On Tuesday, March 31, the New America Foundation's Education Policy Program hosted an event, entitled "The Future of Federal Student Loans." A complete transcript of that discussion follows.

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MaryEllen McGuire: Good morning. My name is Mary Ellen McGuire and I'm the director of the Education Policy Program here at New America. For those of you who are new to New America, New America is a public policy institute dedicated to bringing new voices and new ideas to the fore of the public discourse.

Today, the Federal Education Budget Project and Higher Ed Watch welcome all of you to what we expect will be a frank and very lively discussion on the future of the federal student loan program.

Specifically, we'll be talking about the Obama administration's recent proposal to stop guaranteeing FFEL loans, make the loans directly, and redirect taxpayer savings into a mandatory Pell Grant program.

As everyone in this room knows, this proposal has proved very controversial in the lending community, the higher education community, on Wall Street, and on Capitol Hill. Currently FFEL providers originate $67 billion worth of loans.

Given the money that's at stake, you imagine the force with which lender lobbyists are proceeding to Capitol Hill, attempting to convince congressional staff that they are in fact solvent, that they are weathering the storm, and that they are more efficient and cheaper than direct loans.

Where does New America stand on this issue? New America is not opposed to a two-prong competitive student loan program, as long as it serves students' best interests. We've spend several years and more than our share of blog space offering ideas for FFEL reform, primarily through the use of an alternative auction mechanism to set the lender subsidy rates.

Ultimately, New America's Federal Education Budget Project and Higher Ed Watch contain within their missions the support of fiscally responsible proposals. Fiscal responsibility is the guise under which we'd like to frame today's discussion.

Our objective today is to hear from a variety of perspectives, to discuss the pros and cons of the administration's proposal, and to consider an alternative model or two. To that end, we'll be hearing from four experts.

We'll start today with Robert Shireman, a consultant serving as senior advisor to Education Secretary R. A. Duncan. Mr. Shireman will be followed by Scott Fleming, a director with the Chartwell Education Group. Scott will be providing us with the lender perspective today.

From there we'll turn to Paul Combe. Paul Combe is the president and CEO of American Student Assistance, the nation's first student loan guarantor. And finally, we'll close with Jason Delisle, research director of the Education Policy Program here at New America.

The format today will be as follows. Each of our presenters will speak for 10 minutes, then I as moderator will take liberty and ask a few questions from the dais. From there, we'll proceed to Q&A from the audience.

I will say at the top, if you do not ask a question when you are called upon, I will move on quickly. There is one more thing that I'd like to mention at the top as it relates to our assembled panel.

The Education Policy Program at New America did extend an education to four additional lenders today. All of them politely declined to attend. Thank you very much.

Bob, we'll start with you.

Robert Shireman: Thank you very much, MaryEllen, and good morning, everyone. Last month President Obama laid out a bold goal for America, to restore our place in the world as the country with the largest proportion of Americans with college degrees.

I'll say in developing that bold goal, probably the toughest thing was to figure out whether there was a way to get a president to say the word "proportion" in a major speech before Congress. But that had to do with the detail we went to to avoid things that might cause problems, like graduation rates that can cause schools to deny entry to people in order to get rates up.

So we approached this very carefully, and chose words carefully to make sure that the goal would incentivize the right activity by colleges, by states, and in our federal programs.

A major part of that overall goal is making the Pell Grant program an entitlement, so that not only our high school senior but our children and families in middle school know that -- especially, if they're low income -- there is money there for college when they're ready to apply. And they'll undertake the academic preparation that they need in order to go to college.

One of the pieces that our higher education plan is a reform of the student loan programs. I'm going to give some overall context for how the administration views the student loan programs, and why we are going in the direction that we have proposed.

There are basically, three functions in a student loan program. There is getting the capital, the money for the loans. There is a originating the loans, giving the money to the individual borrower and receiving back from that individual borrower a signed promissory note. Them promising to repay that loan.

And then the bulk of the actual work on the loans is what people call "servicing," which still in Microsoft Word doesn't come up as a verb, but we all apparently use it as one. So I will use it as a verb.

And this servicing is the answering the phone calls about, "Did I have a payment due? Am I eligible for deferment?" Sending out the bills, following up when someone doesn't repay. Letting people know about their full options for repaying those loans.

I'm going to talk about each of these, and let me talk about the third, around servicing. The goal in servicing federal student loans, whether they are direct guaranteed, some other system, there are two main goals that we want to achieve.

One is preventing default. In the current FFEL program, if you look at the default rates by lender that have been posted on line for years, the most recent one's fiscal year '06, the default rates are anywhere from 0.2% to 23.3%.

There may be good reasons for different lenders having different default rates, but the reality is we do nothing in the FFEL program to encourage the use of lenders or servicers that seem to do a good job of preventing default. A major goal of whatever way we design a loan program should be to prevent default.

We also have these entities called guarantee agencies, which one my colleagues at the Department of Education, when I complained of the lack of any analogy to explain to anyone what a guarantee agency is, said, "It's like a Grateful Dead concert. There's nothing else like it."

[laughter]

Shireman: Dan Magellan gets credit for that. So I won't try to explain what they are, but in any case, the concept is that they're supposed to help as sort of a backstop on collection.

So it's a good concept, but the reality is that for the basic approach to the incentives that congressional staff put into the law, create incentives that could be seen as too much of an incentive to collect on loans and not enough of an incentive to prevent default on loans.

In other words, when somebody can make a lot of money by collecting on a default, they may not have enough of an incentive to prevent that default happening in the first place. So again there, there's not enough of a built-in competitive incentive approach to preventing default.

The second area other than preventing default is customer satisfaction. The student borrowers getting the information they need when they need it, knowing about their options in the current direct loan program.

A customer service survey, and independent survey that was done, showed that the direct loan servicer, the private sector servicer, had done as good or a better job than some of the lenders.

Other lenders may not have been part of this survey. Some probably do better, some probably do worse. But the point is here that the way we are moving, the direct loan program and the servicing for the FFEL loans purchased by the Department of Education, is to have multiple private sector servicers competing based on best service and preventing defaults.

So using competition among the private sector entities, they do a good job, they get more business from the federal government collecting on those federal student loans. And if they can't compete, they're not doing a good job, then they get less business.

And to the extent that there might be jobs issues here, there needs to be just as many people in the private sector servicing student loans, whether it's a FFEL traditional, a FFEL purchased by the federal government, or direct loan program, the question is, what are the incentives that we build in, so that we get the best service that serves the tax payers best and serves borrowers best.

That is the approach that we are taking, taking advantage of competition and using the private sector on the servicing side.

In terms of origination, we already have an approach for originating Pell grants, at virtually every school in the country.

We currently contract Accenture, which runs a system called the Common Origination and Disbursement System where schools draw down money from the Federal Government and then provide data back to the Federal Government to say, here are the students who received Pell grants.

The concept of adding on an element to that where they draw down money for student loans and send back data that says, here are the students who received federal student loans is an easy add-on to the system already used for delivering Pell grants. And the major difference is that with a student loan, there is a promissory note that needs to be signed.

There is also in FFEL, a promissory note that the school needs to make sure gets signed, and the processes certainly are different and involve schools having to learn if they are in Pell and moving to the direct loan program, they have to learn something different, but it is not something that is enormously complicated.

It is also important to point out here that lenders are not making the usual decisions that lenders make. Usually in a loan program, a lender is deciding, this is a borrower who I want to lend money to, because I consider this student to be worthy of an education at this college or this is an amount I am willing to borrow because this school is worth it.

That's what you would do with someone buying a car, someone buying a home. You would look at the borrower, you would look at the asset, and you would make a decision about whether that's a risk you are willing to take as a lender. Lenders do not do that in the federal student loan program.

All those decisions are made by the formulas in the federal student loan program or in the federal financial program overall, and with the administration of all of that undertaken by financial administrators at colleges.

And this brings me to the issue of the capital that is provided. The lenders are not making the decisions about risk. In fact, we as the federal government are protecting them against the default risk.

And essentially, when lenders are raising money, they go out to private investors and say, "Hey instead of buying a treasury bond, why don't you buy this bond that is backed up by the Federal Government?"

