Auctions

Federal Reserve Chairman Ben Bernanke says the government’s biggest student loan program, the Federal Family Education Loan (FFEL) program, is poorly designed. His suggested solution sounds a lot like an endorsement for an auction. In a letter to Sen. Chris Dodd (D-CT) on Federal Reserve action to help student lenders weather credit market turmoil, Bernanke notes that the structure of the FFEL program is problematic. He writes:

The other side of the profitability equation--the reimbursement spread paid to lenders under this program--is under the control of the Congress and the executive branch. In particular, Congress may well wish to revisit the question of whether setting a fixed spread over the commercial paper rate is the best approach. You may decide that a more market-sensitive approach--flexible enough to provide a wider spread during times of market stress and a narrower one during normal times--could provide a more robust structure.

Here is what’s behind Bernanke’s assessment of the FFEL program and his suggestion for a "more market sensitive approach."

Two Parts to the FFEL Profit Equation

According to recent reports, some lenders are pulling out of the Federal Family Education Loan (FFEL program due to malfunctioning credit markets - and, some loan industry officials say, due to cuts in federal subsidies. The authors of these reports appear to believe that fewer lenders is bad news. But is it necessarily bad to have fewer lenders participate in the FFEL program and better to have more? Are there too many now or too few?

These questions expose FFEL’s fundamental policy flaw. An auction system, like the one Congress enacted for PLUS loans set to begin in 2009, provides the remedy.

FFEL Can’t Get it Right

The FFEL program's fundamental policy flaw is that it is not designed to ensure that an optimal number of lenders (or any lenders at all) participate in the program at a reasonable price for taxpayers. The result is a continuous debate about how much lenders should be subsidized to ensure that "enough" lenders participate in the program.

More lenders in the program ensures a well capitalized program and greater competition for school and student business, fostering better customer service. On the other hand, more lenders in the FFEL program requires higher subsidies and costs taxpayers more money, making fewer dollars available for say, student grants or other priorities. Unfortunately, Congress, the media and student loan lobbyists never confront these tradeoffs head on. A framework is therefore needed that forces policymakers to be explicit about the tradeoffs. The PLUS auction provides that framework.

Colleges and college aid officials have been funneling their students to big banks like Sallie Mae and Citibank in exchange for cash, gifts and in-kind benefits, according to a series of recent public investigations, the most energetic of which is being led by New York State Attorney General Andrew Cuomo.

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