Sallie Mae learns to love the free market.

Commentary about business and finance.
Aug. 27 2002 5:36 PM

Sallie Mae Sallies Forth

A government-sponsored corporation learns to love the free market.

Last week, the Wall Street Journal reported that Golden State Bancorp, a California-based savings and loan that is in the process of merging with Citigroup, apparently ignored a more lucrative acquisition offer from another financial institution.


The implication was that Golden State's board had been derelict in not considering this offer, but the controversy fizzled when the other putative bidder—SLM Corp., commonly known as Sallie Mae—said it was never seriously interested in Golden State.

But the real story was: Why was government-sponsored Sallie Mae bidding on a large savings and loan?

After all, the company's raison d'être since its creation in 1972 has been to service and process federally guaranteed student loans. Spending $4.8 billion on a thrift might seem a huge and strange departure for Sallie Mae. In fact, it wouldn't have been such a change. In an age when Amtrak is collapsing and the U.S. Postal Service is hiking rates every few minutes, Sallie Mae is the rare government-connected enterprise that is thriving and seeking less rather than more government support.

Like its larger siblings Fannie Mae and Freddie Mac, Sallie Mae is a government-sponsored enterprise (GSE). GSEs are created by—and partially governed by—the federal government but are owned by public investors. The large GSEs have a mandate to further public policy goals like increasing home ownership, or helping people pay for college. They make loans and purchase loans made by others, which they in turn package and sell to investors. The market tends to regard the bonds and notes issued by GSEs as contingent government liabilities. If ever Fannie Mae were in danger of defaulting on its debts, investors reason, Washington would intervene to prevent an economic disaster.

That implicit government guarantee and their direct competition with large financial services companies have made GSEs, especially Fannie Mae, controversial. But Sallie Mae has never been much of a target. After all, the market for student loans—about $40 billion annually—is a tiny fraction of the $2 trillion annual home-mortgage market. And while Fannie Mae clings fiercely to its GSE status, Sallie Mae has lobbied to shed its government-conferred competitive advantage.

Congress created Sallie Mae to provide financing in a relatively untested market where banks feared to tread: lending to college students. In the beginning, Sallie Mae served primarily as a back-office processor of student loans. Sallie Mae would purchase loans from banks—using funds borrowed at favorable rates from a Treasury Department entity called the Federal Financing Bank—and then collect the payments from students down the road. Profitable from its earliest days, Sallie Mae went public in 1984.

Sallie Mae suffered a blow in 1994, when the Clinton administration's Department of Education began making loans directly to students, thus bypassing the banks who were Sallie Mae's clients. Within a couple of years, the department garnered a 35 percent market share of new loans issued; Sallie Mae's stock fell to the single digits.

Rather than throw in the towel, Sallie Mae lobbied to be liberated from the federal charter that restricted its operations to servicing and processing loans. In 1996, Congress passed a law that would require Sallie Mae to shed its GSE status by September 2008 and transform into an independent company.

In 1997, new CEO Al Lord began to push Sallie Mae into related fields like loan origination. Sallie Mae spent more than $1 billion in 1999 and 2000 to acquire several student-lending companies. It also established a joint venture with Chase to originate student loans. The result: Sallie Mae last year originated more than $10 billion in loans, about 30 percent of the market. About 80 percent of its revenues derive from loan origination—as opposed to processing and servicing.



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