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Report to Congressional Requesters: United States Government Accountability Office: GAO: September 2004: FEDERAL FAMILY EDUCATION LOAN PROGRAM: Statutory and Regulatory Changes Could Avert Billions in Unnecessary Federal Subsidy Payments: GAO-04-1070: GAO Highlights: Highlights of GAO-04-1070, a report to congressional requesters Why GAO Did This Study: To encourage lenders to make student loans under the Federal Family Education Loan Program (FFELP), the federal government guarantees lenders a statutorily specified rate of return—called lender yield. Some lenders may issue tax-exempt bonds to raise capital to make or purchase loans; loans financed with such bonds issued prior to 10/1/93 are guaranteed a minimum lender yield of 9.5% (hereafter called 9.5% loans). When the interest rate paid by borrowers is less than the lender yield, the government pays lenders the difference—a subsidy called special allowance payments. In light of the upcoming reauthorization of the Higher Education Act of 1965, we examined special allowance payments for 9.5% loans. What GAO Found: As shown below, special allowance payments for 9.5% loans have risen dramatically in recent years, increasing from $209 million in FY 2001 to well over $600 million as of June 30, 2004. A primary reason for the increase is the sharp decline in the variable interest rates paid by borrowers relative to the minimum 9.5% lender yield. Another reason for the increase in special allowance payments is the rising dollar volume of 9.5% loans, which increased from about $11 to over $17 billion from FY 1995 to June 30, 2004. Given that current market interest rates are at or near historic lows, lenders have a financial incentive to maintain or increase their 9.5% loan volume and can do so in three ways: * After paying costs, including payments to bond investors, associated with a pre 10/1/93 tax-exempt bond, lenders can use any remaining money to reinvest in more FFELP loans that, by law, are also guaranteed a minimum 9.5% yield. * Lenders can issue a new bond, called a refunding bond, to repay an outstanding pre 10/1/93 tax-exempt bond that financed 9.5% loans. Consequently, the refunding bond finances the 9.5% loans and may have a later maturity date than the original bond, allowing lenders to maintain their 9.5% loan volume for a longer time. * By issuing a taxable bond and using the funds obtained to purchase 9.5% loans financed by a pre-10/1/93 tax-exempt bond, lenders can significantly increase their loan volume. Lenders can use the proceeds from the sale of loans previously financed by the pre-10/1/93 tax- exempt bond to make or buy additional loans, which are also guaranteed a 9.5% yield. Under Education’s regulations, loans previously financed by a pre 10/1/93 tax-exempt bond and subsequently financed by (i.e., transferred to) a taxable bond continue to be guaranteed a 9.5% yield. Some Members of Congress and the Administration have proposed making statutory changes with respect to 9.5% loans, which could save billions of dollars in future special allowance payments. An official representing a leading credit rating agency and some major lenders told us that making changes to the minimum 9.5% yield for loans made or purchased in the future should not affect lenders’ ability to make required payments on outstanding tax-exempt bonds. What GAO Recommends: To address the issues identified in this report, Congress should consider changing the yield for loans made or purchased in the future with the proceeds of pre-10/1/93 tax-exempt bonds, and any associated refunding bonds, to better reflect market interest rates. GAO recommends that Education change its regulations so that 9.5% loans transferred from a pre-10/1/93 tax-exempt bond no longer receive a minimum 9.5% yield. Education agrees that special allowance payments should be reduced, but believes it has limited options to do so. GAO believes that Education has other options it can explore. www.gao.gov/cgi-bin/getrpt?GAO-04-1070. To view the full product, including the scope and methodology, click on the link above. For more information, contact Cornelia Ashby at (202) 512-8403 or ashbyc@gao.gov. [End of section] Contents: Letter: Special Allowance Payments For 9.5 Percent Loans Have Increased More Than Threefold Since Fiscal Year 2001: Changes to the Minimum 9.5 Percent Yield For Future Loans Could Save Billions and Is Unlikely to Cause Lenders to Default on Outstanding Tax-Exempt Bonds: Conclusions: Matter for Congressional Consideration: Recommendation for Executive Action: Agency Comments: Appendix I: Briefing Slides: Appendix II: Comments from the Department of Education: Appendix III: GAO Contacts and Staff Acknowledgments: GAO Contacts: Staff Acknowledgments: Abbreviations: FFELP: Federal Family Education Loan Program: HEA: Higher Education Act: IRC: Internal Revenue Code: IRS: Internal Revenue Service: SAP: special allowance payment: United States Government Accountability Office: Washington, DC 20548: September 20, 2004: The Honorable Dale E. Kildee: Ranking Minority Member, Subcommittee on 21st Century Competitiveness: Committee on