Direct Student Loan Program is a Taxpayer Rip-Off

This year marks the 40th anniversary of the guaranteed student loan program for college students. The program, created by Lyndon Johnson as part of the Great Society, has made college affordable for thousands of students. But it also has been scandal-plagued, with billions of dollars of unpaid loans and massive taxpayer losses. Moreover, it has contributed to the runaway inflation in college tuitions.

In theory at least, student loans are supposed to be repaid over time, once the students graduate and start working. Throughout the 1970s and ’80s, the default and delinquency rates on student loans were scandalously high. Stories of highly paid doctors, engineers and lawyers defaulting on their student loans were commonplace. It was as if these deadbeats believed that loan repayment was optional. As a consequence, taxpayers got socked with a multibillion-dollar tab.

Fortunately, in the Reagan years, credit reforms were implemented to strong-arm the participating banks and collection agencies to clamp down on student-loan scofflaws. Consequently, the program’s monetary losses have declined.

But just as the program began to improve its business practices, starting in 1995 the Clinton Administration launched a new program called the Direct Student Loan Program. This allowed students to apply for student aid directly from Uncle Sam, bypassing private lenders altogether. This was supposed to cut costs by eliminating the middleman and leveraging the government’s lower borrowing costs.

In reality, it was a kind of “privatization in reverse.” Rather than contracting out the lending function to professional borrowers, the government decided to play the role of banker, credit agency and debt collector all at once, under the auspices of the Education Department.

This was about as good an idea as making the Charlie’s Angels sequel. The government is a lousy banker. It does a poor job of assessing and pricing risks, managing funds and collecting on debts. Since 1997, the Direct Student Loan Program has lost money for taxpayers every year at an ever-escalating rate. In 2003, the most recent year for available data, the net cost of the program exceeded $2.8 billion. The Government Accountability Office estimates that the loan program has a cumulative net balance of negative $10.7 billion. It is bleeding money.

One original fan of the program, former Federal Reserve Board member Lawrence Lindsey, recently conceded: “I once argued that the cost to the taxpayer of having the government lend directly to students would be less than the cost of guaranteeing student loans issued by the private sector. But the direct lending program has been losing more money every year.” Some 500 colleges have ceased participating because of shoddy management and financial losses.

Ironically, now that the program is a demonstrable failure, Sen. Ted Kennedy (D.-Mass.) has a plan that would essentially bribe schools to use it by increasing Pell Grants to colleges that enroll in it.

The House Committee on Education, chaired by the able reformer John Boehner (R.-Ohio), is expected to decide on the fate of the Direct Student Loan Program over the next few weeks. Boehner should put taxpayers’ interests first and shut this money-losing operation down. Private banks are best able to run a loan program.