not happen until the Federal government has skin in the game on the side of students, instead of against them, due to the absence of bankruptcy protections.  I have written many times in this column and others about the fact that the Department of Education has actually been making, not losing money on defaulted student loans for years.  This is the reason why government oversight and loan administration is so bad, and why prices and default rates are so high.

I was happy to see that Anya Kamenetz wrote an article earlier today for CNN  about the need to restore bankruptcy protections to all student loans.  In her piece, she briefly mentions a “ripple effect” that will cause many problems to be solved.  This is spot on and I could not agree more.  With the Department of Education working at long last FOR the interests of the citizens instead of against them, we should see all manner of creative and effective repayment plans, oversight procedures, and the like to keep the cost of college low, and the quality high.  This will only happen in the presence of full and fair bankruptcy protections, and will absolutely not happen in their absence.

I do hope that the American people have the sophistication to read past the headlines, and wrap their heads around the real problem with student loans, and find a way to stand up and fight for bankruptcy protections, and be proud to do so.  It is an unlikely position to find one’s self in I know, but it’s a fight that absolutely needs to be fought, and will pay off in spades.

Alan Collinge is the founder of StudentLoanJustice.org.

In case you are wondering, in a spirit of cutting my own throat, I have suggested that Alan apply to forbes.com to have his own page. Fortunately he has not taken that great advice from me. He continues to support my effort to become the Tom Sawyer of bloggers.

You can follow me on twitter @peterreillycpa.

Supreme Court Takes Break From Obamacare To Bail 1% Out Of Abusive Shelters

Originally Published on forbes.com on April 25th,2012

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The kids out occupying probably are not going to be that upset by the Supreme Court decision in Home Concrete, because few of them can understand it.   They really should be upset, though, because it is a great present to the sketchiest bunch of the 1%.  In saying that I am respectfully disagreeing with my fellow contributor Robert W. Wood, who says the decision gives taxpayers everywhere  ”a little more security”. 

Here is the issue.  Generally the IRS only has three years to audit you.  If you leave out more than 25% of your gross income, though, they get six years.  What happens if you sell something and overstate your basis in it ?  We have an income tax not a gross receipts tax.  So if you sell something you get to deduct your basis.  Most commonly your basis is what you paid for something, but it can get more complicated than that.  In terms of this discussion, though, let us say you sold something in which you had no basis for a million dollars and just flat out lied about your basis and reported only $100,000 in gain.  Is that an omission of $900,000 in income for purposes of extending the statute to six years ? 

That was the question before the Supreme Court.  Lest you think this was about some poor little old lady who was utterly confused about her basis in the stock in all those AT&T subsidiaries she received 20 years ago, you might look at the piece I wrote about the original Home Concrete decision by the Fourth Circuit – “Should IRS Get Additional Time to Nuke Abusive Tax Shelters ?”  What the IRS was going after in Home Concrete and the other cases that will be affected by this decision was phony basis concocted by the Big Four Accounting firms.  I have a hard time believing there were actually real accountants involved, because in order for the things to even seem to work,  you had to forget all about double entry.  I did my best to explain these deals in a post about Richard Egan, the EMC founder, whom the IRS caught within three years:

The plan for eliminating capital gains works like this.  You write a very large option which entitles you to receive a large premium.  You use that premium to buy a very similar option.  When it unwinds you will most likely have a loss, particularly after fees, but not a very large loss relative to the notional amount of the options.  Get ready for the magic and if you are passionately attached to double entry remain calm.  Form a partnership and contribute these two contracts to the partnership.  Slowly.  Carefully.  One at a time.  First there is that option you bought for say 150,000,000 (Never mind where you got it from).  That’s easy.  Your basis is 150,000,000, the partnerships basis in it is 150,000,000.  Increase your basis in your partnership interest by 150,000,000.  You probably want to take a break.  Now you’ve got that other thing.  The option that you wrote.  Well you got a lot of money and it seems like it could require you to pay out a lot of money.  In some ways it seems like a liability.  But remember this is a partnership.  You need to check Section 752.  Well something that you maybe have to pay isn’t going to pass muster as a liability under 752.  So now you are done.  Your basis in your partnership interest is 150,000,000.

There are a number of further steps to the plan.  The only problem with it is that creating basis out of thin air does not even make good nonsense.  Egan’s attorney, Stephanie Denby, who was tasked with vetting the various deals made this observation:

These transactions clearly take advantage of “loopholes.” The reporting is consistent with tax law although the results are unintended. The promoters will provide tax opinion letters to avoid penalties if audited. It appears that there is a very low chance that these transactions would ever be picked up by the IRS. The promoters I have talked to have not had any audits.
>Secondly, some of the transactions focus on generating basis as opposed to capital loss. Basis is more discrete [sic] and less likely I believe to cross the IRS radar screen.

The AICPA Statement on Standards for Tax Practice indicate that CPAs should not recommend positions that exploit the audit selection process of a taxing authority.  Somebody must have cut that page out of the copy on the shelves at KPMG.

