Calling Their Bluff

By Watson Scott Swail, President and CEO, Educational Policy Institute

As I sit at the Student Financial Aid Research Network Conference in Baltimore this morning, I thought it prudent to talk about financial aid today. Anyone with a pulse has certainly noted the travails of the student loan industry in the United States over the past year. When the Republicans were in power, the Dems squawked about the high subsidies that went to the loan lenders and pledged to do something about it when they wrestled power from the GOP in the 2006 mid-term election. The short of this is that the Dems did take control and they did act on their pledge.

Since then, the loan industry has been in a free fall. Sallie Mae threatened to leave the loan program, Boston-based TERI filed for bankruptcy, and state-guarantors are shaking. PHEAA, the Pennsylvania-based guarantor, has suspended their federal loan program until the market improves.

On a parallel calendar, the federal student loan limits were recently increased for the first time since the late 1980s. The result of all of this recent activity is that more students will likely be borrowing more money from a loan industry that is falling apart at the seams. I’m not sure where the upside is.

On an aside, I had someone tell me yesterday that they were concerned that raising the loan limits by $2k for freshman students would force students to take out bigger loans. This isn’t accurate. In reality, an increase in the loan limit is far, far overdue. Students haven’t been able to access enough money through government-controlled and subsidized systems, which has resulted in the massification of the private student loan market. So students will find a way to get the money they need, or they won’t go at all. Don’t blame the loan limits; blame higher education for being too expensive.

I’m not sure how this all plays out in the end, but this has certainly been a boon for the Direct Student Lending Program, the federal government’s program for lending to students via institutions of higher education. The Direct program was developed by the Clinton Administration in the 1990s and was undercut, to a certain degree, by the Republican-controlled Congress during that same period. The Direct program currently constitutes about 20 percent of the student loan market in the US, but is now growing significantly. Since the credit crunch and student loan problems began, over 400 schools have moved from the FFEL program to the Direct loan program. Expect this trend to continue over the next 12-24 months.

The FFEL/Direct debate has been somewhat volatile since the introduction of the Direct Loan Program. While passed into law via the Higher Education Act, the program was largely not supported by Congress. Understand that the two programs are philosophically different: FFEL comes from the “small government” philosophy where the market should take care of the situation. The Direct camp believes that the market is screwing the taxpayer. Over the years, there has been a cat-and-mouse game played by the FFEL industry and Congress. When Congress suggested that the lender and guarantor subsidies should be lowered (originally over 3 percent of the loan), the lenders and guarantors said that any reduction would force them out of the business. Never happened. Over the past decade-plus, the fee has been reduced from over 3 percent to only 1 percent. During the last cut by the Democrats, the lenders and guarantors cried again; but this time, some were ready to take action, and the big guns were ready to pull the plug on the FFEL program. It appeared that this time they meant it.

Thus, the Department called the bluff of the lenders and guarantors by lowering the subsidies, only to have the lenders and guarantors consider, very publically, to opt out of the FFEL program altogether. Perhaps this was the end game of the Democrats all along: to put pressure on the lenders and, ultimately, the institutions, to take certain forks in the road and grow the Direct program. If so, it is working because some institutions fear that the FFEL program is too risky right now. It doesn’t appear to be affecting the privates, from my discussions, because they are being served by the lenders and guarantors. But the public schools are getting fidgety and trying to ensure that a system is in place to serve students in a seamless manner.

The student loan industry is an ultra-complex system—so much so that it is difficult for industry insiders to explain it to anyone else. For those of us on the outside, we are back trying to figure out which is the best way to go? FFEL or Direct Loan. Almost anyone in the loan industry will tell you that the introduction of the program did meet one, clear expectation: it put pressure on FFEL lenders and guarantors to become more competitive. And they did. And the Direct program, over time, equally became a “better” program. It seems we are best served by two systems, although I am still a huge advocate of an income-contingent system like in Australia, where all fees are taken off of future earnings via the tax system (eliminating the need for such a large loan system). My bet is that the Direct program grows to about 50 percent of the market, and things will level off. But who knows.

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