So the federal government on its balance sheet shows this risk as a contingent liability.

In other words, if there is a default on these loans or if interest rates don't turn out as we had anticipated, this is on us, it is on tax payers, but all of the payments for students, all of the extra interest on top of the overall payments go back to the private sector lenders even though they are not taking the risk on those loans.

And we promise these interest subsidies that we have come up in Congress commercial paper plus some kind of an increment.

And what that means, with that kind of a fixed rate that is not based on any kind of competition. It means that if it is enough of a subsidy or too much, the lenders get to keep it. If it is not enough, they don't make the loans and they come back running to us asking for more.

So on the situation when they had 9.5% returns, it was way too much. They took advantage, they brought in more money, it was not anticipated and they got all that extra money.

And then in the last year, when subsidies had not been high enough, they didn't make loans. We had to go to an entirely new system of providing the money upfront and paying different kinds of fees. So it is not a competitive system and it is not a system that assures that the loans actually get made.

In a direct loan approach that we are proposing, since we are taking the risk, we provide the funds, borrow the funds from the same people who would lend the money for the bonds that would have gone to lenders and secondary markets in the student loan program.

You can think of it overtime as we borrow the money, students repay, and in a sense it creates a revolving fund where only the subsidy needs to come from either tax payers or from borrowing from the capital markets.

Because we are receiving the student repayments, that helps to overall cover our cost. And all of this together, these reforms not only reduce the deficit but lowers the federal debt overtime because it costs us less to subsidize the overall system.

We use those savings to plow into the Pell grant program to the Pell grant program an entitlement, so that not only do we avoid the potential drop in pell grants in a couple of years by $1, 000 to $1, 200, but we propose an actual increase in pell grants that would keep pace with consumer price index plus 1%.

We also include $500 million per year to go to states, because there is an important argument that comes up around FFEL. And that is that some of the entities that are involved in the guaranteed student loan program use a portion of their proceeds to do important things with schools and colleges, helping schools and colleges with outreach and information.

We think that's a valuable and important activity that happens in some states that are lucky enough to have money making agencies, other states don't have it. We want all states to have it.

And so we have created this fund that can be used for that purpose as well as to promote improvements in college completion, improving the number of students who actually complete and improving those graduation rates.

That's the overview and I look forward to questions after the additional presentations.

Scott Fleming: Good morning everybody, thanks for coming out. Sounds like this is a popular invitation and as much I would like to take credit for that, I am sure it is actually got a lot more to do with Bob than it does with the rest of us on this panel.

I do want to thank our host. Actually MaryEllen is one of my favorite people in this entire world and I have said before, I'd walk in broken glass for her. This maybe as close as I get, in fact...

Audience: [laughter].

Fleming: ... but I do appreciate the opportunity. The policy debating on lending has evolved into what I would characterize as TransWorld farce. New America has taken a fairly bold position by getting in between the two camps on this, but I do think it is a dialog worth having.

It is important to say that I am not a student lender. We have worked in the past with student lenders. We don't currently have any contracts with student lenders, but I guess I am sympathetic enough and Neil I think would say yes, and so that makes me qualify to speak on behalf of lenders.

But we do agree, at least the lending community does agree with a lot of what the administration has to say. That is access to college is very important. The Pell community has been a partner with the federal government in promoting college access for decades, and we feel like we have a done a pretty respectable job of doing that.

There are literally millions of borrowers who have achieved a college education because they got a loan from a Pell lender. That's a good thing in our view, and I think the administration will even agree with that that the college access on its face is positive.

Now, obviously, we disagree with some of the methods that the administration is proposing. And before we get too far, I just want to say that it is I think important to point that and Bob did allude to this, that under the current system, we are not actually paying, the government that is, is not paying a subsidy to lenders.

You can look at the subsidy rate, I will go three slides here very quickly, but basically on every loan that has originated since January 1, 2000, and the Federal Government is actually making money. That is they are collecting a negative subsidy rate from the lenders.

If I am a lender, doesn't matter who I am, if I originate a loan since January 1, 2000, I am paying back to the Federal Government.

So it is not that I get to keep any excess proceeds. Actually Congress has repeatedly cut that over time, so that lenders aren't making an excess proceed. We are actually making less on a federal loan than the government loan, based on the interest rate environment.

So what is it that the government is actually doing? It is not that the government is going to make money to pay for enhancements to the pell grant program or any other program that may or may not have a virtue attached to it, that's not the argument I am making right now.

The argument is really the government does a better job of extracting profits from borrowers than the private sector, because the Federal Government is going to be charging borrowers the same interest rate.

And you can see from this chart right here, the red area is the arbitrage rate the Federal Government is going to be earning. That his borrowers are going to pay an identical rate regardless of who the lender is. It is just the government is going to make more money from that than a private lender would.

Well, that by itself doesn't make direct lending or FFEL virtuous or unvirtuous. It just says if the argument is over who does a better job of extracting profits from borrowers and that happens to be the Federal Government, well I am not sure that that's an appropriate use of federal policy.

Just for the sake of illustration, which you probably have already done in your own head, but if I am an undergraduate borrower and I take out the average amount of debt, 22, 700 according to the last College Board's study for an undergraduate degree recipient, it doesn't matter who I am paying the interest rate here.

It is going to matter the same amount overtime. A 10-year repayment at a peer body is $100 in interest, if a private lender is holding it where the Federal Government is holding it.

Now the idea that Bob articulated is that we are going to increase grant aid and that is going to hopefully reduce the amount that students needs to borrow to pay for college education.

And that is actually a great plan in theory; overtime, however, you can see that the Federal Government has considerable increase grant aid to the tune of almost 80% adjusted for inflation over the last 10 years, and that hasn't had any significant reduction in terms of borrowing. Students are still borrowing and that has been up about 70% over the last 10 years.

So there is not a one-to-one correlation saying that for every dollar that I increase in grant aid, that's a reduction in the amount of tuition the borrower has to pay, partly because not every borrower, not every student qualifies with FFEL grant. Only about 50% of undergraduate students actually get a FFEL grant of those who apply.

Graduate students obviously don't get a FFEL grant at all. So in some ways they are saying to graduate students in particular, please pay an arbitrage rate that is extraordinarily high, because the government does have a cheaper cost of capital to subsidize undergraduate students, but only half of undergraduate students that actually qualify for a FFEL grant.

That doesn't seem to be a fair distribution of the benefit.

Well, I will just dive in. I guess the ultimate fighting championship is not the fastest growing spectator sport, because there are two guys being very nice to each other in a cage. It is because they throw them in there and they just beat the lights out of each other.

And that's what this debate has turned into and I am not going to try and take that Tom, because I actually do believe that the administration is approaching this from a sincere belief that they want to do the right thing.

And lenders for the most part don't disagree with what the administration is trying to accomplish, it is simply that we disagree with the practice. So with that said, a switch to a 100% direct lending is effectively a tax.

You are taking a set of borrowers, you are applying the same interest rate regardless of who they borrow from. Just that the Federal Government is going to charge an interest rate of 6.80% and extract all the profit for its own purposes.

Now, the definition of a tax is, as you can see from dictionary.com, is just simply a sum of money demanded by a government, in this case the government is demanding a 6.8% rate of return on a loan that it is making.

Now instead of taxing an asset, what the government is doing in this case is actually taxing aspirations, because you are telling students that are borrowing, that the more that you borrow, the more the government is going to make, the more that the government is going to put back in the FFEL grant program.

That seems to be somewhat backwards in terms of the approach to federal student financial aid policy. It is not that there is anything wrong with the FFEL grant, but it is paying for it by taxing borrowers that have need in the first place.

Now the irony in the 100% direct lending program or the proposal, I think, is that it does put the government in the same position the lenders are being criticized for before.

They are saying to a lender, if you are earning excess interest and you are turning that into borrower benefits in the form of interest rate reductions or suppose it is a benefit for on-time repayment, those are obviously proof that the lender is making too much money.

That the lender is taking advantage of the student or advantage of the Federal Government, because you have more money than you need because you have excess capital to provide benefits like that.

In this case, the Federal Government must be doing the same thing because they are extracting profits from the borrower, and they are applying it to scholarship program in the form of FFEL grants, but in this case it is on how virtuous.

