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

Washington Monthly, Oct, 1995 by Jonathan Cohn

But there were serious problems with this plan. For one, guaranty agencies were literally guaranteed the contract by law, so they never had to bid for the work or worty that they'd get axed for poor performance. Worse still, the guaranty agencies actually had an incentive to do their job poorly. If they reported a lazy bank for failing to try to collect a loan, they got no reward. But if they ignored the banks, and went after all the loans themselves, they got to keep 27 percent of the money they recovered.

Not all guaranty agencies were corrupt; many did their jobs honestly and well. But there were enough bad apples--and enough other loopholes that allowed private companies to make a killing off the student loan program--that the federal government found itself wasting taxpayer dollars that were supposed to be helping young people go to college.

When he assumed office, Clinton pushed to reform this system, both to improve the program's efficiency and to give students the option of paying their loans back as a percentage of their income. Since the government was assuming the risk anyway--and since the maze of banks and guaranty agencies had proven to be a nightmare of waste and abuse--why not lend money directly from the federal Treasury? This would require the government to come up with the cash for loans. But there was potential for long-term savings, since taxpayers wouldn't have to pay interest subsidies to the banks or fork over a 27 percent cut to guaranty agencies. Clinton's idea was to have the IRS--which would have the necessary data on income--handle loan collections.

In a compromise with Congress, the bill the President signed implemented direct lending only partially. The Department of Education would have to compete with the private loan providers--banks and government--chartered groups like the Student Loan Marketing Association (Sallie Mae)--for much of the business. Direct lending would be capped at 5 percent of the total loans in the first year, but eventually anyone who wanted to could participate.

Blinded by the Right

Actually, the final bill was in many ways an improvement over what Clinton originally wanted. Setting up dual programs--both the Education Department (through direct lending) and private lenders (through the old system) would make loans to students--is a tried and true method of maintaining efficiency. Sure enough, when the government implemented a simplified application process and a speedier transfer of funds, private lenders followed suit. Forced to compete with direct lenders, Sallie Mae, which holds more student loans than any other lending agency, now offers all kinds of new repayment options for students. The same benefit was evident in the early years of the Tennessee Valley Authority, which acted as a yardstick to keep private utilities from gouging their customers.

The great disappointment of the battle over student loan reform was the loss of the IRS collection plan. As Steven Waldman recounts in The Bill, this idea died not due to corporate lobbying--which was fierce--but because of congressional turf battles. In the current political climate, there's little chance of reviving this idea. But it is a reform to keep pushing, since it would vastly simplify the process of tying loan payments to income.