Student loan industry's 'takeover' by federal government is overdue

Eileen Ambrose -- Personal Finance

March 21, 2010|By Eileen Ambrose Personal finance

The federal student loan program has gone through many changes in its 45-year history, and now it's time for the next big step: cutting out the middleman.

That's what the Obama administration proposes to do starting in July. Students now get federal loans through a private lender or directly from the government. Obama wants all federal loans to come straight from Uncle Sam, which would create a net savings of $62 billion through 2020, according to figures last week from the Congressional Budget Office. That's money that could go back into financial aid.

The current setup "wastes taxpayer dollars on subsidies to student loan companies," says Pedro de la Torre with Campus Progress, a youth advocacy group supporting the president's plan. "We think money should be going to student aid to help low- and middle-income students to afford college."

One would think more help for college-aspiring students would be an easy sell on Capitol Hill. Besides, many schools have been switching to direct lending anyway.

But lenders are fiercely lobbying against being cut out, arguing that jobs would be lost. Republican critics in Congress have called it a "government takeover."

Sounds sinister. But the federal government essentially would be taking over a federal program under the administration's proposal. And the private sector isn't completely cut out. Some major players, including Sallie Mae, would continue to service loans under a contract with the Department of Education.

Congress has tacked the student loan legislation onto the health care reform bill. The tactic could garner votes from Democrats who are wavering on health care but want to see more dollars going into Pell Grants for the neediest of students.

The popular Pell Grant program has been running at a deficit because more students qualified last year than anticipated, says Mark Kantrowitz, publisher of If the legislation doesn't pass, Pell Grants will be cut, he warns.

While lenders are fighting to keep the student business, they haven't always been so willing to cater to that segment.

The federal government had to cajole lenders to join the student loan program in the 1960s because budget rules restricted its ability to lend money, Kantrowitz says. It enticed lenders with subsidies and guarantees that they would earn a certain amount of interest and get virtually all their money back if a student defaulted. That made the education business safe and lucrative.

Fast-forward to the early 1990s. By then, the government could make loans. And the direct-lending program, which started as a pilot program under President George H.W. Bush, was launched, Kantrowitz says. The program initially was so popular with schools that private lenders lobbied successfully for changes to make direct lending less attractive, he says.

So the majority of schools stuck with the private lenders, saying they offered better service and more choice for students. In fact, so many private lenders were in the program that schools created "preferred-lender lists" to help families choose.

An impetus for change
Things might have continued that way if not for two events: a scandal and the financial crisis.

A 2007 investigation by New York's attorney general uncovered cozy financial dealings between college aid officers - including a director at the Johns Hopkins University - and companies on preferred-lender lists. The scandal tainted the student-loan industry and raised questions about whether it operated in the best interests of families.

Then the credit crunch hit. Lenders starting dropping out of the federal loan program, abandoning students and leaving them to scramble to find another lender, sometimes at the last minute.

That pushed schools on the fence about direct lending to take the leap.

For years, Goucher College in Towson liked giving students the choice of any lender they wanted. "We had over 100 lenders, easily," says Sharon Hassan, director of financial aid. Then lenders started exiting the program. The final straw was Bank of America's exit.

"When you have someone that big saying, 'We are not doing loans anymore,' that sent a signal to a lot of schools: 'Bank of America is leaving, who will be next?' " Hassan says.

Goucher started getting some of its new loans under direct lending this year. "It's worked well," Hassan says.

Stevenson University in Owings Mills switched to direct lending last year after problems with its private lenders.

One of them dropped out of the program in 2008, leaving 140 students adrift, says Deborah Brown, assistant director of financial aid.

Another lender had funding problems and was three weeks late on disbursing loans.

Still, Brown says, she was apprehensive about whether government workers were up to the task. But she said they have been supportive and that students likely didn't notice any difference. "Fabulous. I cannot say enough good things," she says.

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