Student Loan Auctions - The Missing Story
Jason Delisle
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Student Loans
Last week, National Journal ran an article on the recently enacted student loan auction program filled with criticisms. According to lenders, bankers, Bush political officials at the Education Department, college aid administrators' association (NASFAA), and "most" Congressional Republicans, the taxpayers' representatives should not use the market to set student loan company subsidy rates, because it is "unworkable." Their alternative is to pull a subsidy number out of thin air. Really.
The special interests referenced in the National Journal article who criticize the newly enacted student loan auction subsidy setting program never proposed an alternative to the old system, because they profit handsomely from that inherently inefficient (P. 34), and as recent press reports attest, highly corrupt system. Nor did they engage in any effort to improve on the auction proposal put forth by Senator Kennedy. Instead, they chose a strategy (deliberately) to "sit this one out" and focus their efforts on killing whatever auction proposal was ultimately enacted. The National Journal article is Exhibit A of this approach.
On the Sidelines
The Bush Administration offered no proposal or guidance on developing a student loan auction. It merely said it opposed the specific auction proposals Congress considered earlier and also the version ultimately enacted. The student loan banks (e.g. our friends at Sallie Mae, the Consumer Bankers Association, et al) and NASFAA never provided input on how they thought an auction proposal should be designed, only that it should not be designed at all.
Congressional Republicans, never put forth an alternative plan (except for Senator Judd Gregg and Rep. Tom Petri) to the Kennedy auction proposal, they only opposed it. At best, behind closed doors, a handful of Congressional Republicans supported the concept, but offered no suggestions on how to design it, except that it look as little like the Direct Loan program as possible. No profile in courage there. And no applause for House Democrats either who also strangely offered no market-mechanism proposal for setting student loan company subsidy rates, although to be fair ultimately they did support Rep. Petri's plan.
Congressman McKeon is perhaps the most honest of all critics. He opposes the Kennedy auction, and these days is not in favor of any alternative market-mechanism for setting student loan company subsidy rates. McKeon supports Congress picking out of thin air an amount of taxpayer dollars to give to student loan banks. Of course that's a flip flop for McKeon from ten years ago when he said, "Up to now, we have tried to figure out how much to pay the lenders for providing student loans in a political negotiation, but we in Congress really have no way of knowing what the right price is." Apparently, McKeon has figured something out.
We at Higher Ed Watch think the system that McKeon and his supporters prefer for setting student loan subsidies is arbitrary, wasteful, and subject to a dangerous amount of political influence. It is, or course, the later point that makes the system so popular with many Members of Congress and the banks collecting the subsidy. It consists of Congressional staff and bank lobbyists sitting in a back room setting taxpayer-provided subsidy rates on student loans, without information on what the best rate is to achieve the competing goals of the student loan program: providing loans at terms Congress spells out in law at the lowest cost to taxpayers, but at the best level of service to borrowers.
Auction Options
While almost all auction systems have their flaws or tradeoffs, they're generally preferable to the government simply giving away taxpayer dollars to the well connected. For that reason, the New America Foundation has supported student loan auctions, helped Rep. Petri draft his auction proposal, and did not oppose Senator Kennedy's effort. As we told the National Journal. "It's a foot in the door."
The Petri proposal, however, would have tasked the Departments of Education and Treasury to lead a study group of technical experts in designing a student loan auction that ensures maximum savings to taxpayers and a commitment to quality service to borrowers. It would have launched a two-year pilot using up to twenty percent of the guaranteed loan portfolio to test the model. The Government Accountability Office was to study the effort and report to Congress. A number groups in the National Journal article that criticized the Kennedy auction – namely U.S. PIRG, the student groups, and college registrars' association -- supported the Petri version.
The main problem with the Petri auction plan was that because it left design questions to the Administration and outside experts, the precise size of taxpayer savings weren't predictable by the Congressional Budget Office -- and thus unusable as an offset for increasing the Pell Grant. That's a big reason Congress went with the Kennedy plan. But the Petri auction proposal did allow for an open and full vetting of the tradeoffs that must be made in converting the subsidy setting process from a political one to a competitive one.
For example, in designing an auction itself, Congress had to decide how many lenders are needed to accomplish the competing goals of the loan program. The auction embraced by Congress decides two lenders in each state is the right number to meet the goal. It also decides that a new auction should be held every two years. But an auction every two years, in each state, to determine two exclusive lenders might not be the best approach. Maybe there should only be one auction nationally every five years. Maybe there should be more or less winners. Maybe there should be exclusive rights for a shorter period of time. The Petri auction proposal would allow for a more open and full discussion of those key decisions and others before implementation.