Well, simply because the government is doing it and not the private lender doesn't seem to make the case that it is virtuous or not virtuous, it simply is what it is. If it were a private lender doing it, he would be criticized but in the case of the Federal Government, it is not. And that seems to be a bit of a paradox.

Now stepping back from the tranche warfare for a second if I can, the government is going to provide $1.4 to $1.8 trillion in student financial aid over the next 10 years. That's an enormous amount of money.

The $100 billion for FFEL is not an insignificant amount, but it is still by all accounts it is not going to tip the scales, college is not going to be any more or less affordable even with a substantial amount of money dedicated to the FFEL grant program.

The real issue is that the cost of college is out of control. Lenders are not setting tuition prices, the government is not setting tuition prices, both are in a position to do much better if tuition goes up, and if the government is making the loans and they extract all of the profits. If the private lender is making loans, then we too can benefit.

But the issue isn't that the tuition is going down, it is quite the opposite. So we are going to spend an enormous amount of money to find us a college education. And it doesn't seem like the government is getting a true value from the investment that it is making because the cost continues to rise.

Now if you were to eliminate FFEL, you do actually have a net negative effect. One of the first things that goes is the philanthropic activities. You don't see college access programs being supported, you don't see the financial aid nights, those types of things.

There are scholarship and [inaudible 27:08] programs, interest rate reductions, all of that disappears, in some cases making the loans more expensive for borrowers but in many cases, making the process much more difficult for borrowers to understand.

You can argue and I think many will, but the government can take over those responsibilities. But that doesn't come free, it is not without a cost, the government if it is going to replace those activities, it has to pay for it somehow. Also you are eliminating choice.

When I attended school and I borrowed from the neighborhood community credit union where my parents had banked for 30 years, that was a choice that I was able to make. Under a 100% direct lending scenario, that's not an option any longer.

Maybe that's a good thing or not a good thing, but in my view and I think the view of many, it is a good thing to have consumer choice among lenders.

You also have loans to protect the borrower interest. And this is one area I think where we agreed to the extent that the private or the administration has admitted and, I think can cease the point that private servicing is done better, that the private sector actually can facilitate servicing student loans, more effectively than the Federal Government can.

They currently contract to it. The proposal is to expand the number of contractors so that the private sector handles all the servicing for loans regardless of who makes those. And so I think that's what we would say, is that the private sector does do a better job of servicing but you don't need to eliminate the FFEL program to achieve that level of servicing.

Now I think I would go out on a limb and say if you wanted to impose certain limits on FFEL rates or things like that, there are certainly policy arguments to be made on how you can improve the level of service even within the FFEL program, but I don't think you get there just by eliminating it altogether.

Finally, and this isn't on this slide, but I think there is a case to be made that if you go to a 100% direct lending, all the innovation that is currently present in the FFEL program disappears.

The federal budget, by its very nature, is resistant or perhaps impervious to innovation. You can't do anything to benefit borrowers by sliding down the interest rate here or there because there is a cost to the Federal Government.

Even if a borrower wants you to take a 2% reduction which many borrowers in the FFEL program do claim a 2% reduction on interest rate payments because they have made for consecutive years long-time payments. If the government wanted to do a similar thing, there is a cost impact.

So the government can't offer you the same benefit. There is still substantial controversy over what shall actually means when it comes to the direct lending program.

If the government wants to be more responsive to borrowers, in some cases it has to play very fast and loose with what the federal law says. Now that just says that the Federal Government and the federal budget and Congress too have a hard time being as nimble as the private market.

And just a quick aside, Bob mentioned the interest rates setting and I think that's true. For many many years 9.5% rate was the floor, then it became a ceiling and more than anything else, I think it simply says the Congress has a very hard time setting market interest rates.

They can't react quickly enough to market conditions to tell the lenders what they interest rate should be, so that leads me into my next point.

And that is can you move beyond FFEL versus DL. I think you can. I think we are actually at a point where we should. The first thing that I would is stop putting Congress in the position of having to set a federal rate or rate for student lenders. Let the market set a rate. You can do that by any number of different mechanisms.

You could use federal index rate that is already out there. You could use home mortgage rates for example, and peg the borrower interest rate to that. Let the direct lending program make rates at that level, and if the private lenders can beat that rate, then they can compete directly against the Federal Government and make the loan.

Doing this, you eliminate the need for any special allowance payments on the part of lenders, which is, over time, the only part of the FFEL program that costs the government money, unless you include the in-school subsidy payment, which I haven't heard anybody argue that we're trying to do away.

Except maybe the College Board, I think they suggested moving it to the back end.

But I think we agree with the administration, you can use the common origination and disbursement system to originate private loans as well as federal direct loans. There's no inherent limitation on the capacity to do that.

You can provide credit enhancement to the borrower at no additional cost to the government, because if a borrower defaults on a loan that's guaranteed by the government, the government makes that money back on collections. That's always been the assumption in the federal budget, so you can do so without any cost.

And by doing that, by eliminating special allowance payments and by eliminating several of the other costs associated with the existing FFEL program, you generate savings that can still be applied to support Pell or any other borrower benefit that you need.

The advantage of doing this, in addition to the cost savings, is that you do also preserve consumer interest. You have competition among lenders, you have incentives for strong servicing, and you have the individual attentiveness to borrowers that the FFEL program can provide. You do have private participation and you improve the overall program effectiveness.

That said, there is a lot that, I think, we agree with the administration on, and I want to highlight that, that it's not about a blind allegiance to any particular vein of thought. We agree, there's an important issue in this country right now, and that is college access.

I think the private lenders in FFEL are committed to improving college access overall, we simply disagree with the methodology that the administration has put forward.

[background noise]

Paul Combe: Good morning. I guess my role is none of the above, from a process point of view. If we look at the last 15 years in student loans, in student lending, there has been this ongoing debate between FFEL versus DL. And the debate really has focused on -- and I'm going to loosely go through the presentation, by the way, just to save time.

It has been loosely based on which program costs less. It's a budget question, it's been a budget battle, and there have been a lot of ancillary arguments. But the fundamental issue we've been talking about has been which program costs less from the federal government's point of view.

And in many respects, we need to start looking at the program as how effective have those two programs been? And I'm saying together how effective those two have been. There's been a lot of competition between the two programs, and when DL was implemented back in the early '90s, it was actually solving a problem.

The problem was -- I was a director of financial aid on campus, and had to deal with multiple lenders, multiple guarantors, multiple systems, multiples forms, and so on, from that point of view. And it was a problem, it was an issue that had not been solved. DL focused on solving it, and DL was an efficient program from that point of view.

It's a single system, it's a single delivery mechanism, single processes, single procedures and so on, so it solved that problem. But in implementing that, it actually created a competition between the FFEL program, and the FFEL program started creating those types of efficiencies and developing the systems in common and so on.

And that competition grew in the late '90s and into 2000, and actually started with price competition. We would not have had the student loan rates drop as they had without that effective competition between the two programs.

So the simple point is, if we have to choose between -- we're in this box and we're choosing between one and the other, no matter which way we go we're going to lose something from this process. And the fact of the matter is, what we should be looking at is how to take that competition and implement it from a policy point of view so it's effectively working to go forward.

So we are continuing to improve the systems through competition in the programs, we are continuing to improve on price, and we are most effectively, continuing to improve on service to borrowers.

Bob lined up the program, that we have three issues we've got to deal with. We've got the capital, the source of capital, and how to deal with the capital and bring it forward. The origination process and so on. And everything that happens after that: the loan servicing, debt management and so on, from that point of view.

And I think that's the appropriate way of looking it. The simple point is there are ways of bringing multiple sources of capital into this program. Scott outlined one, where you can effectively have that competition going on, so there is a price competition in that point of view.

Efficiency through the single system -- and DL has shown it. A single origination system, it's a federal financial aid program. I firmly, believe that origination process should be managed by the federal government, but allowing both for private and public capital to play on that.

Because the two programs have been running, basically trying to kneecap each other over the last 17 years, the programs were built independent of each other. If a campus chooses DL, they choose the DL system, which by definition precludes private capital.

