Controversy over student loans

Tucked into the first bill was Title II, Sections 2101 to 2303, which concerned federal loan programs to college students. This might be of interest to the Princeton community.

Title II eliminated private-sector middlemen in the federal student-loan program to harvest an estimated savings of about $60 billion in administrative costs over the next decade. The bulk of these savings is to be redirected to more generous student loans and to additional Pell Grants. The latter are need-based grants to low-income undergraduate and certain post-baccalaureate students.

So why is Title II so controversial? Isn’t it efficient to harvest savings in administrative costs? The answer to this question can be found in Alfred E. Neuman’s famous equation: Every dollar of government spending equals a dollar of someone’s income.

In this case, the potential savings in administrative costs represent the profits and salaries earned at small and large banks, such as Citigroup and Bank of America, and at SLM Corporation (known as Sallie Mae). All of them act as middlemen under the Federal Family Education Loan Program, which was established in 1965.

These private lenders have received a generous interest-rate subsidy from the government, along with federal guarantees that cover close to 100 percent of the loans made to students. In other words, to these lenders, the FFEL program has been a very profitable, virtually risk-free business.

An analysis performed by the first Bush administration in 1990 showed that the FFEL program was more costly to taxpayers than a direct-loan program administered by the U.S. Department of Education would be. Presumably that analysis prompted the Clinton administration to establish the Federal Direct Loan Program under the Omnibus Budget Reconciliation Act of 1993. Under that program, the Department of Education directly lends students the money, through their universities.

Under their “Contract with America,” congressional Republicans in 1994 took aim at this direct-loan program, basing their opposition on the notion that the government simply should not compete with private enterprise in the student-loan program. Congress, however, did not abolish the new direct-loan program altogether. In the end, it kept both the FFEL and direct-loan programs, though the former gradually came to account for about 75 percent of the total loan program. As far as students are concerned, both programs make loans available to them on comparable terms, including interest rates.

In several reports since the mid-1990s, the non-partisan Congressional Budget Office reaffirmed earlier estimates that the direct-loan program is cheaper for taxpayers per dollar of loan reaching students. In a report last month, titled “Costs and Policy Options for the Federal Student Loan Programs,” the CBO put the federal savings from eliminating the FFEL middlemen at somewhere around $60 billion for the next decade. This estimate provided the analytic platform for the program change mandated in the recently passed health-care reform legislation, which eliminated the FFEL program.

The Obama administration and its allies in Congress defend eliminating the FFEL program on the argument that they are merely seeking to maximize the program’s intended benefit — namely financial support of students — per taxpayer dollar.

The CBO analysis has eroded the traditional argument that the private sector is inherently more efficient than government can ever be. Public support for the private middlemen had been further eroded by reports about two years ago that some of the FFEL middlemen bestowed personal financial favors on student-loan administrators at colleges in return for channeling students to these lenders.

Instead, the champions of the FFEL middlemen now argue that eliminating the FFEL will cost jobs among private lenders, an argument that styles the FFEL program as partly a jobs program. They also have argued, as in 1994, that government should not compete with the private sector, even in government-financed activities — and presumably even if the alternative costs taxpayers more per dollar lent to students.

You, the students, stand between these contrasting views on government contracting and, after graduating, you will stand between them as taxpayers.

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Where do you come out on this issue? What would you like future Congresses to do: restore the FFEL program even at the cost of some Pell Grants and student loans, or stick with the direct-loan program only, which is administered by the Department of Education?

Uwe E. Reinhardt is the James Madison Professor of Political Economy and a professor in the Wilson School. He can be reached at reinhardt@princeton.edu.