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Investor who shorted subprime hits college stocks

Date: Friday, June 25, 2010
Author: Reuters

Problems that fueled the subprime mortgage crisis, such as easy access to loans and a lack of oversight, also plague some for-profit U.S. colleges, producing unprepared graduates burdened by debt, a hedge fund investor told lawmakers.

Steven Eisman, who bet against the subprime mortgage market and has shorted for-profit education stocks, criticized the schools on Thursday for their high costs, much of which he said was paid for by federal loans to students.

"Until recently, I thought that there would never again be an opportunity to be involved with an industry as socially destructive as the subprime mortgage industry. I was wrong," said Eisman in written testimony to a Senate committee.

The U.S. Department of Education has already proposed rules that would force for-profit colleges to release data to students on graduation and job placement rates.

It has said it will soon consider whether these institutions need to demonstrate that they prepare students for jobs before students would be eligible for federal grants and loans.

For-profit schools are run by companies such as Corinthian Colleges Inc (COCO.O), ITT Educational Services (ESI.N), Career Education Corp (CECO.O) and Apollo Group Inc (APOL.O), owner of the University of Phoenix.

Eisman, a portfolio manager at FrontPoint Financial Services Fund LP, cited the spectacular profitability of the companies. He contrasted the 40 percent operating margin of ITT versus the 7 percent to 12 percent margins of other companies that get major government contracts.

The for-profit education industry accounted for 9 percent of the students, but 25 percent of various types of federal student loans and 44 percent of all defaults, said Eisman, whose shorting of the subprime mortgage market was detailed in Michael Lewis' book "The Big Short."

Seventy percent of the Education Department's investigations are into problems at for-profit schools, department inspector general Kathleen Tighe told the Senate's Health, Education, Labor and Pensions Committee.

But Harris Miller, head of the Career College Association, representing 1,500 schools, 95 percent of which are for-profit, called the hearing a "firing squad."

He argued that the lawmakers missed an essential point -- that schools have to refund tuition paid by students who drop out.

Eisman predicted that in the next 10 years, students of these schools would default on $300 billion in loans.

"It seems to me that what we have to do is change the rules," said Senator Al Franken, a Minnesota Democrat. "I think $300 billion is a lot of money and it's the taxpayers' money."

Senator Mike Enzi, a Wyoming Republican, warned against excessive regulations inspired by anger over the worst schools that could hurt good schools.

"In combating this behavior, it is essential that we use a scalpel and not a machete," he said.