Subsidies and Red Herrings

Student loan industry officials have been pushing Congress to revisit cuts it made last fall to subsidies lenders receive for participating in the Federal Family Education Loan (FFEL) program. They cite job losses in the industry as one reason to boost subsidies.

“How do you feel about thousands of hard-working people being laid off?” one advocate for FFEL recently wrote to Higher Ed Watch. “Because that's really the biggest tragedy of the College Cost Reduction and Access Act...FFEL lenders haven't gone away, but thousands of people's jobs have!”

There is no doubt that fewer people are employed in the FFEL industry as a result of both the subsidy cuts and credit market turmoil. But while we are sympathetic to the hardships that these job losses cause individuals and their families, we take issue with the argument that FFEL job losses represent a major public policy problem. In fact, the jobs argument confuses the real problem: the lack of an auction for setting lender subsidies makes it impossible to determine just how many FFEL jobs are actually needed.

FFEL Is For Students

Congress did not intend FFEL to be a jobs program. FFEL's sole purpose is to provide loans to college students at roughly uniform terms that are more generous than those offered in the private market. That’s it. One can debate how much lenders should be subsidized to accomplish this goal, or how generous loan terms should be for borrowers, but job creation and losses shouldn’t be part of the equation. Moreover, many FFEL supporters champion the program because, they say, it fosters competition among private lenders. If that’s true, then they have to admit that jobs will be lost when larger, more efficient lenders win more student business.

Too Many FFEL Jobs, or Too Few?

The jobs argument assumes that the "correct " number of FFEL jobs existed prior to the subsidy cuts and credit crunch, meaning any job reduction will harm the program. Herein lies FFEL’s central problem. Congress does not know how many lenders are needed to ensure all students get a FFEL loan. Congress simply makes up a subsidy rate and hopes it attracts enough loan providers to fill the need. In any given year, the subsidy is likely to be too high or too low.

Taxpayer dollars are wasted when the subsidy is higher than what is necessary to ensure all students get loans. Wastefully high subsidies encourage lenders to hire more staff to compete with one another for market share. In this regard, FFEL creates jobs -- marketing, processing, servicing, political fundraising, and Congressional lobbying jobs. But were these additional jobs necessary to accomplish the FFEL program’s goal of getting students loans with beneficial terms set by Congress? Or, put another way, is the current reduction in FFEL jobs going to prevent students from obtaining government subsidized student loans?

To be fair, Congress can easily guess a subsidy rate that is too low, where not enough lenders -- and their employees -- participate in the program to ensure all students get loans. But the point here is that if Congress continues to use the current system of guessing a subsidy number for lenders, there are likely to be too few, or too many, FFEL jobs at any point in time.

Auction Solution

Policymakers can do a better job of ensuring the optimal number of lender employees by setting the subsidy level by auction. While the PLUS loan auction, which is scheduled to begin in 2009, allows only two lenders to make loans in each state, it authorizes lenders to set their own subsidy level in the auction. If a loan company expects to need 1,000 employees to make all PLUS loans in Minnesota, then it can submit a bid for a subsidy rate it believes will support the necessary level of jobs. Unfortunately, the law creating the auction caps lenders’ bids, preventing loan providers from bidding at what might be the most appropriate rate. Congress needs to revisit that provision to ensure there is sufficient bidding in a variety of market circumstances. At a minimum, the Secretary of Education should be granted the flexibility to adjust the cap in each auction when special circumstances arise.

Make Loans, Not Red Herrings

The debate about lender subsidy levels is a healthy one as long as we look for ways to ensure that the FFEL program can accomplish its goal at the optimal price for taxpayers. The argument that job creation and preservation should somehow be a consideration in this debate is nothing but a red herring. It is a rhetorical distraction from a debate about how best to deliver federal student aid and ensure college access.