Education and the Workforce: House of Representatives: The Honorable Chris Van Hollen: House of Representatives: Under the Federal Family Education Loan Program (FFELP), lenders-- including banks, state agencies and other nonprofit and for-profit organizations--annually make, or originate, billions of dollars in loans to help students and families finance postsecondary education costs. To encourage lenders to make loans, the federal government guarantees lenders repayment and a statutorily specified rate of return--called lender yield--on the loans they hold. Lender yields as well as the interest rates paid by borrowers are typically tied to, and vary with, money market financial instruments, such as the 91-day Treasury bill. When the interest rate paid by borrowers is less than the guaranteed lender yield, the government pays lenders the difference--a subsidy called special allowance payments. In exercising its oversight of the FFELP, Congress has periodically changed the formula for lender yields to better reflect market interest rates, federal budget constraints, or the costs incurred by lenders to finance loans. To finance loans, some lenders, specifically state agencies and state-designated authorities, may issue tax-exempt bonds to raise capital to make or purchase loans, thereby providing other lenders with more funds to make more loans. Investors who buy these bonds receive interest income that is exempt from federal taxation. Because these investors do not pay taxes on their interest earnings, they are willing to accept a lower pretax rate of return on their investment, which lowers the financing costs for agencies and authorities issuing the bonds. As student loan borrowers repay their loans, loan holders use the money to repay, in turn, bond investors. Concerned that the lender yield for loans financed with tax-exempt bonds did not adequately reflect the lower costs associated with tax- exempt financing, Congress reduced the yield in passing the Education Amendments of 1980. To do so, Congress reduced the special allowance payments to be paid on loans financed with tax-exempt bonds to one-half of that otherwise payable. At the same time, however, Congress guaranteed that the lender yield for loans financed with tax-exempt bonds would be no less than 9.5 percent. Several years later, in passing the Omnibus Budget Reconciliation Act of 1993[Footnote 1], Congress eliminated the one-half special allowance payment and minimum 9.5 percent yield provision for loans financed with tax-exempt bonds issued on or after October 1, 1993. In so doing, Congress provided that lenders would receive the same yield on loans, regardless of whether tax-exempt bonds or other sources of funds had been used to finance the loans. Due to these changes, loans that are financed with the proceeds of tax-exempt bonds issued prior to October 1, 1993 are guaranteed a minimum 9.5 percent yield. (These loans are hereafter called 9.5 percent loans). Believing that changes to the law should have resulted in a decline in special allowance payments made for 9.5 percent loans since 1993, various news media, policy makers, and others have recently raised questions about the extent to which the government continues to make such payments. In light of the upcoming reauthorization of the Higher Education Act of 1965, which authorizes the FFELP, you asked us to examine special allowance payments for 9.5 percent loans. To conduct our examination, we analyzed the Department of Education's (Education) data on 9.5 percent loan volume and special allowance payments paid to lenders from fiscal year 1986 through the third quarter of fiscal year 2004, the most current data available at the time of our review. On the basis of our review of the documentation for these data and our discussions with Education officials about the steps they take to ensure the reliability and validity of these data, we determined that the data were sufficiently reliable for the purpose of our examination. In addition, we interviewed officials with Education; the Internal Revenue Service; a major credit rating agency that examines and rates the quality of student loan bonds, including those issued by several holders of 9.5 percent loans; a leading bond counsel law firm that provides legal advice to lenders that issue tax-exempt student loan bonds; and 12 lenders that reported holding 9.5 percent loans in fiscal year 2003. We gathered additional data on the amount of 9.5 percent loans in taxable bonds from the top 10 holders of 9.5 percent loans in fiscal year 2003. These 10 lenders held 70 percent of reported 9.5 percent loan volume in fiscal year 2003. On August 19, 2004, we briefed your staff on the results of our work. This report summarizes the information we shared with your staff and transmits the slides we used to brief your staff that day. In this report, we are also making a recommendation to the Secretary of Education and suggesting a matter for Congress's consideration. We conducted our work between December 2003 and August 2004 in accordance with generally accepted government auditing standards. Special Allowance Payments For 9.5 Percent Loans Have Increased