Analysis: The argument against bringing banks back into federal student lending
Bringing private lenders back into the federal student loan program has been a staple of the Republican platform since the Obama administration kicked banks, credit unions and other financial firms out. The Education Department is now the sole originator of the federal loans. Talk of resurrecting the old bank-based model has reached a fever pitch since the GOP retook the White House, but a pair of new papers argue it is not a solution to problems with the loan program.
"People want to go back to this because they think it has something to offer over the current direct loan program. But if you look at their motivation, there is a lot of confusion and a lot of misinformation about how the program worked,"said Jason Delisle, a resident fellow at the American Enterprise Institute, a conservative think tank.
High default rates and complaints about servicing and debt collection have fueled criticism of the government's dominant role in higher education finance. Opponents of direct federal lending say banks could do a better job, saving money and reducing risk for taxpayers. Delisle, in a paper released Wednesday, rebuts that view of the old model, known as the Federal Family Education Loan (FFEL) Program.
He argues that the $60 billion program was private in name only as it relied on government spending and operated under the government's terms. The government guaranteed private student loans with federal subsidies, shielding lenders from the risk of default using taxpayer dollars. Lenders had no real discretion over the terms of the loans they made or who was eligible to receive them.
Market forces didn't determine how much money lenders made. Congress did. And that system was riddled with inefficiencies, the paper said. Using what's known as fair-value accounting, Delisle estimates that for every $100 loaned under FFEL, taxpayers paid $20.20 to cover default losses. By comparison, taxpayers incur a $13.40 loss on direct government loans.
Proponents of reviving FFEL argue the government spends too much administering direct loans, far more than private lenders did under the old program. Any administrative cost savings in FFEL, though, are "rendered irrelevant" by compensating lenders at "arbitrarily high rates set in law," Delisle wrote. He also noted that default rates were about the same under the old and current programs.
Subsidizing private lenders provided no real value to taxpayers, Delisle concluded, a position echoed by Tamara Hiler, a senior policy adviser for education at the centrist think tank Third Way. Hiler said there is no evidence that reinstating FFEL would do anything to reduce college costs or improve the borrowing experience for families.
"The previous administration's efforts to simplify servicing are the types of thing [Education Secretary] Betsy DeVos could continue to implement. That's where we could make things more efficient and really bring benefits to students in a way that reinstating FFEL wouldn't," Hiler said.
She said FFEL could expose students to "predatory practices" by private lenders, and create unnecessary confusion as they navigate the loan process. FFEL lenders, she noted, were sued by a group of state attorneys general for offering students $50 to refer friends or paying them bonuses of $1,000 for taking out new loans.
The role of private lenders in the federal program will be up for debate as Congress considers reauthorizing the Higher Education Act. Rep. Virginia Foxx, R-N.C., chair of the House Committee on Education and the Workforce, has said banks should have a stake in the program. Her Senate counterpart has been silent on the issue, however.
Margaret Atkinson, a spokeswoman for Sen. Lamar Alexander, R-Tenn., said the chairman of the Senate Committee on Health, Education, Labor and Pensions has not taken a position at this time.
"He will be carefully considering ideas to better operate the federal student loan program - which has been run poorly and is in need of reform," she said. "In examining any proposal, Alexander will prioritize the best interests of students and taxpayers alike."
Democratic lawmakers vehemently oppose banks and other private lenders originating federal student loans.
Sen. Patty Murray of Washington, the ranking Democrat on the committee, said she would "strongly oppose any efforts to revive a program that did more to help big banks than it did to help students pursue higher education." A Democratic aide on the House education committee said there is no need to expand the role of private actors in a federal program that already relies significantly on private contractors.
To be sure, Delisle believes banks should play a role in the student loan market. Rather than subsidize private lenders, he said the federal government should cede the parent and graduate loan business to them. Unlike undergraduate students, parent and graduate borrowers have had a chance to establish earnings and credit histories, making them good candidates for purely private loans, he wrote.
Wells Fargo, Citizens Bank and Discover Financial already offer graduate student loans, while Sallie Mae and Citizens have rolled out parent loan products without origination fees that the government charges.
"In an attempt to get at a policy that reduces the federal role in the student loan market, conservatives and Republicans have latched onto this guaranteed loan program as a way to do it, and it's not," Delisle said. "If you want to reduce the federal government's role, the places to do that are graduate student loans and parent loans."
Democrats say placing restrictions on parent loans could hurt low-income families with a slim chance of accessing credit in the private market. They also contend that private loans have weaker consumer protections and more rigid repayment terms than federal loans.
"It's important to think about what the unintended consequences are for rolling that program back, and whether certain groups of students would be affected if those programs were not available," Hiler said.