Direct Lending: Why Obama's Student Loan Proposal Should be Adopted - Commentary on Obama's Student Loan Proposals

Direct Lending: Why Obama's Student Loan Proposal Should be Adopted
President Obama has proposed a major change in the way the federal government finances college educations for students. Instead of the various federal loan programs that now have college administrators handling all the paperwork but banks receiving subsidies from the federal government (and very generous ones they have been, over the years), all federal loans should revert to the original direct student loan program, cutting out the middlemen banks.

This is a great idea. The banks basically have been getting a welfare handout from the federal government ever since the GOP "privatized"federal loans--they make a hefty spread between the interest rates earned on these laons and the rates paid on money to fund the loans. The federal government insures them against any default on those federally funded loans. The 2007 College Cost Reduction and Access Act amended the Higher Education Act of 1965 in ways that made it less likely that the companies would be getting subsidized at too high a rate by cutting the interest rates and reimbursement rates on loan losses. See

Note that the original justification for instituting a more expensive way to give federal aid to students was a glitch in the federal budget process. The budget process didn't count direct lending repayments when it calculated the cost of direct lending. Accordingly, the cost seemed to be much greater than it actually was, since the loan showed as a loss in the year that it was made. On the other hand, the process looked favorably at privatized loans--since the governments payments for defaults and interest subsidies wouldn't be made until later years, they showed up as costing nothing. See this history of the loan program. Accordingly, even the heavily subsidized bank loans appeared to be saving the federal government money by comparison to the actually much cheaper direct loan program! As a result, direct lending was eliminated, and the banks had a new gravy train--payment of a substantial spread just for putting their name on the loans (the federal government guaranteed that they wouldn't lose money on studetn defaults).

Finally, under Clinton in 1992, the direct lending program was reinstituted, but on a very small basis compared to the privatized program, being phased in over time, and allowing the Secretary of Education to require colleges to switch to it. The expectation was that direct lending would ultimately replace guaranteed loans. But the 1994 Republican "contract" on remaking the federal government instead targeted the direct loan program for elimination: they preferred to completely privatize everything. When universities complained that direct loans were much more efficient at getting aid dollars where they were needed than the cumbersome, middle man-heavy guaranteed loan apparatus, Congress instead refused to permit the Department of Education to encourage universities to move towards direct loan programs, which has resulted in a steady decline of the direct lending program during the Bush years, as desired by the financial institutions that profit from the privatized guaranteed loan program. According to US News and World Report, the student loan industry "used money and favors... to get what they wanted." See this history of the loan programs.

Now, Obama wants to come full circle and restructure the loan program, removing the handouts to intermediary banks. It's obviously the right idea. But will the Congressmen who've taken lots of campaign donations from Big Banks go along? There's a great discussion of this on Angry Bear, Federal Family Education Loan (FFEL) Program, Mar. 7, 2009.

Higher Ed Watch (linked by Angry Bear) reports that the student loan industry has assiduously wooed "blue dog" Democrats and those with close ties to financial institutions.

[T]he student loan industry has gone to great lengths over the last two years to woo key Democrats. Sallie Mae outlined this strategy in an internal strategy document it produced shortly after the Democrats took control of Congress in 2006. That document, which was obtained by Rep. George Miller (D-CA) and published on this blog, laid out the student loan giant's plans to target generous campaign contributions toward "Blue Dog and Financial Services Democrats," as well as members of the Congressional Black and Hispanic Caucuses. A Higher Ed Watch investigation in July 2007 found that Sallie Mae had lived up to its pledge -- donating, through its political action committee, more than $100,000 to members of these three groups in the first six months after the election.

Similarly, many colleges, according to Higher Ed Watch, have links to the loan industry, and may even assist the financial industry in lobbying against the Obama provisions. They are touting the "FELP participant-provided services like college access programs, financial literacy education and loan delinquency and default prevention." I am very skeptical about the value of those programs--especially as compared to the same kinds of programs offered by colleges and universities for their own students.

One commentator at Angry Bear makes a significant contribution to the discussion. We spend upwards of $20,000 per year on each prisoner in the United States. We spend only about half that much on K-12 education. Yet education is the key to a sustainable middle class. And the banks have fought bankruptcy relief for student loans in the same way that they have fought bankruptcy modifcation for loans on principal residences.

Something's gotta change. The Blue Dog Democrats and those that are too close to the Big Banks need to step back and vote for the good of the country, not the quid pro quo for those campaign contributions.

March 10, 2009 i