And if you choose the FFEL program, you exclude the federal government as a lender from that point of view. And at the same point in time, certain FFEL systems can exclude other FFEL lenders from that point of view.

So the system can actually become a means of restricting competition within a thing. So there needs to be single system, and that DL answer is, I think, the appropriate thing.

My interest is actually on the last part of this. Because if we look at the problem that DL solved in the early '90s, what problems do we need to look at what problems do we need to solve today? And today the problem is debt. And it's not only student debt. From a national point of view, we don't have a credit crisis; we have a debt crisis, from that perspective.

You can't pick up a newspaper on any given day without seeing some story about how student debt has affected the borrowers, after they've graduated. So if we look at it from a policy point of view, we've got to remember that we've chosen debt. As a nation, we've chosen debt as the primary means of financing access to education.

We've given the students a Hobbesian choice. Go to the college of your choice and get in debt, or not go. And so from that perspective, the fact that we are using debt is one of the key elements that we have to look at in solving the problems that we have to do.

So my basic comment is that we need to step back; it's not this either FFEL or DL choice. We need to look at ways that make sure we're solving today's problems as we go forward, and that problem is student debt.

So if we're looking at it and we really wanted to... Last summer I was invited to speak in China, and asked to describe the US program. They're looking to develop their own loan program. There's no way I could have recommended that they come up with what we came up with today, from that point of view.

So if we're looking at how we're going to go forward, we need to choose the principles that are going to guide us. And it's not just the cheapest program. One of the things I liken it to, if we can do health care, we can do it cheap, but cheap is not preventative.

You don't get healthcare -- preventative things are the first things to go when you're talking about efficiency in budgets from that point of view. So if we're going to do it, we need to focus on the right things, and the right thing is going to be on the consumer.

Because we tend to think of the borrower as an applicant first and then a recipient, we forget that once they sign that promissory note, they do become consumers. And whether it's from the federal government or a private lender, they are a consumer and they have rights.

But the interesting thing is, because we are inflicting this debt on them for access purposes, for policy to better their lives, and if we better their lives, we get better taxes, we have a better nation, an educated force. Because we are doing that, they are actually consumers with extra rights.

And we've got to think of this factor, that if we are getting them into debt, the federal government has an obligation to help them get out of debt in this process. And so the key element -- and Bob has focused on it -- that is how we do, effectively provide those debt management service programs.

So we can have alternative sources of capital, we can look at a single system that opens up the program to competition and choice for the borrower. But we need to also focus on how we affect, efficiently providing debt management.

So the key point is, if we look at what is debt management, we need to think about it from the point of view, the federal programs -- we've had a long dialogue in this country about financial literacy, the use of financial literacy and so on, and how we do that.

We need to start thinking of these federal programs as not only the main financial aid program access to education, but over the life of the loan, these programs become the ultimate teachable moment for those students learning how to manage credit.

And we need to start focusing on that fact, that it's not just waiting for the borrower to get in trouble, that debt management is not due diligence, that you're not sending a letter when they're 30 days past due or 45 days past due.

It's not waiting for them to get in trouble, it's actually being there in a proactive way, providing them the information they need before they get into trouble, so they can make reasonable, good consumer decisions in that process.

Congress has supplied to the students in this program all kinds of remedies to solve problems, but communicating those remedies is very difficult to the borrower, unless you can proactively communicate with them.

So debt management really is looking at the federal student loans as that teachable moment. And it is a continuing intervention.

It needs to be providing educational activities in a proactive way, targeted and engaging to the borrower before they get into trouble, so that it impacts their financial wellness. This is proactive. It's something that is not measured by profitability. It can't be said you can do these five things and that's debt management. It's due diligence process.

You need to be able to be out there and effectively competing to do this from that perspective and moving forward. Bob has mentioned that the guarantor community, and ASA is the oldest guarantor in the country -- we were created in 1956, that nobody can describe what they do.

ASA effectively back in the mid-90's, we looked at this. We looked at the role of the guarantor and basically came up to the same conclusion.

My joke with my board of directors at the time was a "New York Times" cartoon that showed a man standing in front of the boardroom saying, "The good news is we can lower costs by eliminating the middle man. The bad news is we're the middle man."

[laughter]

Combe: So the point is when we looked at this back in the 90's and looked at is there a role in origination process. And as I said, effectively, you can create a more streamlined origination process and eliminate the guarantor's functionality there.

Federal government does guarantee the loans right now. So that whole concept of insuring the loans went down when the [inaudible 42:17] went down in the late 80's. And even from a collection point of view, that's something that the private sector would be happy to do from that point of view.

And as a public purpose entity, we needed to focus on what is our role as a not-for-profit, as a public purpose entity. And as a public purpose entity, we should be doing something that the federal government, that the government should do, but can't do effectively and that the private sector can't do.

And the one thing that this public purpose can do is the debt management side. It is a public purpose initiative that provides the services to the borrower over the life of the loan that they need in a proactive way.

So one of the points is, ASA became, fought for, got the voluntary flexible agreement arrangement. Voluntary flexible agreement gives the Secretary of Education the ability to waive rules and regulations, to look at new ways of financing guarantors.

ASA entered into a VFA in 2001. And what we basically said is our mission now was to help students, successfully complete a program of education financing repayment. Not access to education, but complete that program of financing repayment.

So we created the VFA, basically changed the financial structure so we're only paid for loans in good standing, and set up a series of programs above and beyond the standard due diligence process. And each one of these programs is aimed at a targeted population at a targeted time, to give them the information they need at that time.

So the journey is basically aimed at getting the first payment in the door. So it's an effective program, looking at getting that first payment in to maintain those payments over that cohort default period. Transitions is for withdrawing students. There's a consolidation program.

So each one of these is aimed at that teachable moment for the borrowers from that point of view. At ASA, we look at it from the point of view that debt management is a contact sport. You need to be reaching out and contacting the borrower.

And that means not just making a telephone call or leaving a message. It means actually getting into a dialogue with the borrower from that point of view.

And all data shows that once you enter into that dialogue, that you have this contact with the borrower, it's effective. So this is ASA's cohort default rate, the green line versus the national cohort default rate. And I'm not sure if you see it, but from 2000, ASA, we were a Massachusetts guarantor. We had a fairly good portfolio.

So in 2000, we were below the national average. But you see once we started the VFA, the spread just kept getting bigger and bigger and bigger from that point of view. So that contact, that communication has been effective from a national point of view.

This is the cohort rate. The other rate that measures guarantors is called the trigger rate. The trigger rate measures of all the loans that are in repayment, of all loans that can default, what percentage does default. Again, in 2001 ASA was 61% of that national average. And we are able to drop that rate from 61 to 60 to 54% all the way down to 49% in 2004.

At that point in time ASA became more of a national guarantor. Our portfolio grew from about four billion dollars to over 45 billion dollars in national volume, from that perspective. So you can see we went back up to 58%, because the risk of the portfolio went up to 59 and then started getting control of it again, and back down to 59. We have never gone up to the point.

So we have what is effectively a national portfolio right now that looks like it all came from Massachusetts. So contact works. And so the simple point on debt management from that point of view is, you need to be able to arrange these programs in such a way that there is multiple sources of capital, so there's competition from a price point of view.

There is the efficient single system that does it. And there is competition on this type of service that effectively provides the bar with. It can only be done not from a contractual point of view; it can only be done from a public purpose point of view with those entities competing with each other from it.

The final point, this is actually just a model between the financing and... Whoops.

Sorry. That slide showed how we move the money from the back end for where guarantors are paid for collections to the front end, where we're paid for loans in good standing.

So in the old model only 33% of the revenue came from origination and managing the portfolio. And over 62% came from collections. Now this is ASA's data, by the way, meaning we have a low default rate to begin with, so the numbers are not too high.

Under the new model you can move as much as 70% of all revenue to managing loans in good standing. So if you're only paid for loans in good standing, if they go to 90 days past due, you stop getting paid. So all the incentive is to keep the borrower in good standing or get them back into good standing from that perspective.

Thank you.

Jason Delisle: Hi, I'm Jason Delisle, here with Numerica Foundation. And because I'm going last, I will try and keep it brief so we can get to questions. I'm sure a lot of you are dying to ask questions.

