Create a College Access Contract

America’s financial-aid system provides too much taxpayer support to banks that make college loans, asks too little of students who assume them, and burdens families with too much debt. We need to rethink the system in order to improve college access and affordability. Federal higher-education policy largely fails to reward rigorous college-preparatory work in high school. It penalizes students who hold jobs while in college. Lenders make extraordinary profits, while young people leave college burdened with debt and, more often than not, without the degree or skills necessary to repay it.

A new College Access Contract would harness the free market so that students would get more financial aid, and banks less.

There are two key reasons why the student-loan giant Sallie Mae is consistently ranked at the top of the Fortune 500 list -- one, large government subsidies; and two, a government guarantee against risk. Banks making student loans are guaranteed profit equal to the prevailing market interest rate for commercial borrowing, plus 2.34 percentage points during repayment. That’s much larger than immediately apparent. For Sallie Mae, which has a very low cost for commercial borrowing, the government subsidy has translated into roughly a 43-percent profit on core capital.

Worse, in addition to providing unnecessarily large bank subsidies, the design of America’s financial-aid system is rife with perverse incentives. Lenders have little reason to put resources into collecting payment from delinquent borrowers because the government guarantees 98 percent of student-loan principal against default. The federal government and states have little reason to increase grant aid to keep up with rapidly rising college costs because student loans are available to back up aid reductions and tuition hikes.

For students, a particularly perverse incentive is the penalty for working one’s way through college, even though attending and completing college is more challenging for low-income students than for upper-income students. Grant aid is reduced by 50 cents for every dollar a student earns above approximately $3,000 during a calendar year. A typical lower-middle-class student who works to pay for college gets zero federal grant aid.

High-school students are not asked to work hard academically before going to college. In general, federal financial aid for postsecondary education is available to any student accepted by any accredited university, college, community college, or trade school with negligible regard to how prepared the student is for postsecondary work. A benefit of the system is that higher education is broadly accessible, but federal financial aid often pays for students to learn in college what they should have learned in high school. Students needing remediation in college, who are disproportionately low income and minority, are in greater danger of dropping out or taking longer to graduate than other students (thus inflating their total college costs and borrowing level).

All those problems might be tolerable if students were learning in college the skills they will need in the workplace. But too many students are not working hard academically in college, and too many colleges are failing students. Consider that for members of minority groups and students from low-income backgrounds who attend four-year institutions, the college-dropout rate is more than 50 percent. Two-thirds of college graduates can’t read and successfully compare and contrast basic abstract texts, such as two newspaper editorials, according to the National Assessment of Adult Literacy.

A meaningful College Access Contract would guarantee that low-income students could graduate from college free of federal student-loan debt, and that middle-class students could graduate with zero-interest federal student loans -- if, and only if, they meet the following conditions:

1. They complete a rigorous college-preparatory curriculum in high school. High-school curricular rigor is the No. 1 indicator of college completion -- more important than race, family income, or parental education, according to Education Department studies. The quickest way to get high schools to upgrade curricula is to get parents to demand it. The prospect of a significantly cheaper college education should spur action. But states and school districts would need extra aid from the federal government to upgrade their high schools, particularly in low-income areas.
   
   
2. They work at a paid job or perform community service for an average of 10 hours a week while in college. Regular earnings would reduce the total amount that students need to borrow. A work or service requirement also mitigates the moral and political hazard associated with guaranteeing debt-free college or zero-interest borrowing. Loan forgiveness in the absence of reciprocal responsibility encourages more borrowing. Equally, if not more, important, a work or service requirement is likely to help students do better academically. Students who work up to 15 hours a week while in college report that they manage their time better and study more effectively, according to the U.S. Public Interest Research Group.
   
   
3. They complete a degree or demonstrate minimum competence in an academic area. Students could demonstrate competency by graduating with a degree in an academic major from a rigorously accredited institution, or by passing some sort of communication-skills test, such as the Collegiate Learning Assessment. Regardless, participating colleges should be required to publicly report results. Public reporting would inspire institutions of higher education to pay more attention to the quality of teaching and learning.

Can we pay for such a contract, which would supplement existing financial-aid programs? Yes. By infusing market mechanisms into the student-loan-delivery system, we could save taxpayers billions of dollars each year. The right to originate loans guaranteed against default by taxpayers is something of great value that the government currently gives away free to the banking industry. Why shouldn’t banks have to bid against one another for this sure source of profit, especially when it’s the taxpayers who create this "business opportunity?"

Banks could compete by offering the highest bid for the right to sell government-guaranteed student loans to designated colleges for multiple years; or for the right to be a "presumed," but not sole, lender; or by agreeing to accept the lowest government subsidy. There are multiple design possibilities for a student-loan auction. What they all have in common is that loan terms for student borrowers, which are established by statute, would not change; there would still be multiple providers; and they’d save taxpayers billions that could be funneled into direct student financial aid.

The idea of a student-loan auction is hardly radical. The government runs more than 30 different auctions for items as varied as Treasury securities, spectrum licenses, and drilling rights. We have learned a lot about them over the years, problems to avoid and key elements. These auctions are not without their flaws, but they’re far preferable to the government’s giving away public assets to the well connected.

Rep. Howard P. (Buck) McKeon, Republican of California, put it best when he told The Chronicle almost 10 years ago, "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." He went on, "It would be much better if we had a market process to determine that."

How much would an auction raise for additional financial aid to students who meet the conditions of the proposed College Access Contract? It’s hard to say for sure. But recently one of the country’s largest lenders, the Missouri Higher Education Loan Authority, began to auction off its portfolio of federal student loans and has garnered a 7.1-percent rate of profit. That hints at the market value of federal student loans and suggests that taxpayers could save in the range of $20-billion, if not more, over the next five years.

Instead of needlessly going into bank coffers, the funds could go to states to help pay down student debt and upgrade local high schools, particularly high schools serving concentrations of low-income students that disproportionately need better curricula and teachers.

To ensure that states would not merely reduce their own education funds as a result, they would be required to maintain their own fiscal efforts for higher education. Because inflation-adjusted reductions in state aid to higher education are the single greatest contributor to tuition increases nationally, a "maintenance of effort" condition would have the added effect of keeping public-college cost increases down.

Philosophically, this suggestion of a College Access Contract financed by student-loan auctions joins progressive goals and market principles. Politically, it is attractive because it embraces traditional values like hard work, service, and reciprocity. But the main reason to embrace the College Access Contract is to teach young people that in this life, you don’t get something -- even a college education -- for nothing. You have to work for it.