Why you should care about direct lending

    As a student, would you feel better getting your loan from a private bank which receives government support, but is still always in danger of becoming insolvent or letting your credit dry up, or would you want your loan straight from the government? As a taxpayer, would you rather see government dollars go to ensure that private banks make enough money to provide student loans, or would you rather have your taxpayer dollars go straight from the government to the student?

    Right now, we have a little bit of both — unless President Obama gets his way. He wants to end a series of governmental subsidies that ensure that banks make money on student loans and instead have the government simply provide the loans.

    Here’s the system he would like to change. Right now, the federal government program to ensure that enough student loans are provided at reasonable rates is called the Family Federal Education Loan, or FFEL. Through the program, private lenders who loan money to students receive two types of subsidies from the government.

    The first subsidy is a 97 percent guarantee against default on the loan. What this means is that if a student is not able to pay back her loan, the lender receives 97 percent of the outstanding amount owed. In 2007, according to the Office of Management and Budget, the government provided some $6.3 billion of this support.

    The second subsidy is a guaranteed interest rate on these loans. This support is in place is because the government sees the provision of student loans as a basic public good that should be supplied as cheaply as possible. Without these supports, there would likely be fewer and more expensive loans available to students, so the government guarantees a 6.8 percent interest rate on student loans. In 2007, banks collected $7.7 billion from the government in the form of this guaranteed interest rate.

    In addition to these two direct subsidies, we also have what are called “Guaranty Agencies.” These agencies are either public or non-profit entities which do much of the work to administer the cumbersome hybrid federal-private student loan program. These agencies are responsible for, among other things, actually performing the 97 percent default payment, for which the Department of Education reimburses them. On top of simply handling money for the government, these agencies receive a variety of set fees to make their operation profitable. And since each state designates one organization to the Guaranty Agency, they all have monopolies. In 2007, they received some $877 million from the government.

    While these all seem like boring bureaucratese and relatively small figures (from the perspective of a federal government, which just passed an $819 billion stimulus package), it’s a very simple case of the government essentially using taxpayer dollars to funnel money to banks. Through FFEL, the banks basically cannot lose money. Neither can the Guaranty Agencies, which get to skim some off of the top in exchange for handling money for the government. What makes the entire set-up so offensive is that there is actually an alternative way to fund student loans.

    Alongside the byzantine and essentially corrupt FFEL program, there is something called “Direct Lending.” It’s actually quite simple. In 1993, the Clinton administration and the Democratic Congress figured that they could avoid going through private banks and guaranty agencies and just have the federal government lend out the money to students. Since the government was already on the hook for 97 percent of any losses banks suffered, not to mention obligated to guarantee the banks certain profits on these loans, it made sense for them to just step in and start lending.

    Despite massive opposition from Student Loan Marketing Association and other banks, the program was established and still exists — nay, is going strong — to this day. In 2008, some 1,370 schools were using the Direct Lending program, which saw a 50 percent increase in participation in 2008. On the other hand, many private lenders, in reaction to the credit crunch and financial crisis, either stopped lending to students or required even more federal subsidies.

    It makes sense that a system which doesn’t have to ensure baseline profits for private actors would be cheaper and more efficient — and it is.  According to the Congressional Budget Office, if the Direct Lending programs totally replaced FFEL, the government would save $94 billion over 10 years, which would then be used to shore up funding for Pell Grants, which are federally provided grants to low-income students.

    Of course, the banks which currently pocket large, no-risk profits from their federally guaranteed loans, are huffing and puffing in indignation. Most hilariously, they and their stooges in Congress –- who, of course, either receive large campaign donations from the banks or come from districts in which there a lot of student lending-related employees –- are portraying the plan, in the words of Rep. Howard McKeon (R-CA), as a “government takeover of the private-sector-based student loan program.” Either McKeon doesn’t know how FFEL works, or he’s just being deceptive in support of financial institutions. No matter what, he’s supporting an antiquated, corrupt system which harms both taxpayers and students.


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