Submitted by Patrick Bott on June 24, 2008 - 5:21pm.
An auction is a fine Goldilocks solution NAF. Too bad it’s pure fantasy. The government could very easily switch gears and guarantee lenders 100% reimbursement for default losses on their FFELP portfolios and then leave the lenders free to set the interest rate on their loans. Of course that means that there will be variability amongst different FFELP providers with regard to the interest rates they charge borrowers. Nevertheless, FFELP borrowers would still enjoy rates that would be lower than they’d otherwise be since the government is footing 100% the cost of defaults on behalf of the lenders / borrowers. No command and control auction, no command and control subsidies, and no disruptions in service since the lenders would be free to pass along to the borrower their cost of funds (a fixed subsidy, and fixed borrower rate doesn’t allow that NAF—a problem you’ll note was responsible for the mass FFELP lender exodus). Also, since the government guarantee is 100%, there would be little incentive for lenders to not lend to higher default institutions. Competition among lenders determines their profits from the program, not the “back-room” deals you purport to decry (although as per the norm, you supply nothing more than hearsay to support your claim of impropriety). So there you have it NAF, a KISS solution (of the kind you supposedly favor) to the ‘problem’ you’ve identified.
A better compromise
An auction is a fine Goldilocks solution NAF. Too bad it’s pure fantasy. The government could very easily switch gears and guarantee lenders 100% reimbursement for default losses on their FFELP portfolios and then leave the lenders free to set the interest rate on their loans. Of course that means that there will be variability amongst different FFELP providers with regard to the interest rates they charge borrowers. Nevertheless, FFELP borrowers would still enjoy rates that would be lower than they’d otherwise be since the government is footing 100% the cost of defaults on behalf of the lenders / borrowers. No command and control auction, no command and control subsidies, and no disruptions in service since the lenders would be free to pass along to the borrower their cost of funds (a fixed subsidy, and fixed borrower rate doesn’t allow that NAF—a problem you’ll note was responsible for the mass FFELP lender exodus). Also, since the government guarantee is 100%, there would be little incentive for lenders to not lend to higher default institutions. Competition among lenders determines their profits from the program, not the “back-room” deals you purport to decry (although as per the norm, you supply nothing more than hearsay to support your claim of impropriety). So there you have it NAF, a KISS solution (of the kind you supposedly favor) to the ‘problem’ you’ve identified.