The Petri auction model also provided for an opportunity to weigh the pros and cons of two different styles of auctions: (1) an auction for the right to make the loans versus (2) an auction of loan assets once they have been originated. Which auction model best sets a subsidy for lenders to accomplish the competing goals of the loan program? The approach embraced by Congress chose a rights based auction over an auction of loan assets, but it did so with minimal public debate on what tradeoffs that decision entails. The Petri approach allows policymakers to develop both models, compare their performance, and choose the best one.
The Missing Story
The overriding point is that because key stakeholders and their lobbyists consciously chose not to provide input into the design of the enacted auction plan explains much of why the auction system embraced in law looks the way that it does. Because House Democrats, nearly all Congressional Republicans, student lenders and other stakeholders provided no serious input to the auction design, Kennedy made decisions he had to make in order to do the right thing – get Congress and bank lobbyists out of the business of setting taxpayer-supplied, student loan company subsidy rates.
Going forward, those who sat out the auction debate while the policy was designed could further the debate now by advising Congress and the Department of Education on how best to make an auction work. Of course, it’s expected that those who would rather let Congress make up a subsidy rate then let a market decide it will continue to sit on their hands and offer nothing but criticisms, hoping for a return to the old subsidy setting approach. But all should be aware that by doing so, these critics are endorsing a corrupt, big government, and wasteful student loan program.
[Disclosure: The author formerly worked for Senator Judd Gregg (R-NH), and prior to that was a member of Representative Tom Petri 's (R-WI) staff. The Editor of Higher Ed Watch formerly worked for Senator Edward Kennedy (D-MA).
Student Loans-The Only Story!
Hey, you guys hear that college tuition and fees went up by 6.6% for public schools (little bit less for private schools)? Just checking, haven't seen any posts on that? We sure spend a lot of time on lenders don't we? What advocates for the taxpayer the NAF is. How many billions in wasted federal subsidies has tuition inflation caused? How many billions have been spent to graduate half of the college degree-seeking population? Chump change next to lender subsidies-eh?
Is the point of this post that you expect the condemned to help choose the method of their execution (as surely the asinine auction process will eliminate many FFELP lenders)?
The solution is simple, get rid of federal intervention in student lending! Then you will have all the benefits only markets can deliver. Where does it say in the Constitution that Congress has the right to legislate government participation in inter-state commerce anyway? I thought it could only regulate such? Maybe we should spend intellectual energy and taxpayer monies creating a fair and level playing field for free-market loan entrepenuars instead of chasing Moby Dick? Wouldn't that be the most efficient use of taxpayer money?
Thin Air
What's so wrong with picking a number out of thin air and then refining it every few years? Such a process, called hillclimbing or generate & test, will eventually reach the lowest subsidy that lenders are willing to accept and remain in the business. Such an approach is more likely to yield the optimal subsidy rate than the current auction proposal. This proposal is very deeply flawed. Since it is auctioning off only Parent PLUS loan volume and on a state by state basis, there are only 3-7 states worth competing for. The rest have such a small annual volume (divided by two, since there will be two winners per state) that lenders are unlikely to bid much under the ceiling. Even in the other states, I doubt that the bids will get much less under 10% below the ceiling. Consider that the discounts on Federal student loans, before the recent subsidy cuts, represented a roughly 5% hit to the lender's spread. So it mystifies me why anybody would believe that a lender would bid for a much lower SAP. The CBO estimate of CPR + 0.60% represents a 66% hit to the spread compared to the CPR + 1.79% ceiling. That's completely unrealistic. A better approach would have involved bundling the states into six geographic regions, giving a bigger prize to the winners. That would then approach loan volume levels that are big enough for some real competition among lenders.
Thin Air, But...
Congress could certainly refine the arbitrary subsidy number each year to "eventually reach the lowest subsidy that lenders are willing to accept and remain in business." But this approach doesn't answer any of the tough questions that need to be answered. For example, the "lowest subsidy level" is different for every lender. So in determining the correct subsidy level, Congress would have to decide which lenders it wanted to remain in the program. Congress would also have to decide how many lenders are needed, because at every subsidy level, not all lenders are willing to lend. Thus, Congress can set a new number every year, but it first has to decide how many banks it wants lending. Congress has shown no ability or desire to make such a difficult decision.
Your second point about using large lending regions was politically impossible - though it was an approach that some advocated during consideration. The problem is, some state non-profits cannot lend outside their respective state (this is what Members of Congress and staff were told) so any auction that would require lending in more than one state meant that some non-profits couldn't lend. Members of Congress said that was a non-starter.
-Jason Delisle
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