More Than Threefold Since Fiscal Year 2001: Special allowance payments for 9.5 percent loans have risen dramatically in recent years, increasing from $209 million in fiscal year 2001, to $556 million in fiscal year 2003 and reached about $634 million at the end of the third quarter of fiscal year 2004. Two reasons account for this increase: (1) a decline in the interest rate paid by borrowers and (2) a rise in the dollar volume of 9.5 percent loans. In some cases, restrictions exist on how the nonprofit, for- profit, and state agency lenders that hold 9.5 percent loans may use their earnings, including their special allowance payments, from 9.5 percent loans. Decline in Interest Rate Paid by Borrowers Is Primary Reason for Increase in Special Allowance Payments: The primary factor influencing the increase in special allowance payments has been the sharp decline in interest rates paid by borrowers relative to the minimum 9.5 percent government guaranteed yield for lenders. As borrower rates have declined, the amount the government has been required to pay to make good on its promise to lenders has increased. To illustrate, in 2001, the borrower interest rate was 8.2 percent.[Footnote 2] Because this borrower rate is tied to the 91-day Treasury-bill rate and the Treasury-bill rate subsequently declined, the borrower interest rate on the same loan in 2003 was 5.4 percent. While the borrower rate declined, the yield for a lender who used the proceeds, or funds obtained, of a pre-October 1, 1993, tax-exempt bond to originate or purchase the loan remained at 9.5 percent. Over this period, the difference, or spread, between the borrower rate and the 9.5 percent lender yield increased from 1.3 percent to 4.1 percent. As a result, the special allowance payment required to ensure a lender yield of 9.5 percent increased for each dollar of loan volume in this example. Increasing 9.5 Percent Loan Volume Is Another Reason for the Increase in Special Allowance Payments: Another factor influencing the increase in special allowance payments has been the rising dollar volume of 9.5 percent loans. Although the overall volume of 9.5 percent loans has increased since fiscal year 1995, volume among lenders has varied. Most lenders experienced a decrease in their 9.5 percent loan volume between fiscal years 1995 and 2003, but by the end of the third quarter of fiscal year 2004, some of these lenders had sharply increased their 9.5 percent loan volume. For example, one lenders' 9.5 percent loan volume had decreased by 46 percent between fiscal years 1995 and 2003 but then increased by 136 percent between 2003 and the end of the third quarter of fiscal year 2004, making its 9.5 percent loan volume greater than it was in 1995. There are primarily three ways--referred to as recycling, refunding, and transferring--that a lender can slow the decrease in, maintain, or increase its 9.5 percent loan volume. * First, after paying costs associated with a pre-October 1, 1993 tax- exempt bond (such as payments of interest and principal to bond investors), lenders can reinvest, or recycle, any remaining money earned from 9.5 percent loans to make or purchase additional loans that, under the law, are also guaranteed a minimum 9.5 percent lender yield. Using this method, lenders are able to slow the decrease in, maintain, or slightly increase their 9.5 percent loan volume. * Second, lenders can issue a new bond, called a refunding bond, to repay the principal, interest, and other costs of an outstanding pre- October 1, 1993 tax-exempt bond. Based on how the HEA has been interpreted, 9.5 percent loans originally financed with a pre-October 1, 1993 tax-exempt bond, but subsequently financed by a refunding bond, continue to carry the government guaranteed minimum yield for lenders of 9.5 percent. Moreover, the refunding bond may have a later maturity, or payoff, date than the original bond. Using this method, lenders can maintain their 9.5 percent loan volume. * Third, under Education regulations, a lender can significantly increase its 9.5 percent loan volume by issuing a taxable bond and using the proceeds to purchase 9.5 percent loans financed by a pre- October 1, 1993 tax-exempt bond. The lender then uses the cash available from the pre-October 1, 1993 tax-exempt bond to make or buy additional loans, which are guaranteed the minimum 9.5 percent yield. Under regulations issued in 1992, the loans transferred to the taxable bond continue to be guaranteed the minimum 9.5 percent lender yield, so long as the original bond is not retired or defeased. (At the time the regulation was promulgated, Education anticipated that interest rates would rise, resulting in a higher lender yield for loans financed with taxable bonds than for loans financed with tax-exempt bonds. Education believed that if the 1992 regulation was not promulgated, lenders would have had an incentive to transfer loans from tax-exempt bonds to taxable bonds in order to obtain a higher yield, thus resulting in higher special allowance payments for the government.) Among the top 10 lenders holding 9.5 percent loans, more than half of the dollar volume of their 9.5 percent loans had been