The federal government’s Direct Loan program dominates the student-loan market today, issuing 90 percent of all loans made across the country each year. Students pursuing everything from short-term certificates to master’s degrees qualify on a no-questions-asked basis for $100 billion of these loans every year at terms more generous than any private lender would dare offer. The government even lends to parents and graduate students to cover the entire cost of whatever a university decides to charge. At $1.2 trillion in outstanding debt, the student-loan program now rivals the Federal Housing Administration’s mortgage program.
Naturally, this kind of loose lending and market dominance by a government program rankles conservatives and free-market supporters. Making matters worse, the loans have high default rates — over 20 percent for undergraduates. And default isn’t the only risk taxpayers face. Students qualify for loan forgiveness after making low income-based payments for 20 years, or as early as 10 years if they work for any non-profit or the government.
At first, the solution seems obvious. Pare back the Direct Loan program and let the market step in. Yet absent a government program, many undergraduates are unlikely to find a private lender willing to make them affordable loans. Others will not have access to any loans at all. What’s wrong with that? Nothing, if it only prevents students from pursuing degrees that offer low returns on the investments. But more so than in other markets, private lenders are likely to shun even the good bets when it comes to student loans. That’s because there is no natural source of collateral, and traditional undergraduates generally have limited credit histories and earnings. And it can take years before a degree really starts to pay off, so lenders have to tie up capital in loans with long terms.
Whatever the economic rationale for a government student-loan program, the political rationale actually does the heavy lifting. Voters have never been more anxious about affordable access to college, and that’s the rub for right-of-center lawmakers. They know they want a smaller government-loan program, but they also know that unfettered free markets probably won’t ensure widespread access to affordable college financing — and pity the politician who wants to make it harder for students to get subsidized loans. In fact, Republican lawmakers have been behind some of the biggest expansions of the program. It was Republicans, after all, who in 2006 eliminated the cap on how much graduate students could borrow.
Many politicians on the right in Washington think they have a way out of this bind, a plan they mistakenly believe shrinks the federal role but maintains access to subsidized loans. They want to return to the guaranteed student-loan program, officially called the Federal Family Education Loan program. Under that program, which existed from the 1960s up until President Obama and Democrats in Congress eliminated it in 2010, private lenders made the loans and the government guaranteed them against default losses.
Bringing that program back is now a standard — if misguided — Republican talking point. (Ironically, opposing loan guarantees for mortgages issued by the FHA and Fannie Mae is, too.) Last year the media reported that President Donald Trump’s campaign was “planning on moving the government out of lending and restoring that role to private banks, as was the case before President Obama fully shifted loan origination from private lenders to the government.” Representative Virginia Foxx, the Republican Chairman of the House Committee on Education and the Workforce, says she wants to reverse a Democratic Congress’s decision in 2010 to make all federal student loans through the Direct Loan program. This, they say, will bring private capital back into the program.
Sure, private capital offers important advantages over government lending. Lenders manage risk, restrict loans to investments that stand a good chance of paying off, and vary loan terms accordingly. But a guaranteed student-loan program, as Republican lawmakers want, dispenses with all of these features. Remember, politicians want students to have widespread access to loans at terms that the government sets, but private capital adds value by doing the opposite.
Here’s how the guaranteed loan program addressed (or tried to address) those conflicting goals. It entitled every student to a loan at terms the Congress set in law. Then, to ensure that lenders would deliver loans at those exact terms, it shielded them from default and interest-rate risk using taxpayer dollars, precluded them from denying access to less creditworthy borrowers, and prohibited them from using prices (i.e., interest rates) to provide signals to borrowers about the quality of different educational choices.
And Congress didn’t want markets involved in setting how much the government paid lenders, lest they set the payments too low and jeopardize access to loans. So lawmakers set the payments themselves in law, erring on the high side, informed by plenty of “research” provided by the lenders showing where to set the rate. Those inefficiencies resulted in higher costs for taxpayers compared with the Direct Loan program.
In short, the guaranteed loan program was designed to include private capital but preclude the government and students from realizing its inherent benefits. Which is why the movement to restore it is such a distraction from alternative policies that would actually bring the benefits of private lending to bear in the student loan market.
Rather than subsidize private lenders, why not restrict the amount that the current loan program lends, such as by eliminating government loans to graduate students (Stafford and Grad PLUS loans) and to parents of undergraduates (Parent PLUS loans)? Unlike undergraduate students, graduate and parent borrowers have had the chance to establish earnings and credit histories. Graduate students have already earned college degrees. All this makes graduate students and parents good candidates for purely private loans.
Of course, this policy will mean less access to student loans, and Republicans may balk. Which is why they need to come to grips with the fact that bringing private capital into the loan program in a way that adds value is in conflict with other goals for the program. Trying to have it both ways will only result in waste, complexity, and higher costs for taxpayers. If policymakers believe the more important goal is to provide widespread access to loans at terms the government sets, then there is nothing private capital can offer over the Direct Loan program.