Q: should Washington have a bigger share of the student-loan industry?

0 Comments | Insight on the News, April 29, 1996 | by Richard W. Riley, | Grover G. Norquist

Yes: The federal government can gisve students loans faster and at less cost to taxpayers.

For much of the last three years, lawmakers have waged a fierce battle about a complicated but crucial issue facing millions of American families: student loans. The Clinton administration's direct-loan program is an initiative that puts the interests of students, families and taxpayers ahead of the needs of well-financed special interests.

Before getting into the nitty-gritty of how student loans work, I think it is helpful to consider why the federal government is involved in student lending.

The federal role in student loans is simple: It is in the national interest to have an educated populace. On average, college graduates earn almost twice the annual salary of high-school graduates. The cost of the nation's investment in the education of student borrowers is recouped many times over through increased productivity and greater earnings.

In the terms of the marketplace, however, most students are not creditworthy borrowers. The typical student is cash poor, owner of few, if any, assets that could be used as collateral and often earns too little to be considered a good credit risk. If such a borrower could get a loan, in all likelihood it would carry a high interest rate -- high enough to lead many students to decide not to go on to higher education. That is why student loans are backed by federal money and the interest charged on those loans is capped. At the same time, by making a college education possible for millions of Americans, federally sponsored student loans produce a tremendous return for the US. Treasury and students, whose incomes -- and tax payments are greatly increased with their college degrees.

Since tuition increases have outpaced inflation for more than a decade, students and their families have turned increasingly to federal loans to finance higher education. The College Board reported that federal loans accounted for $26 billion of the $47 billion in total student aid available for the 1994-95 academic year.

Those who profit from student loans prefer the old guaranteed student-loan program in which the federal government guarantees banks a profit -- a process that has grown cumbersome for students and colleges and unduly expensive for taxpayers. The need for reform in this area led the Clinton administration as well as a bipartisan group in Congress three years ago to create the direct student-loan program a simpler, faster, more efficient way of getting loans to students that cuts out the financial middlemen.

The choice of which program to use is made by the colleges, which bear the administrative brunt of student borrowing through their financial-aid offices. Now in its second year of operation, direct lending gets high marks from administrators and almost 2 million student borrowers at more than 1,350 participating universities -- including Virginia, Rice, Harvard, Old Dominion and Ohio State. As one University of Florida official told the Chronicle of Higher Education, "I don't even want to think about going back to the guaranteed-loan system. The whole idea of going back is a nightmare." The participating institutions account for approximately 35 percent of student loans nationwide. Another 450 schools are supposed to join the program next year.

One chief advantage of direct lending is that it helps students better manage their finances when they begin to repay their loans. Student borrowers can choose from an array of repayment options, including a plan that lets them set their monthly payment as a percentage of their income. This option is called "income-contingent repayment." It gives students an important option that makes their debts more manageable when their incomes are low, their families are young or their careers are just beginning. Another plus is the promotion of competition within the student-loan industry. By giving colleges a choice between the two federal loan programs, direct lending stimulates technological and administrative innovations in both of them. Capping or eliminating direct lending, as the special interests and some congressmen propose, would deny hundreds of colleges the choice that they have made to enlist in direct lending.

A third benefit of the direct-loan program is its simplicity. Direct lending is a straightforward process involving only one lender instead of the maze of 7,000 financial institutions in the guaranteed-loan program. That multitude of players is a major source of confusion in guaranteed lending. Guaranteed loans typically are sold by financial institutions two, three, even four times. The student borrower who takes out multiple loans faces an intricate game of hide and seek to determine where loan payments must be sent as well as the terms that apply to each loan after it is sold.

Simplicity relates to a fourth advantage of direct lending -- greater accountability. The General Accounting Office has declared that the guaranteed-loan program is so far-flung and rife with flawed data from some participating institutions that it cannot be audited. For a federal program that deals with tens of billions of dollars annually, that standard is unacceptable. By contrast, the first year of the direct-loan program has been 100 percent reconciled. This is the first time that any federal student-loan program has achieved that goal. Without question, the direct-loan program is easier to monitor than the guaranteed loans from more than 7,000 private financial institutions receiving an array of federal subsidies and payments.