The current federal student loan programs are not perfect. They are a mishmash of subsidies and regulations that cause distortions, not the least of which is to raise the sticker price of tuition significantly more than it probably would be otherwise.
This doesn’t mean that it’s not possible for the student aid system to get worse — even much worse. And that’s what a new bill from Massachusetts Sen. Ted Kennedy would likely do.
To Kennedy, who is once again chairman of the Senate Health, Education, Labor & Pensions, or HELP committee, the problem isn’t the fact of government interference or subsidies, but the fact that private banks are still involved at all.
Kennedy wants to make student loans a 100% government-run system, because he and others claim that this would save money by knocking out the middleman. So in his recently introduced Student Debt Relief Act of 2007, which is co-sponsored by fellow Democratic Senators Barack Obama, Chuck Schumer, and Dick Durbin, the government would basically bribe schools with extra federal aid to participate only in the Direct Lending program, rather than have subsidized dealing with private banks.
But we only need to look at the history of this “direct” loan program to see that Kennedy’s plan would result in massive waste as well as burdensome red tape for students and parents trying to finance a college education.
When signed into law by President Bill Clinton in 1993, “direct lending” of student loans to college students was sold as a way to actually make money for the government, again by cutting out the “middleman,” Since the 1960s, the government has subsidized banks and other firms that lend to students to make student loans more affordable. Clinton and other advocates argued the government would spend less money and could even profit if it made the loans and collected the interest itself.
As with many claims for government programs, direct lending hasn’t yielded the benefits it promised. Not only is the program not making a profit for the government, but over the decade it has been in existence, the costs of direct lending have been coming in higher than the government’s initial estimates, and these cost differences have been increasing.
At the same time, subsidized loans from banks have cost the government less than their estimated costs. The White House budget for fiscal year 2006, reported that direct lending has cost the government $7 billion more than intially predicted over the last decade, while subsidized loans have cost the government $5 billion less than they were estimated to. In the words of a report from the respected spending watchdog Citizens Against Government Waste, “the Direct Loan programs flunks out.”
Direct Lending has also failed in its promise to greatly reduce default rates. Clinton administration officials predicted there would be no default rates with direct loans. Yet Department of Education statistics show a projected default rate above 15% for direct loans in 2005. The rate for subsidized loans, by contrast, was a slighly lower 13%.
The reason schools, with both programs to choose from, have stayed with the banks is that the banks’ offer the private sector’s level of service. Some 600 schools have stopped participating in direct lending, and survey of schools cite poor service as the primary reason.
So if we were to make federal student loans totally government-run, we would also lose the innovation that private firms can show in servicing their customers even in a situation that’s not the free-market ideal.
Expansion of tax-favored education savings accounts would be a great way to help students and parents with college costs. The tax benefits would go solely to parents and students, without encouraging tuition hikes at schools. But while we’re debating solutions for student aid, we must make sure that the programs don’t take even more giant steps toward total government control.