What I want to do quickly is just give you my perspective as a conservative and a Republican on some of the absurdities I see in the debate on Federal Student Loan programs.

And we'll start with one that I think is a little bit difficult. I opened up the Roll Call newspaper; I think it was this week or maybe last week. And I saw an ad criticizing the Obama administration's proposal to go to 100% direct lending and eliminate the guaranteed loan program.

The criticism was that this would increase the national debt. It turns the argument on its head that we're trying to move toward a lower cost program, and here now someone has told you moving to the lower cost program will increase the national debt.

The argument that they're trying to make here is that because direct loans the federal government is lending directly, it has to borrow to make the loan. So in that sense, when it issues a $2000 loan, the federal government borrows the $2000 from somebody else to make the loan.

And in that regard, yes the national debt is going up. But when a lender makes a loan on behalf of the federal government, the federal government's on the hook for that loan for 97% of the principal of the loan. So, essentially the risks and obligations to the taxpayer of both of those loans are nearly identical.

And to suggest that somehow we have an increase to the national debt when the bank makes a loan that the taxpayers are on the hook for, is totally absurd.

To take it one step further, what you could then argue if you follow that line of reasoning that this ad suggested in Roll Call, we could eliminate all of the national debt tomorrow if we had banks issue treasury bonds for the federal government, and we just kept them on their books. We back them all 100%. And it's just gone. It's just there.

The federal government is still on the hook for all of it. But it's not on our books anymore. And that's essentially what this argument is in saying, direct loans increase the debt and the Fell program doesn't. It just doesn't make any sense.

Again, it's important to remember in this argument that according to OMB and CBO, and a lot of other budget experts, the direct loan program is cheaper and, therefore, has less of an impact on the national debt. So that's one argument.

Another one you'll hear that is sort of strange that strikes me as particularly strange, especially as a conservative, is that the Fell program is more efficient because it relies on private entities, lies in the private market.

Direct loans don't, the federal government is making the loan. And so it doesn't have any of the efficiencies that go along with the private market.

I'm receptive to this, because I think generally that's the case when you involve the private market, it is more efficient. But because the student loan programs are so strange and designed in such a way, especially the FFEL program, the guaranteed loan program, the efficiency of the private market is never really brought to bear.

The subsidies that are set and paid to lenders are set by Congress. There's no competition in the private market for those subsidies. We don't say to lenders, "Compete on the subsidy and then we'll take a low bidder and we'll find out how much efficiency is really there."

We don't do that. Congress just makes up a subsidy -- Bob was talking about it and so was Scott -- where we have basically pick an index and add a little bit more to it. Right now it's 1.79 percentage points.

Why 1.79? I don't know. It's really just made up. It's members of Congress sitting around saying, "What do you think? 1.8? 1.9? 1.4?" And then the student loan lobbyists come in and say, "No, it's got to be 1.65, 1.62." and we settle on a number.

Now to the extent that lenders are really efficient -- this is the private market efficiency argument coming in. To the extent that the lenders are very efficient in making the loans, the still collect the same subsidy. So all of the benefits of efficiency accrue to themselves through higher profit margins.

Which is not necessarily a bad thing. We want companies to be profitable. But to turn around and make the argument that this efficiency somehow benefits the federal government of taxpayers under the FFEL program is, totally absurd.

And the irony of the efficiency argument of involving private lenders I would say is that it actually might be less efficient. If you think about it, you think of the draw on the private sector. Lenders making loans in the FFEL program are actually carrying out a government program. So this is really government activity done by a private company.

But we've enlisted literally thousands of lenders to do this. Sales forces, thousands of peoples in sales forces that go out and try to make these loans, which by the way, the terms of the loans are set by the federal government already, so there's very little room to differentiate the product.

But still we have thousands people making them, sales forces, money spent on advertising. Which again, this is essentially government activity that private lenders have taken on. Guarantee agencies, software programs that lenders come up with. And no think, when you have that kind of complexity...

As a Republican, that immediately I think of, if you have that kind of complexity in a government program, imagine the oversight that you need to make sure no one is doing anything incorrectly or doing anything improper, which we know has happened several times in this program.

And in fact it's this complexity that makes this program kind of scandal-prone. The 9.5% bond scandal. We had the pay-for-play scandal. And who knows what other ones may be lurking out there that we haven't discovered yet, because the program is so complicated.

So that, I think, is the private market efficiencies debate of this program. I'll run through just a couple more really quickly.

Scott was talking about the borrower benefits. You hear this a lot in this debate, that lenders again, the terms of the loan for the borrower are set in statute. The interest rate is fixed at 6.8% for the borrower. The length of repayment is 10 to 20 years or longer if you have a lot of debt. So all of that is set in law.

And what people are talking about and what Scott is talking about when we say that the lenders provide borrowers benefits, is that they provide a little bit more. A little bit better terms than what's set in law.

What lenders are doing is they're saying is, "The subsidy I'm getting from the federal government is generous enough that I can pass a little bit more of that onto the student, " in the form of better benefits.

So the most common one is that, a few years ago, lenders would give students a one percentage point interest rate reduction for on-time repayment. That was the most common one.

But you don't need to preserve high subsidies for lenders in the hopes that they'll pass these benefits on to borrowers. Remember, all the terms of the loan are set in statute.

So Congress, if the borrower benefits are so important to members of Congress -- and you'll hear them on the Senate floor or on the House Floor saying, "We need to preserve the borrower benefits." They can write them into law.

If they want a 5.8% interest rate for all students, they can write that into law and all students will get it. Now Scott said that the direct loan program provides extra borrower benefits. It costs something. The guaranteed loan program provides these borrower benefits through lenders, it doesn't cost anything.

Well, it does cost something. It's the lender laying off a little bit extra of the subsidy it gets from the federal government to create a more generous student loan. So the money is all coming from the same source, it's coming from the taxpayers through a subsidy.

So the borrower benefits from the direct loan program and the guaranteed loan program can provide the exact same terms for borrowers and the same level of generous level of benefits, it's that Congress just needs to write it into law, like they do for the base set of benefits.

But I've found that most of the members of Congress who are arguing that we need to preserve high lender subsides in the hopes that maybe they'll pass that along to a student, none of them are offering any legislation to actually write the borrower benefits into law.

They'd rather pass it through a lender and hope that they give it to a student, which I think is not the best way to go if you really want students to have better terms on their loans.

And the last point I want to make is the argument about customer service. This comes up a lot between these two loan programs in this debate.

And again, as a conservative and Republican, the argument that people say is, "The direct loan program is run by the federal government so it's got inferior public service, and the guaranteed loan program is run by private lenders and it's got superior customer service."

I'm a little bit receptive to that, but private lenders do have a little bit different incentive to provide really good customer service in that they are competing for the students' business for the loan, and they may be competing for further business for different products.

So if you have your student loan from Citibank, and it's the only product you have from Citibank and you call them and they never answer the phone, when you want a mortgage or insurance, you may not go with Citibank because you're so upset with the customer service you've gotten.

So there is a little bit of disciplining that goes on that may not go on with a government-run servicer.

But it's not quite so black and white, because in the direct loan program, the federal government contracts with private servicers, so again, they don't have the same competitive discipline that I just described in the Citibank example, but they are competing for the business for contract from the federal government.

And in fact, maybe some of the same private servicers running both loan programs.

But let's just assume for a minute that the FFEL community and the guaranteed loan program, their supporters are right. There's much better customer service in that program than in the direct loan program, for both students and financial aid offices. But what's that worth? How much more should we pay for it?

Better customer service costs you more. Is it worth a $1 billion dollar more each year? $5 billion? We don't know, and no one talks about it in those terms. I think it's really important to ask that, because that's the trade-off. If that's what the supporters of the FFEL program really believe, then they have to also ask how much is it worth, and how much more are we paying for it.

I really doubt that it's worth $94 billion over 10 years. That's quite a large trade-off to be making for slightly better customer service, and I'm using CBO's cost estimates that just came out a few weeks ago over 10 years, the extra cost for the guaranteed loan program.