Maybe the Supremes are right about the decision, but it is hardly a victory for ordinary taxpayers.  The people who hired the practitioners who were best at obscuring the audit trail are the winners in the case. Robert Wood reported:

Robert McKenzie, tax lawyer with Chicago’s Arnstein & Lehr LLP said four clients of his firm with similar issues would likely reap tax savings approaching $40 million. Indeed, some reports say the case calls into question up to $1 billion in tax revenues. The IRS was hoping to collect this huge amount in about 30 related cases involving “Son of Boss” tax shelters.

So congratulations to all the folks who paid 0% on large capital gains and got away with it. If you are a regular reader of my blog, you know that I usually root for the taxpayer, but I’m not cheering about this one.

You can follow me on twitter @peterreillycpa.

Student Loans - Beyond The Interest Rate Debate

Originally Published on forbes.com on April 25th,2012

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President Obama is arguing to keep the interest rate on a class of student loans from increasing.  Alan Collinge is hunting bigger game, a complete systemic reform.  A recent proposal for a forgiveness program just does not cut it in his view.  Here are his thoughts.

Freshman Congressman Hansen Clarke (D-MI) recently introduced HR 4170:  The Student LoanForgiveness Act.  The legislation has received quite a lot of media attention, and strong support from well-networked groups on Facebook, and other platforms.   Unfortunately, the bill looks far less like a forgiveness plan, and far more like yet another repayment/earned benefit plan combined with a bailout for banks who made highly risky loans without sufficient underwriting.  Unfortunately, I have to give it an unequivocal “thumbs down” from the citizen’s perspective.  Here is my take:

The Bill:  HR 4170 aims to accomplish a number of goals for student borrowers, including the creation of a new, 10-year forgiveness program, a permanent 3.4% cap on the interest rate for federal loans, a reduction in the length of the Public Service Forgiveness program from 10 years to 5, and the creation of a mechanism by which the Government purchases private loans, and brings them into the federal program.

I have all of the same reservations with the 10-year repayment plan that I’vewritten about elsewhere in the past. Like the other repayment programs, this is fraught with risk, uncertainty, and clear downsides that could and certainly will prove to be life-wreckers for many, all things being equal.

Of particular concern: The Department of Education would absolutely attempt to kick as many people out of this program as possible to avoid having to forgive the large amounts that they would be liable for (Google “disability discharge”, and “Department of Education” if you have any doubts about the Department’s track record on granting discharges for other reasons).  As such, the completion rate of this or similar programs (like the existing IBR and PSLF programs) will ultimately be very small.

How Small?For example…earned benefits that banks and credit card companies routinely offer to their borrowers (ie interest rate reductions for ontime payments, etc) have a success rate of about 15%. For federal student loans, this is not going to get it done for the people.  Not even close. In the presence of bankruptcy protections, I would have more faith in the current and proposed repayment programs, but not in their absence. Not by a longshot.

What should concern the public generally about this bill is that it does nothing to address the systemic problems with the lending system such as inflation, predatory foundations in the absence of consumer protections, systemic corruption, and others.

Also, because of a maximum forgiveness on principal of $45,000 for new loans(consolidation loans, for example), this would not be very helpfulfor people with defaulted loans with large balances, and large fees attached.

What really angers me as an “Occupier” who is sick and tired of seeing the banks come out of every cesspool they create smelling like roses:  a private loan purchasing program in the legislation that is essentially another bank-bailout by which the lenders can get full book value (plus penalties and fees) for their worst performing loans. This is disgusting to me as a citizen.

I also have reservations about this from the borrowers perspective: I have heard others voice hesitancy about “federalizing” their loans because of the absence of consumer protections, strong collection powers of the government, etc. I agree with those concerns- they are not trivial.

Also very concerning- and this is why trying to codify a repayment program like this is so difficult- is the means for “paying” for this legislation. This bill calls upon a little known DOD fund used for overseas contingency operations (OCO) to pay for the costs associated with this legislation. This fund has had as little as $0.2 billion and as much as $168 billion in it in various years that I could find. This raises a plethora of new questions, and problems that you can imagine. This is beyond shaky.

The problems with this legislation really only underscore the need to restore bankruptcy and perhaps other fundamental consumer protections to student loans. The Department of Education would be far more likely to come up with a good workable set of forgiveness programs with fundamental protections in place. Conversely, history (decades of history) clearly demonstrates that the Department will not do anything to help students in their absence.

So I’m unfortunately having to call this bill a dog that won’t hunt for the citizenry. If someone steps up to argue for actual student loan forgiveness, there certainly is a strong, surprisingly realistic argument to be made for that, but we haven’t heard it yet from the politicians, advocates, or anyone that I have read to this point. This is unfortunate.

Alan Collinge is the founder of StudentLoanJustice.org.

You can follow me on twitter @peterreillycpa.