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Bank Profits Shortchange Students

Americans' worries over paying for college seem to rise even faster than escalating tuition. So it is understandable that members of Congress, as they rewrite the nation's higher education laws this year, are trying to come up with ways—including increasing the long static limits on student loan levels—to ease the burden. Under congressional budget rules, the legislation expected to emerge as early as this week from the House Education Committee will have to balance any expanded student aid with savings somewhere else. And all signs suggest that the committee will make the wrong choices.

There are two different systems for providing student loans. From the student perspective, they are essentially the same. But from the taxpayer's perspective, one costs a penny or two for every dollar lent while the other costs about ten cents on the dollar. In the more efficient approach known as direct lending, the capital for the loans comes wholesale (through U.S. Treasury auctions) and the loans are distributed by the campus along with other federal aid. After students graduate, payments are collected by private companies through competitive contracts with the U.S. Department of Education. The interest income to the government helps to recoup the costs of defaults, subsidies to students, and administration.

The other approach is so Rube Goldbergesque that almost no one can really explain it. But the basic structure is this: the government accesses capital by promising banks a retail-level rate of return set by Congress, and the loans are delivered through systems that are separate from other federal aid. The bank guarantee is administered by state agencies, which get payments set by Congress, and those same agencies make collections on defaulted loans, keeping a percentage that is also set through the political process in Congress. In this government-guarantee program, the interest and default risks are covered by taxpayers, while the income goes to the banks and other entities such as Sallie Mae (along with a few crumbs to state agencies that help maintain political support for the program).

If you're wondering whether there is any good reason to maintain this separate, expensive system, the answer is no. Over the past decade, England, New Zealand, and Australia have all developed their own student loan programs to improve access to college. They all looked at the U.S. system of government-backed student loans made through banks. They considered the alternatives, the costs, and the benefits. Not one of them followed the U.S. example.

The United States started to move in the direction of a sane, efficient program in 1993, when Congress made a serious effort to restrain the burgeoning budget deficit. The Clinton administration and a few Democratic and Republican members of Congress saw that billions of dollars could be saved by implementing a direct student loan program. Fighting an onslaught from the banks and a host of other entities that benefit from the faux-private system, they got much of what they wanted.

The phase-out of the government-guarantee system began with colleges that volunteered to participate, and it was intended that additional institutions would be brought on board at a later stage. Even with the election of a Republican Congress that threatened to eliminate the new program, direct loans grew to about a third of all new student loans in the third year of the program.

But in 1995 the new Congress demanded that the Department of Education stop the phase-in of the new program. In order to preserve the partial phase-in of direct loans, the Secretary of Education proposed a truce in the fight and embraced the idea of "choice." Not student choice, but college choice of the program that would serve their students. Since then, choice has been the reigning mantra in the direct-versus-guarantee fight.

Now think about this for a minute. In either program, the loans are essentially the same. But we're telling colleges that they can decide how much it will cost taxpayers to provide the benefit. Perhaps we could apply a similar approach to some other programs. How about we let Social Security checks be delivered by Federal Express if the beneficiary so chooses? How about Food Stamps: let's let the poor choose to have them delivered via singing telegram if they want, at taxpayer expense.

Today in several state capitals the functional equivalent of these perverse results are emerging. State agencies that get a small portion of the bank profits in the guarantee program are pressuring colleges in the direct loan program to change their allegiance, in order to bring income into the state. In California, the $5 million or $10 million that this shift might bring into state coffers pales in comparison to the $70 million that it will cost taxpayers. A similar disturbing scenario is emerging in New York. And the U.S. Department of Education is standing by idly, even though the pressure tactics may be illegal.

Guaranteed loans have resulted in huge taxpayer subsidies for banks and other lending entities. According to the latest Fortune 500 rankings, as the largest holder of federal student loans Sallie Mae is the second most profitable company with a 36.9 percent return on revenues. The obvious thing to do is to cut back on those excess profits so that students can be helped more than they are today.

But so far, Congress is taking only baby steps in curbing its gifts to Sallie Mae and banks. Instead of really challenging the industry, the committee is looking to charge higher interest rates for students who consolidate their loans after they graduate. The committee chairman's justification is that these are no longer deserving students, but they are graduates who already "have realized their dream of a college education and have entered the workforce." I'll tell you whose dreams have been realized: the banks and Sallie Mae. And we're all paying dearly for it.

Bob Shireman is a senior fellow for The Aspen Institute and serves on the federal advisory committee on student financial assistance.

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