Now I've just run you through a few of these arguments. There are many more. And if you'd like help in understanding them or like to hear a different perspective, you can always tune to our Higher Ed Watch blog, where we spend a lot of time trying to help people understand these arguments. Thank you.

McGuire: Thank you. I'm just going to try to keep this short, because I'm sure there are a lot of questions from the audience. One of the things that I want to address, sort of building off of Jason, is the arguments that we've heard.

And another argument that I saw recently featured in an advertisement is that moving towards the administration's position is a mistake because you'll be nationalizing the student loan program.

And my response to this, and I'm interested in what your comments would be on this from the panel, is how do you nationalize a program that is already federally run?

The FFEL program provides a subsidy to banks. It guarantees against risk and now the program actually provides funders with capital, which is exactly what they were designed to do.

So I am just interested in what your thoughts are on this argument that you have been nationalizing the federal student loan program. Bob, do you want to start?

Shireman: We have kind of asked the same question when we have heard the argument, that is, we are not in a situation of government run program versus a private sector run program. They are both some of each. Certainly the impression has been created over the last 15 years that the direct loan program is a government program.

So, maybe the way we should actually handle this is to let people think that and say, "OK, we'll do something in between. Let's use private sector servicers in the direct loan program instead of having all these government employees collect on the loan.

We will go the middle route. We will hire private sector servicers and use competition. We can even call it something different. We are splitting the difference. We will use private sector servicers and give up on our big government program that hasn't existed."

[laughter]

McGuire: That's good.

Fleming: Yeah, I figure that I have to respond to that.

[laughter]

McGuire: We are hoping you will.

Fleming: The issue I guess -- and if I am going to be brutally honest -- I don't think the nationalization argument works that well for the lenders, just because they have been using government capital.

A true nationalization, and Bob alluded to this, would be if the government would take over every aspect of the lending programs -- administer it themselves, service it themselves, hire 10, 000 new federal government employees to handle the servicing and not go through federal contracting.

So, yeah, you do end up actually -- chase me on this point -- push out 2000 private lenders by going to a 100% direct lending. It's not true nationalization but there is an impact there. You are actually putting a lot of people out of business, if you were to go a 100% direct lending.

Maybe not all of them want to stay in the lending business, but there are a lot that do. By moving to 100% direct lending you are ending business for a lot of people who are currently involved.

So, yeah, it's not a true nationalization, but there are impacts. I don't think we can talk lightly about those when who knows what is going to happen, in terms of the private servicing contracts, there may be companies out there that employ a few hundred people on the student loan industry.

They are probably not going to win a servicing contract but they aren't going to be making loans anymore. So those 200 people are going to have to find something else to do.

Whether you agree that they should be making loans and whether the government should be subsidizing those loans, or in the current context not subsidizing those loans since the government is not paying us subsidy right now, that's still an issue that you are going to have to deal with.

What happens to those 200 people? Are they going to move on to something else, or they are going to be government contract employees or are they going to find another job somewhere?

It's not the same as nationalization but I don't think you can completely escape that argument.

Combe: Well, the point you made that this is a federal program, I think we have lost track of that somewhere along the line that this is financial aid. This is a financial aid program. It is there for a purpose. It is providing access to higher education.

Along the way, these arguments -- because we are in the box between felt and Delisle -- we have all these arguments that go on. But they are within the construct of that. Those are the only two book sets you can have and those are the only two decision points you can make.

At some point of time, the argument starts to sound like the old beer commercial taste grade, "Let's fill it." [laughter] Sorry to go back, but the simple point is if we are looking at -- this is, I think, the key point -- nationalization, federalization -- I don't care.

If we focus on what we need to do right now, and the point is we have a rare opportunity. We have a President who is willing to make change, who is looking at these changes.

The programs are obviously at a point where the FFELs are not working, period. It's from that perspective. So, if we are going to do that, do we stay in the box and just keep that, "This one fails, therefore we are here." Without looking at what are things wrong with that program as well, in a constructive way. And the only way we can look at is how it helps the borrower.

I don't think the borrower in some sense has been asked. Do they want to borrow from -- this point of view? What does the consumer want in this process? We don't have that question. I have seen some numbers that if given the choice, borrowers would pick a local private lender. So the point is how you bring those people into the program, so they have that type of choice.

So I think that's the point. You can deal with all these issues of the budget and so on, but it still misses the point, "What's good for the borrower? What works effectively for them?" Not only from the point of view of access and origination and getting the money, but over the life of the loan, in managing that debt that we are giving them as part of our financial recovery efforts.

Delisle: I think the nationalization argument is kind of silly, but again, it tries to play on this through deception, at the FFEL program, the guaranteed loan program as some sort of private lending. It's private loans or private market activity, but it's government activity.

These lenders are making the loans because of the government program. That's really what it is.

From a conservative point of view, if a thousand lenders go out of business -- we are running a government program -- but everyone still gets the loan at the end of the day, all the students of it loaned, that's good. We've gained efficiency. We have fewer people running a program that delivers the same benefits to everyone.

Yeah, those people have lost their jobs but maybe they will find jobs that are perhaps more productive, more necessary, or generate a higher return for themselves, for taxpayers, and for the economy as a whole.

But if this is an argument about jobs and we want the program to preserve jobs and create jobs, well, then triple the subsidy to lenders -- quadruple it. They will get more money and they will hire more people. They will have more sales forces, they will do more advertising, and we will create more jobs.

Now, I don't know if that's really the best use of our resources, but if you want to create more jobs that's how you can do it through this program.

McGuire: My next question I am actually going to direct to Bob, and certainly if anyone wants to comment on it or Bob's response, please do.

Bob, as you know, the direct lending program has been plagued by criticisms about poor quality of service for some time now. There is, and I do think it is a valid concern in the community, about the capacity of the department to assume all future loans.

So my question to you is what plans does the administration have to ensure a smooth transition to 100% direct lending, if that in fact comes to fruition?

Shireman: Well, the department has been preparing for a 100% federal loans even before this administration, previous administration began, and part of this is because of the ECASLA, the emergency program that was set up to keep the FFEL origination occurring.

Many of those loans, perhaps most of those loans, will be purchased by the federal government, and the federal government will be contracting with private sector servicers to collect on those loans.

Whether it is FFEL loans purchased by the federal government or direct loans made by the federal government, we are preparing to have full servicing capacity for all of those loans.

Having that capacity doesn't depend on whether Congress acts or not, because the lenders have the right to sell all of their loans to us. So we have to be prepared with the private sector servicers who can handle that full capacity.

That's part of the reason for the contract that is currently in its selection phase, to select some multiple servicers. The benefit of having those multiple servicers is we can promote the kind of competition to make sure that we get high quality service, prevent defaults and get borrowers the information that they need.

McGuire: Would anyone like to comment? [pause]

Alright, I will throw it to the audience. Christina is here with the microphone. If you can just raise your hands, I will direct her your way.

[pause]

Clayton: Alma Clayton Patterson, Association of American Colleges and Universities. Bob, you underscored a number of times the notion of an entitlement. Can you say a little bit more about the effect on student motivation and aspiration, and our global economic sustainability?

Shireman: Thank you. Yes, we have proposed making the Pell grant an entitlement, because it's been every time we ran into these situations where there is a shortfall in the program. There are articles around the country that make it sound like you may or may not get a Pell grant or there may not be an increase in the Pell grant.

Even though on a year by year basis, whatever Congress has set the Pell grant maximum at, everybody who qualifies gets their Pell grant the way it is run right now.

It does not have that firm feeling of a promise from the federal government. We are going to reach this national goal of completing degrees. The population that we can make the most progress with are low income students and low income families.

So making a firm commitment from the federal government that the program is not just going to be there this coming fall, but it is going to be there the fall after that and after that and after that and after that.

So we can give somebody an estimate, who is in middle school right now, and say, "Well, if you are going to college today, here is how much you would get."

This program is locked in. So it is going to be there when you graduate from high school. It not only makes them think, "I can pay for college, " it makes them think, "Yes, I should take these courses. I should really try in algebra, because there is money for me for college. College is not out of the question."

That's the kind of feeling we want to promote in K12 to help prepare for it and get us to that college completion goal.

McGuire: Thank you. Actually it's there and then I will come on with Doug Letterman.

