Direct Lending

Here's something that we never could have predicted: President Bush is leaving the federal Direct Student Loan program in a stronger position than he found it.

Back in January 2001 few student-aid observers thought that Direct Lending, which had been championed by the Clinton administration and Congressional Democrats, would survive the Bush presidency. Some loan industry lobbyists were so confident of the program's demise that they actually advised the administration to show restraint. "It would be foolish for the Bush administration to try to eliminate direct lending," Jeff Andrade, an advocate of the Federal Family Education Loan (FFEL) program, told The Chronicle of Higher Education shortly before Bush was sworn in. "The program is withering on the vine on its own." [Andrade soon after received a plum assignment at the U.S. Department of Education.]

Now, nearly eight years later, the Direct Loan program's fortunes are on the rise. In the wake of the credit crunch, the program's volume has increased by nearly 50 percent this year, according to the Education Department. Roughly 400 schools have switched to Direct Lending from the competing Federal Family Education Loan (FFEL) program over the last 12 months, bringing the total number of schools offering Direct Loans to about 1,370. If the program's growth continues at its current pace, Direct Lending will overtake the FFEL program for the first time in the program's history. [An additional irony is that, as a result of the credit crunch, the FFEL program is looking more and more like direct lending -- with the federal government providing federal capital and liquidity to struggling lenders to make federal loans.]

Tuition and Student Debt Up, College Board Says

Dept. of Ed Issues Final Rules on Public Service Loan Forgiveness

Cuomo Moves to Sue Loan Company

Education Department Reports 43 Percent Growth in Direct Loan Program

Audit Urges Restructuring of PHEAA's Board

Congress Returns, and so Does the Endowment Debate

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.

When interest rates on variable rate Stafford loans reset this July to a low 3.61 percent (4.25 percent after the six-month grace period for recent graduates) the consolidation loan market, once robust and competitive, will be a shadow if its former self. There are policy explanations, economic explanations, and of course, political explanations for the change in the consolidation market. And like many things in student loan policy, the story is filled with irony.

Not Many Loans Left to Consolidate

As we pointed out earlier this week, borrowers with variable rate Stafford loans (those originated before July 2006) will be able, as of July 1st, to lock in the new low rate for the lives of their loans by refinancing. However, demand for this option may be low, as few borrowers are likely to have any unconsolidated, variable rate Stafford loans left (consolidation is a one-time option). From 2002 to 2006, interest rates on these loans dropped so low that nearly all borrowers who were eligible at the time to consolidate their loans did so, locking in rates between 2.77 and 5.30 percent. For a brief time, even borrowers still enrolled in school could refinance their loans, though in-school consolidation was discontinued as part of the Higher Education Reconciliation Act of 2005. What’s more, new loans taken out since July 2006 all carry fixed interest rates, removing the main benefit of consolidation.

Attention recent college graduates: starting July 1st, you will have a once-in-a-lifetime opportunity to significantly reduce your federal student loan costs. We at Higher Ed Watch are telling you this, because if some in the student loan industry get their way, you may never hear about it.

For six months beginning July 1st, members of the Class of 2008 who have taken out variable interest rate federal student loans will have the opportunity to refinance those loans and lock in a low, fixed 3.61 percent interest rate. That's about 3 percentage points lower than the variable rate that was set last year. This is the biggest one year drop in student loan interest rates ever, and the 4th lowest interest rate in the 15 year history of the student loan consolidation program.

We've been asked our reactions to the Department of Education's announcement yesterday shoring up the student loan market. Higher Ed Watch has two main thoughts.

First, Congress' response legislation to the student loan credit scare and the Department's implementation announcement yesterday puts to bed any question of loan availability for this fall. Every student will be able to get a federal student loan. We continue to note, however, that no student has gone without a federal student loan to date, and that in addition to the thousands of lenders still making federal student loans, two fail safe systems were in place before yesterday's action to ensure that no student would go without access to a federal student loan in the future. Still there was panic for this fall and spring, and it now should be gone. That's a good thing.

The Department of Education recently announced modifications to its lender of last resort program as part of its effort to prepare for the possibility of federal student loan shortages as a result of the credit crunch. The net result is a contraption Rube Goldberg would be proud of -- what in effect are direct student loans that are more difficult to administer and more costly for taxpayers than the regular Direct Loan program.

The lender of last resort (LLR) program is designed to ensure all students have access to Federal Family Education Loans (FFEL) by requiring that guaranty agencies provide loans to students that have been turned down by conventional lenders. Though we support guaranteeing access to student loans, the similarities (and costly differences) to the regular Direct Loan program make LLR a significantly inferior option. In fact, Washington appears to be trying to avoid the more obvious and efficient solution -- boosting the regular Direct Loan program.

Student Aid Bill Approved by House Committee

Fed Chairman Rebuffs Calls from Pro-FFEL Lawmakers for Lender Bail Out

Settlement Doesn't Stop Sallie's Online Presence, Chronicle Investigation Finds

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.