transferred to taxable bonds as of March 31, 2004. The extent to which lenders have transferred 9.5 percent loans to taxable bonds varies considerably. For example, one lender had none of its 9.5 percent loans in a taxable bond, while another held 90 percent of its 9.5 percent loans in a taxable bond as of March 31, 2004. Some lenders interviewed have been transferring 9.5 percent loans for several years, while another lender just started to transfer 9.5 percent loans in 2004. Additionally, some lenders have also transferred 9.5 percent loans to tax-exempt bonds issued after October 1, 1993, thereby continuing the 9.5 percent minimum guaranteed yield. As a result of recycling, refunding, and transferring, the overall dollar volume of 9.5 percent loans has increased from about $11 billion in fiscal year 1995 to over $17 billion at the end of the third quarter of fiscal year 2004. While the dollar volume of 9.5 percent loans presently accounts for only about 8 percent of all outstanding FFELP loan volume, these loans account for 78 percent of all special allowance payments made to FFELP lenders thus far in fiscal year 2004. Earnings on Tax-Exempt Bonds that Finance 9.5 percent Loans May be Used for Borrower Benefits: Under the Internal Revenue Code (IRC), earnings on loans financed by tax-exempt bonds are limited.[Footnote 3] Lenders can reduce their earnings on loans financed with tax-exempt bonds, and avoid exceeding IRC limitations, by providing benefits to borrowers. Some lenders reported that they have used, or plan to use, earnings in excess of IRC limits to provide interest rate reductions or loan cancellation for borrowers. In contrast to tax-exempt bonds, earnings on taxable bonds are not limited. As a result, lenders have discretion in how they use their earnings from taxable bonds that have financed 9.5 percent loans. Changes to the Minimum 9.5 Percent Yield For Loans Made or Purchased in the Future Could Save Billions and Is Unlikely to Cause Lenders to Default on Outstanding Tax-Exempt Bonds: Changing law and regulations with respect to 9.5 percent loans made or purchased in the future could reduce the amount of special allowance payments required to be paid by the government without compromising lenders' ability to meet their obligations under their outstanding tax- exempt bonds. The Administration and some members of Congress have, in fact, already put forth proposals to make such changes. The Administration has proposed limiting the extent to which lenders can receive the substantially higher special allowance payments on 9.5 percent loans in the future and estimates savings of $4.9 billion over fiscal years 2005 through 2014 by doing so. Proposed legislation introduced in the 108th Congress also seeks to revise the law pertaining to 9.5 percent loans in order to reduce special allowance payments and change lender yields to reflect current market interest rates.[Footnote 4] Changing current regulations that allow lenders to transfer 9.5 percent loans to taxable bonds and retain the minimum 9.5 percent yield could also significantly reduce potential special allowance payments in the future. While Education officials told us that they had considered revising the department's regulations, they believed that Congress could effect such a change by law more quickly and easily. Education officials told us that promulgating new FFELP regulations would likely be difficult and time-consuming, in light of the HEA's requirement that the department engage in negotiated rule making in promulgating FFELP regulations. Negotiated rule making requires the department to convene a committee that would include FFELP industry representatives, such as lenders, and attempt to reach consensus among committee members on proposed regulations. Given the interest of lenders who hold 9.5 percent loans, reaching consensus on new regulations would likely prove to be very difficult, according to Education officials. However, the inability to reach consensus does not invalidate the negotiation of rules.[Footnote 5] Moreover, regulations are not subject to the negotiated rulemaking requirement if the Secretary determines that applying this requirement would be 'impracticable, unnecessary, or contrary to the public interest.' Representatives from a major credit rating agency as well as some lenders who hold 9.5 percent loans told us that eliminating the minimum 9.5 percent yield for loans made or purchased in the future should not affect lenders' ability to meet their obligations under, and make required payments on, their outstanding tax-exempt bonds, nor should it have long-term negative effects in the student loan bond market. Conclusions: Unlike other loans for which the lender yield varies with current market interest rates, the lender yield for loans financed with pre- October 1, 1993 tax-exempt bonds are guaranteed a minimum yield of 9.5 percent. Given that current market interest rates are at or near historic lows, lenders have a significant financial incentive to slow the decrease in, maintain, or increase the volume of loans that yield such a relatively high rate of return unavailable on other FFELP loans. This