Doug Letterman: Hi, I am Doug Letterman, from Inside Higher Ed. Because this is mostly directed at Bob. As somebody who has covered this on and off for a long time, I have long considered the fighting between the two programs to be distracting, if not destructive.

I am curious if there has been a lot of talk, recently about a third way. Several of you have referred to it in some ways.

I guess I am asking Bob, is there a third way that would fully take advantage of the strengths of the existing two programs and avoid the weaknesses of the existing two programs. Obviously, you hinted that you think your way is a third way a little bit.

But I guess, have you seen any programs or any proposals or any instructions truly open to a proposal that would take it truly in a third way?

Shireman: I have seen some talk of other ways without enough detail to know what it really means, but there are probably other ways of achieving the same kinds of goals. So we can figure out how we can get capital at a reasonable rate, have a origination system that works well for schools, and has the right incentives at the back end to pay for servicing.

Really, I think a lot of what we are talking about, 90% plus of what we are really talking about here, is how do you arrange for and pay for servicing on loans. Do you do it at the back end, do you have a front end thing where somehow entities are selected by some school or some student or something.

It's not a question of who gets loans, who doesn't get loans. It's all a question of how do we arrange for and pay for servicing of loans, because that's where the real work is. There are probably other ways of doing it.

When there are detailed enough proposals to get the kind of analysis from Congress and Congressional budget office to know what it means going forward in the legislative process, then that's worth looking at.

Delisle: Maybe I want to add one thing to that. I think that if there is some sort of consensus building or moving towards a third way and it involves private lenders.

It is really important that the compensation mechanism and the incentive system for lenders to participate or even servicers (what everyone calls them) have some sort of market pricing mechanism. So that we don't get in this business. We get away from this business in a new loan program.

Congress arbitrarily setting subsidy rates, not really knowing what it is trying to do and making up these rates. So, the best way to reform would be to create some sort of pricing mechanism. Now, there is an auction out there that is, maybe try this year, maybe next year.

It's on books though. In the Plus loan program, where lenders have to put in bids for how low they would be willing to go to offer the loans as they exist today. This has met with incredible opposition from the lending community.

In my experience, with that aspect of student loan reform, I would be surprised if consensus emerged from the lending community around anything. A third way that would have them competing for the subsidies they earn from the federal government. But again, I think that would be one of the most important components of any of those proposals.

Shireman: It is interesting to note once you ask the right questions you start getting commonality from people. There is common ground here. It is not this FFEL versus DEO.

One of the points that I think needs to be brought forward is that if there is going to be a means of getting to a third way. I think you are right. This is going to be very difficult to get the lenders, and the guarantors for that matter, into some kind of agreement on what it should be -- not-for-profit lenders, private sector lenders and so on. It is going to be very difficult.

It is going to take leadership and I think that's the point where it is the opportunity for the administration to take that leadership role and actually open up a dialog. So if we close off the dialog because the administration has its proposal, then we are not going to have the conversation.

The only way we can have the conversation is the administration takes the leadership position, and actually take the same position you are taking now, in trying to identify those possible third ways.

Do you have a back-stop already, so why not have the dialog?

McGuire: OK. Another question?

Shelly Saunders: I am Shelly Saunders, American Students Association. Just to follow up on that point, is there a reason why we are rushing through budget reconciliation as opposed to having a more open forum for the third way?

Shireman: I would say this is an open forum. It is not determined whether budget reconciliation will happen or not -- that is up to Congress. But it seems to me there is a lot of good conversation going on and people putting together proposals that they have been working on for a number of months.

One other thing -- ECASLA only goes until this next coming year. A decision has to be made whether there is reconciliation or not.

Michael Dannenberg: Michael Dannenberg, of the New America Foundation. This question is for Bob. Correct me if I am wrong, but I think part of the administration's proposal is that students would get to choose amongst their servicers that would be awarded a contract. If that's wrong, please let me know.

If it is correct, that choice I am guessing has a cost. Australia, for example, collects its student loans system through their internal revenue service. We could do the same. I am wondering what the cost is for not doing that. So, what's the cost of the choice that Jason referred to?

Was there opposition to having the IRS collect student loan payments because of ideological reasons, because you thought there were these superior borrower services, or because the cost, the savings, weren't worth it?

Shireman: On your first point, I am not aware of a student choosing servicers component, though that could part of the discussions on the contract. I just don't know on the current contracts that are being discussed. IRS collection of student loan payments is not something that we spent time looking into.

There definitely are complications if we were to go in that kind of a direction, not the least of which is... you would want to be careful about unpaid student loan payments not being treated as an unpaid tax liability, which has some pretty severe consequences.

Now, those are the kinds of things that one could potentially deal with, but it is not something that we looked at too.

McGuire: In the back.

Angie Anderson: Hi, it's Angie Anderson from State University, New York. I actually have a question for Jason. Is that correct? You mentioned choice as something that students had in the FFEL program, and I am confused, because I think that a student chooses his school not based on what they are provided.

So do you have any examples or statistical evidence of a student choosing his school, solely based on the fact that they would have a FFEL loan and be able to choose a lender versus going to a DL school where they don't get to choose?

Delisle: You bring up a good point though when you ask for statistics and evidence. I have yet to find a really good, rigorous study about showing how students feel about the customer service they are getting between different lenders and also the direct loan program that wasn't funded by lenders. So I don't know many things that address that issue.

But as far as students choosing schools for a particular loan program, I don't think that happens at all. And then when they get to school, I don't think they spend a lot of time trying to figure out which lender to borrow from. They get a list of lenders. There's one at the top, the list isn't usually in alphabetical order, and they pick the lender at the top.

Or there may be some sort of negative feedback, where there are three lenders on this list that the financial aid office has prepared for the student, and they've heard something really, really bad about one of them from other students at the school. Maybe. So they don't pick that one, they pick one of the other two.

I really think that's about all that goes into choosing. Now lenders can always sell your loan too, so there's no guarantee that you're going to have that lender forever. And if you don't like the customer service the lender is giving you, you can't move your loan to another lender.

So these ideas of choice and customer service are pretty muddled. Does that answer your question?

Angie Anderson: Actually, I meant Scott.

[laughter]

Delisle: Do you have anything to add, Scott?

Fleming: I was going to respond anyway.

[laughter]

Fleming: I think maybe the only thing I agree with Jason on is that borrowers probably don't choose schools based on lenders. I think that's probably a given. But I do think the American economy is based on some amount of consumer choice. Now you may not know anything about the lenders you're given on that list. Maybe you don't want to; maybe you just want to take the one at the top.

But I think historically, Americans like to be able to say, even if I don't want to the homework to choose the lender, I'd still like to be given the choice. We don't go to McDonald's and say, "I'd like the breakfast." We go and say, "I'd like the number one, because I like the eggs," or whatever.

So I think there's an inherent value that's hard to measure, an intrinsic value included in choice, that there is a benefit to that. Now as far as there being a choice in servicer. Mr. Dannenberg, Michael, I got your attention, I see. You may include a choice among services, but I see that as being a very difficult thing for students.

Because on the front end, at least you may know the lender. In my case, I knew the lender. I wanted to borrow from the credit union. Many students may not want to do that. But in terms of servicers, you're trying to decide on somebody maybe four or five years down the road, who's going to service that loan based on what information?

That they competed successfully in a government contract, because they could do it more cost-effectively than the next guy.

I don't know that that's necessarily the same thing as preserving consumer choice.

Combe: It's interesting, if you bring up the concept of the school and the relationship to the borrower's choice, I think it's an important element that we have to bring into this. The school is the trusted agent in this process.

When the student selects, they do select a school. They don't select the school because the school has a lender, they're selecting the school for the education and they're going there. And as such, they really do have a lot of authority.

A number of years ago, Mike reminds me, we were in the debates about the school as lender program. The inherent problem with the school as lender program, there was a conflict interested there if the school was a lender and you think of student choice from that perspective.

So one of the things, as we go forward, that we have to think about if we think about the consumer -- and very often the freshmen don't think about who they want to lend, especially if their local bank can't do it.

And basically because of the nature of this program, we've gotten fewer and fewer lenders in this program because of the high entry costs of running the systems and so on.

