Direct Federal Students Loans: a Better Option Than Relying on Private Lenders

Friday, May 8, 2009

AS COLLEGE admissions are being finalized, thousands of high school seniors are deciding where they will enroll -- and soon it will be time for their families to worry about how to pay for those educations. Often, that means loans.

Young students are risky borrowers: They have little or no income and no collateral, and they often need lots of money for tuition, room and board. But it is essential that every qualified student be able to pay for an education. So, since 1965, government subsidies have all but guaranteed profits to private lenders that issue higher-education loans that carry single-digit interest rates and terms that students wouldn't find in the private market. Long controversial, that system broke down last year when private lenders couldn't raise money during the credit crunch. The feds had to swoop in with emergency financing.

In other words, no one -- not even the student loan industry -- can claim the system is working.

President Obama's budget, released yesterday, would eliminate the subsidies to private lenders. The subsidy scheme is too expensive, many experts claim -- much more so than a parallel program under which the Education Department uses Treasury funds to lend money to students directly. The Office of Management and Budget estimates that the government could save $41 billion over 10 years by putting all federal student lending under the government's Direct Loan Program. The Congressional Budget Office says that savings would be more like $94 billion. Mr. Obama wants to put those savings toward increasing and then guaranteeing Pell Grants for low-income students.

Industry representatives challenge the figures, but not convincingly. They also argue that the private lenders provide special services, such as default-prevention counseling, to students after loans are issued. But under Mr. Obama's plan, the government would use private companies to service the loans it originates. A sensible competitive bidding process should result in the cost-effective delivery of services after origination.

We see little compelling reason to continue propping up private lenders. Sallie Mae, the largest private lender, agrees. Its compromise proposal would also allow private firms to originate loans and then pass them on to the Treasury in return for fees. Sallie's proposal might sell better in Congress, but lawmakers should get a clear sense of what it would cost. An early estimate indicates it could capture only 82 percent of the savings of Mr. Obama's plan over five years.

Congress could adopt Mr. Obama's sensible plan to reduce these subsidies without buying into his desire to essentially turn Pell Grants into an entitlement program. The president can't count on all of his projected savings to materialize. Even if he could, Congress should maintain the flexibility to adjust the Pell Grant program's funding as budgets demand.

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