incentive will remain even if market interest rates gradually rise in the future. Ironically, moreover, an Education regulation over 10 years old and originally intended to limit the government's exposure to increased special allowance payments has today presented lenders with an extraordinary opportunity to generate additional loans that earn a 9.5 percent yield. As we have shown, lenders are taking advantage of these opportunities. Industry experts acknowledge that the government could take action to eliminate the 9.5 percent yield for loans made or purchased in the future without compromising the ability of lenders to meet their obligations with respect to their pre-October 1, 1993 tax- exempt bonds. Without government action, the taxpayers remained exposed to additional special allowance payments that can easily and rapidly escalate into the billions of dollars. Matter for Congressional Consideration: In light of the rapid increase in special allowance payments for loans guaranteed a minimum 9.5 percent yield and the continuing financial incentive for lenders to originate or purchase additional loans that qualify for a guaranteed yield of 9.5 percent, Congress should consider amending the HEA to address the issues identified by this report, but particularly to change the yield for loans made or purchased in the future with the proceeds of pre-October 1, 1993 tax-exempt bonds, and any associated refunding bonds, to more closely reflect these loans' financing costs and current market interest rates. Recommendation for Executive Action: Given that lenders are increasing the volume of 9.5 percent loans based on Education regulations that allow lenders to transfer 9.5 percent loans to taxable bonds and tax-exempt bonds issued after October 1, 1993 while retaining the special allowance payment provisions applicable to loans financed with pre-October 1, 1993 tax-exempt bonds, and the resulting increased costs for taxpayers, we recommend that the Secretary of Education promulgate regulations to discontinue the payment of the special allowance applicable to loans financed with pre- October 1, 1993 tax-exempt bonds that are subsequently transferred to taxable bonds or tax-exempt bonds issued on or after October 1, 1993. Agency Comments: We provided a draft of this report to Education for review and comment. In commenting on our report, Education agreed that special allowance payments for 9.5 percent loans should be scaled back considerably and that, as noted in our report, such a proposal was included in the President's fiscal year 2005 budget.[Footnote 6] Education also stated that it had considered changing its regulation or its interpretation of the regulation last year, but believed at that time that the HEA would be reauthorized and amended to address the issues discussed in our report before any proposed regulation or regulatory interpretation it might undertake could become effective. Education stated this was the case because of certain requirements contained in the HEA and other laws, including a requirement that it engage in negotiated rule making. Education also commented on the statutory exception to the general requirement that it engage in negotiated rule making, which we highlighted in our report. As mentioned in our report, the Secretary need not subject a rule making to the negotiated rule making process if the Secretary determines that the process would be "impracticable, unnecessary, or contrary to the public interest." In its comments, Education stated that the courts have construed this exception only to cover routine determinations that are insignificant in nature and impact, inconsequential to industry and to the public, or which raise issues of public safety. While we believe that it is Education's responsibility to interpret the law as it relates to its own programs, on the basis of our review of the case law, we disagree with Education's characterization of the case law concerning the scope of the exception in the Administrative Procedure Act. Specifically, it does not fully address the courts' treatment of the "public interest" prong of the three-pronged exception noted above. The federal courts have interpreted the three-pronged exception in many cases involving a wide variety of factual situations. Education's characterization of the case law describes the courts' discussion of the first two prongs, "impracticable" or "unnecessary," but does not fully address the potential applicability of the third prong, which, if met, would independently justify use of the exception. In fact, in the case cited by Education in its comments, Utility Solid Waste Activities Group v. E.P.A., 236 F.3d 749 (D.C. Cir. 2001), the court briefly explains the "public interest exception" by pointing to a situation where announcement of the rule in advance would "enable the sort of financial manipulation the rule sought to prevent." Id. at 755; see also, Attorney General's Manual on the Administrative Procedure Act, pp. 30-31. Thus, it is clear that the applicability of the "public interest" exception turns neither on the insignificance of the rule nor on whether it raises issues of public safety. See also Nader