The federal government should stop paying private collection agencies to pursue defaulted student loans because the strategy is poorly overseen and filled with rewards for the agencies that ultimately harm consumers, according to a report released Wednesday by the National Consumer Law Center (NCLC).

The report analyzes how the U.S. Department of Education manages and pays the 22 agencies it uses to collect student loan debts. Those agencies are paid nearly $1 billion annually, according to the report.

The NCLC criticizes the incentive structure for the collection agencies and argues that the agencies are not collecting debts in line with federal law and contract terms, are not effectively monitoring borrowers’ complaints and are not ensuring corrective actions are taken. 

The Education Department has failed to penalize companies for ongoing bad behavior, continues the report, which essentially backs a report released earlier this year by the Education Department’s Inspector General. If not scrapped entirely, the report recommends an overhaul in the incentive struction for agencies.

Recurring borrower complaints are supposed to lead to a reduction in agency performance scores, under the terms of the government’s contract with the agencies. The Inspector General's audit stated that, in spite of the more than 3,000 complaints received between the 2010 and 2012 fiscal years, officials never docked the scores of any of the agencies.

The report is the latest in a series of critical reviews aimed at Education Secretary Arne Duncan's management of the Office of Federal Student Aid. The NCLC already has sued the department over its refusal to release full documents showing how the federal government awards bonuses to the collection agencies.

The report does not mention how much the collection agencies recovered for the Education Department. Through a link in the report's footnotes, however, it's noted that collectors were paid $819 million in commissions in Fiscal Year 2013. Collection totaled $8.65 billion. Both totals are projected to essentially double within two years.

Still, the NCLC wants the Education Department to explore in-house collections and further wants Congress to abandon the performance-based structure of the federal student aid office.

Criticism of the federal student aid office appears to be affecting the Education Department's stance on Capitol Hill. Senate Democrats are beginning to question the oversight of the private colletion agencies.

Sen. Tom Harkin (D-Iowa), who as chairman of the Senate Health, Education, Labor and Pensions Committee oversees the Education Department, has proposed legislation that would call on the Education Department to ban contracting with any debt collectors found to have violated major federal consumer protection laws.

He also has proposed requiring the department to conduct a study of the collection agencies it uses, specifically reviewing how borrowers are treated and the cost of contracting with agencies compared to using traditional government methods.

The Internal Revenue Service previously used private collection agencies but stopped after receiving complaints about how the collectors treated taxpayers and about their soaring costs relative to the amount of revenue they returned to the U.S. Treasury.

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