Student loans: the wrong cuts - Republicans want to cut Clinton's student loan program

Washington Monthly, Oct, 1995 by Jonathan Cohn

Young people in this country are feeling the squeeze. Even as it's getting harder to get a decent job without a college degree, college itself is becoming prohibitively expensive for more and more people. From 1984 to 1993, median family income increased by 3 percent, while the average cost of tuition and fees at private colleges went up 91 percent. In real terms, the median family income keeps going down while tuition--at public as well as private schools--keeps shooting up.

The story gets even worse. As tuition explodes, federal and state education money is drying up and students are bearing a larger and larger share of the tuition burden. Reflecting the need for more aid, the federal student loan guarantee program saw loans grow 57 percent between 1992 and 1994. And these loans leave students with huge debts. Paying back $50,000 at 8 percent over 10 years, for example, would mean a monthly payment of $644. This makes it impossible for many graduates to go into low-paying lines of work like teaching, and it also discourages many from seeking a college education in the first place.

Meanwhile, a host of financial institutions have been making a mint off struggling students. Until recently, the federal government did not actually loan money to students directly; rather, it guaranteed private loans. The system proved expensive and wasteful. Private lenders made huge sums of money while doing little work and taking no risk. And service to students was decidedly not a priority.

In 1993, President Clinton decided to do something about it. Under his plan, which passed in Congress that summer, the government went beyond merely guaranteeing bank loans. Students were given the option of borrowing money directly from the Treasury. "Direct lending," as this program is called, quickly became wildly popular among students and schools, in part because the government streamlined the process to reduce paperwork. It has also saved taxpayer dollars by cutting out the middlemen.

The crucial element of direct lending, though, is the option of what's called income-contingent loans, which lets students pay off their debt as a percentage of their income, rather than set, monthly sums. Tying debt repayment to income was Clinton's original goal in reforming the student loan program: He wanted to encourage college graduates to take low-paying jobs in public service.

The benefits of direct lending, then, are connected both to government reform and to the broad social good. As a reform, it has injected competition into a student loan system once monopolized by lethargic private lenders. The social good is that by allowing flexibility for students repaying their debt--something that banks were unwilling to do--the government encourages post-graduate jobs in Teach for America and the Peace Corps, as opposed to just Wall Street and Madison Avenue. For these reasons, student loan reform is an all too rare success story in the federal government's recent history. "It's the best thing since microwaveable brownies," Colorado State University student Anthony Gallegos raved in U. S. News & World Report.

Sound like a good candidate for a round of bipartisan back-slapping? It would seem so, but despite direct lending's clear successes, Republicans in Congress are moving to limit sharply--or eliminate entirely--the program, which would also spell the end of pay-as-you-can loans. The financial institutions who were once making out like bandits have been lobbying hard to get back the business they've lost. And the GOP is inclined to give it to them, even though it's a bad deal for everyone else. Instead of doing more to fix the student loan program, Republicans seem intent on breaking it again.

Federal Loan Follies

Since 1966, the Federal Family Education Loan Program (FFELP) has helped more than 40 million Americans through college. But the program carrying out this admirable mission also developed a reputation as one of the federal government's most inefficient. The program cost billions to run--most of which went not to students but to quasi-governmental corporations that had learned to scam the system. For years, the loan program was denounced from both sides of the aisle as wasteful; it prompted a constant stream of investigations and warnings from the General Accounting Office. In 1991, for example, loans lost to default cost the federal government $3.6 billion.

The trouble was inherent in FFELP's basic design. Until Clinton's reforms, the government did not actually lend money to students, but rather coaxed banks to do so--by both guaranteeing loans and offering subsidies. Because the banks had very little incentive to get the money back once they'd loaned it--they'd get their money regardless, whether from the student or the government--"guaranty agencies" were created to police the banks. These guaranty agencies, state-chartered but privately owned, had three jobs. When a bank asked the government for reimbursement, claiming that a student had defaulted on the loan, the guaranty agency would: (1) find out if the bank had made a "good-faith" effort to collect; (2) if it had, pay the bank with money it was holding on behalf of the federal treasury; and (3) finally, pursue the loan itself, in a last ditch effort to save the federal government from swallowing the cost of the loan.