v. Sawhill, 514 F.2d 1064 (D.C. Cir. 1975). Moreover, in reviewing challenges to an agency's use of an exception, the Court of Appeals for the District of Columbia has stated that it will review the "totality of the circumstances," including the complexity of the statute and congressionally imposed time frames. See Methodist Hosp. of Sacramento v. Shalala, 38 F.3d 1225 (D.C. Cir. 1994); Petry v. Block, 737 F.2d 1193 (D.C. Cir. 1984). Determining whether the unique circumstances present here support the agency's use of an exception is beyond the scope of our report and is a matter, in the first instance, for Education. Nevertheless, we continue to believe that Education should consider all of its options in effecting the desired policy change as we recommend in the report. This could include, for example, determining whether Education could use less formal guidance, as it has in the past, to clarify or alter its position; whether a full consideration of all the facts and circumstances as well as all the applicable case law would support use of an exception to the negotiated rule making requirement; whether an interim final rule could be issued to take effect immediately; or whether negotiated rule making could be accomplished on an expedited basis. Given Education's position that it is essentially unable to implement regulations until July 1, 2006, more than 21 months away, we think it is important that Education fully explore all of its options, consistent with applicable law. Education's written comments appear in appendix II. We are sending copies of this report to the Secretary of Education, appropriate congressional committees, and other interested parties. In addition, the report will be available at no charge on GAO's Web site at http://www.gao.gov. If you or your staff have any questions about this report, please contact me at (202) 512-8403 or Jeff Appel, Assistant Director, at (202) 512-9915. You may also reach us by e-mail at ashbyc@gao.gov or appelc@gao.gov. Other contacts and staff acknowledgments are listed in appendix III. Signed by: Cornelia M. Ashby Director, Education, Workforce, and Income Security Issues: [End of section] Appendix I: Briefing Slides: [See PDF for image] [End of slide presentation] [End of section] Appendix II: Comments from the Department of Education: UNITED STATES DEPARTMENT OF EDUCATION: OFFICE OF POSTSECONDARY EDUCATION: THE ASSISTANT SECRETARY: Ms. Cornelia M. Ashby: Director, Education, Workforce, and Income Security Issues: United States Government Accountability Office: Washington, DC 20548: Dear Ms. Ashby: Thank you for providing the Department of Education (the Department) with a draft copy of the U.S. Government Accountability Office's (GAO's) report entitled, "Federal Family Education Loan Program: Statutory and Regulatory Changes Could Avert Billions in Unnecessary Federal Subsidy Payments" (GAO-04-1070). We have reviewed the draft and have the following comments. This study reports the recent increases in the Department's special allowance payments to lenders and other loan holders on student loans financed with tax-exempt securities, i.e. "9.5 percent loans," and describes three strategies employed by such lenders and loan holders to maintain and even increase their 9.5 percent loan portfolios. The report recommends the Department change, through rulemaking, its current interpretation of the provision in the Higher Education Act of 1965, as amended (HEA), that governs eligibility for the special subsidy for 9.5 percent loans. In general, under the Department's regulations, loans that are eligible for the special 9.5 percent subsidy retain that eligibility as long as the tax-exempt bond whose proceeds were used to make or purchase the loans remains open. In other words, absent a change in the law, unless and until the original financing instrument is retired or defeased, the loans it supports qualify for the special subsidy. The Department believes that these special allowance payments should be scaled back considerably, and, as you noted, the President proposed this in his fiscal year 2005 budget request. Last year the Department considered undertaking the process to issue new regulations or to reverse the Clinton Administration's regulatory interpretation. However, we quickly realized that doing so would have resulted in the new policy becoming effective no sooner than July 2005-long after we expected the HEA to be amended to address the issue. This is so because of certain requirements in the HEA and other applicable laws. Section 492 of the HEA[NOTE 1] requires the Secretary to obtain public involvement in the development of proposed regulations for any program authorized under Title IV of the HEA, and to develop such proposed regulations by means of a negotiated rulemaking process. Changes of regulatory interpretation, like new legislative rules, require rulemaking under the Administrative Procedure Act (APA), [NOTE 2] as interpreted by the United States Court of Appeals for the D.C. Circuit. [NOTE 3] Therefore, the Department believes negotiated rulemaking is required for changes of regulatory interpretation, like changes to the 1996 interpretation at issue here, just as it is required for new legislative rules. The Department's experience with the negotiated rulemaking process for the Title IV programs dates to 1994. In the development phase the issues to be regulated, and therefore negotiated, require the advice of and recommendations from individuals and representatives of the groups involved in the federal student aid programs, such as students, legal assistance organizations that represent students, institutions of higher education, guaranty agencies, lenders, secondary markets, loan servicers, guaranty agency servicers, and collection agencies. Participants in the negotiation phase are chosen by the Secretary from individuals nominated by the aforementioned groups and must include both representatives of such groups from Washington, D.C. and industry participants. To the extent possible, the Secretary selects individuals reflecting the diversity in the industry, representing both large and small participants, as well as individuals serving local areas and national markets. At the conclusion of the negotiation phase, the Secretary publishes the Notice of Proposed Rulemaking and accepts public comment. After considering public comment, the Secretary issues the final rule. As the draft report notes, the Secretary may choose not to subject Title IV rulemaking (or Title IV change of regulatory interpretation) to the negotiated rulemaking process if the Secretary determines that the process, with respect to the particular regulations (or changes of regulatory interpretation) that are preferred, would be impracticable, unnecessary, or contrary to the public interest, within the meaning of the APA. [NOTE 4] That standard appears in the APA as an exemption applicable to all federal agencies that are otherwise required to conduct rulemaking. However, the draft report neglects to note that the courts have generally construed the standard only to cover routine determinations that are insignificant in nature and impact, inconsequential to industry and to the public, or which raise issues of public safety. [NOTE 5] The standard is not met here to exempt this issue from rulemaking, including negotiated rulemaking, because the issue would involve a policy decision to change a current interpretation of regulations issued under Title IV of the HEA that would greatly affect the student loan industry. Moreover, it is obviously not a matter of public safety. Additionally, the Department is bound to follow the "Master Calendar" provisions of section 482(c) of the HEA. [NOTE 6] These provisions provide that, with certain exceptions not applicable here, any regulatory changes initiated by the Secretary affecting Title IV programs that have not been published in final form by November 1, prior to the start of the award year on the following July l, cannot become effective until the beginning of the second award year after such November 1 date. Therefore, if final regulations are not published by November 1, 2004, then they cannot take effect before July 1, 2006. We look forward to working with the Congress to address this important reform that will enable the government to modernize the Federal student aid programs to help millions of students and families realize their dreams through higher education. I appreciate your examination of this important issue and the opportunity to comment on the draft report. Sincerely, Signed by: Sally L. Stroup: NOTES: [1] 20 U.S.C. 1098a. [2] 5 U.S.C. 551 etseq. [3] See, e.g., Paralyzed Veterans of America v. D.C Arena, 117 F.3d 579 (D.C. Cir. 1997) [4] 5 U.S.C. 553(B)(3)(B).). [5] See, e.g., Utility Solid Waste Activities Group v. E.P.A., 236 F.3d 749, 754-55 (D.C. Cir. 2001). 20 U.S.C.. 1089(c). [End of section] Appendix III: GAO Contacts and Staff Acknowledgments: GAO Contacts: Jeff Appel, Assistant Director (202) 512-9915 Andrea Romich Sykes, Analyst-in-Charge (202) 512-9660: Staff Acknowledgments: In addition to those named above, the following people made significant contributions to this report: Cynthia Decker, Margaret Armen, Richard Burkard, Jason Kelly, Rebecca Christie, and Jeff Weinstein. FOOTNOTES [1] Public Law 103-66, secs. 4105 and 4111, 107 Stat. 312 (1993) [2] Statutory formulas used to calculate borrower rates are based on several factors, including when the loan was disbursed and loan type. The borrower rates used for this example are for Stafford loans disbursed after July 1, 1998 and are now in repayment. [3] Special allowance payments may or may not be included in the calculation of excess earnings for Internal Revenue Service purposes depending on when a tax-exempt bond, or any associated refunding bond, was issued. [4] See, for example, the College Quality, Affordability, and Diversity Improvement Act of 2003 (S. 1793) and the College Access and Opportunity Act (H.R. 4283). [5] See, U. S. Group Loan Servicing Inc. v. Riley, 82 F. 3d 708 (7th Cir 1996). [6] A similar proposal was made in the prior Administration's fiscal year 2001 budget. GAO's Mission: The Government Accountability Office, the investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. 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