Which is one of the arguments, frankly, for a single federal system. The borrower should be able to come with their local community bank's application and get it processed as efficiently as any other application. And they should be to choose that bank, their local guarantor, if they want, regardless of the school.

But the school is always going to have an authoritative role there. So we have to think about that concept of a neutral third party. There can't be conflicts there.

They have to be in a position to be able to make some decisions on behalf of the borrower, provide a list of lenders and or guarantors or service providers who they believe have provided good service and they have the data to show that over time.

That neutrality thing also goes from a debt management point of view. And I'm a firm believer that the only way you can really provide effective debt management is you never have any asset and interest in the loan itself, that you can't be associated with that loan.

You have to have a distance, because you have to be able to advise that borrower regardless as to whether it's profitable to the lender. It's in the borrower's interest. And in that sense there has to be that someone who is an advocate for the borrower, who gives the borrower a voice throughout this process.

And the key thing is, no matter how you work it, because in the end even if there is some form of private capital involved, in the end the federal government is involved in that transaction. In some sense, the federal government is not a neutral party in this transaction.

That's one of the things we need to think about, that it can't be a government service provider who's providing the contract, because some things may not be cost-effective for the government that may be effective for the borrower to do.

So this concept of neutrality, I think, is very important as we go forward. So if you're thinking about the consumer and their rights and their choice, you need that effective third party both from a campus point of view and from a debt management point of view.

And those are the two bodies, if you really worked it out, that would be consistent over the life of the loan with the borrower. It's going to be the school and it's going to be that debt management person. And if you ask the schools -- and we've asked that ASA -- who's responsible for debt management, the schools will say they are.

They firmly believe it. It's their alum that you're talking about. They believe it. They don't have the ability to carry out the work effectively, though. They just don't have the staff to deal with the last 20 classes as well as the incoming class.

So it is this matter of there is a strong sense of responsibility from the schools in managing this process. And we've shown data within ASA that the most effective way of dealing with the borrower and communicating with them is actually through the school.

McGuire: OK. We actually had two gentlemen up here. I don't -- there's Christina. I have one here and one here.

Delisle: And please address people by their last names.

[laughter]

Man: Good morning. [name] with US Student Association . Correct me if I'm wrong, but I heard no one oppose competitive bidding for the FFEL program. And if anyone would like to elaborate, if they feel competitive bidding is good option to continue with on the road to making this all better.

Fleming: From the lender perspective, a lot of the competitive bidding proposals run into a lot of operational challenges. And you can see with the PLUS Loan option that New America in particular has been very fond of, the operational challenges have been so significant that even Congress agreed that you couldn't go forward with implementation right now.

Part of the problem is that lenders in the private sector originate capital based on their costs of producing that. They have to come up with the money to make that loan. That changes over time.

So you can't go in on a date certain and say, "This is how I bid for the origination rights," on a particular loan product, because my costs for capital may change. It may change three weeks from now, it may change six months from now. It may change two years from now.

But under the PLUS Loan option, I actually have to commit to make those loans at a certain rate over a certain period of time. And if I don't, my participation in the Title IV program could be limited, suspended, or terminated.

Those are pretty unfavorable conditions for a lender to feel like I want to compete. And that's why you don't have any lenders coming forward to say, "This is a great idea."

Now there is a similar proposal that I think could be very effective, in getting lenders involved in more competitive arrangements, and that has nothing to do with Congress setting the rates. That would be with simply telling the private sector that this is the rate on a federal direct student loan, period.

If you can beat that rate, compete against the federal government to take the borrowers from the federal government, and do it.

If you were to do that, and the private sector can compete -- and currently I think they could -

Then certainly with the credit enhancement of a guarantee, then the government could get out of the business of making special allowance payments, you do set a market rate, the borrower does get an interest rate that based on the current cost of capital, and you do it all without the government having to incur any additional costs.

To me, that sounds like it's maybe too much of a silver bullet, but it seems like a pretty rational response. You avoid the problem then I think that just about everybody at the table agrees with, is that Congress does a pretty poor job of setting interest rates.

Shireman: We use competitive bidding in order to price the capital for the direct loan program. They're called "treasury auctions," highly efficient. That's why our cost of borrowing is relatively low and the interest paid by borrowers exceeds what our current borrowing rates are.

It also means that when interest rates go up, the cost to us of the low interest rates that students will be paying at that point is less, because we do not have to pay lenders their cost of borrowing, which is higher than ours.

So we use competitive bidding. It works well. Everyone has no problem in making sure that everyone gets the direct loan that they're eligible for. We also use competitive bidding on the servicing side, taking into account the quality of service that can be provided as well as cost to tax payers.

The competitive bidding on the PLUS auction attempts to take the active providing capital and providing servicing long term and put it all into one auction, which isn't actually a good way of doing it.

So we split it up into, get the capital, provide for the servicing, rather than, and it goes back to my point about, this is all about how do you arrange for and pay for servicing. And if you try to do it all as one thing, you end up with all of these problems.

If you chunk it out with the different pieces, which is get the capital, provide for origination, arrange for servicing, then it's doable and it works.

McGuire: OK.

Combe: My concern with auctions, and again it goes back to the consumer, is they're hostile to consumer choice. Basically, the consumers travel in an auction. The loan is put out to a bid at a certain price.

There's no competition in it from the borrowers perspective. And the borrower gets the results to the auction. It may be an effective program for the federal government lowering costs, but it's not an effective consumer program.

And that's really the key point. There must be ways where we can market price capital and still provide the consumer with some choice in that process.

Delisle: You all have to remember, the way the PLUS Loan auction was designed, and it was designed more politically than around the perfect policy solution.

Since we had to make sure the auctions were run at the state level and not regionally, because certain senators wanted to make sure certain lenders could lend in those states, and so all of these things start to crop up when you're tinkering with an existing system.

But I would like to add one important point. And Scott eluded to it that lenders have said they're not going to bid to make PLUS loans in this auction, and that's a big, weak part of the program. But that same problem exists in the FFEL program as it is currently designed.

A reporter asked me, "What happens? Why might an auction fail?" I said, "No lenders show up." And they said, "Oh wow, that's terrible." I'm like, "Yeah, but the FFEL program could fail too, if no lenders show up."

It's the exact same risk. We actually almost saw that happen with the credit market problems. And Congress stepped in and created these ECASLA programs. Where they said you can sell the loan back to the federal government and we'll even, in a round about way, give you federal capital to make the loans.

So that's what's largely kept them in the program. Without ECASLA, it's possible that the FFEL program would have experienced pretty serious disruptions in the same way that the auction could have failed.

McGuire: OK.

Neil Schneider: Hi. My name is Neil Schneider. I'm with the American Speech-Language-Hearing Association. And since the subject of the event is student loans generally, I wanted to ask Bob about the Perkins loan changes and if any of you have comments.

And also, Congress has dictated that in certain situations, people can get their loans cancelled for certain things. And I'm wondering how any of you feel about how those fall out and these changes.

Shireman: Thank you. We have proposed a dramatic expansion of the Perkins program. Our feeling is that colleges need some flexible money that they can provide to students for whom the regular Stafford Loan limits are not enough.

And that we can't micro-manage from the federal level what those circumstances might be. And so the concept that the local level of schools having a pot of money they can apply to those special situation, is a good concept.

In order to accomplish that, we basically instead of having little revolving funds at colleges that we put money into, which was, just from a budgetary stand point, I won't get into the details, but was difficult to grow that approach.

A lot of schools don't want to manage a local revolving fund and there are other reasons as well. So we instead make it part of the overall federal student loan program.

Instead of about a billion dollars in loans, it would be about six billion dollars. So a lot more flexible money for colleges. The terms of the loan would be five percent. There would not be an in-school interest subsidy as there is now. So some trade off there for wanting to have much more money.

Not quite as good benefits on the loans. They would gain access to the public service loan forgiveness that exists now in the direct loan program as well as income based repayment that's available.

And those are good back end protections that help to make sure that people can go into public service, even though they may have a substantial amount of federal student loans.

Combe: One thing on the issues you look at with the Perkins Loan, and again, going back to debt management, is by definition you're instituting multiple payment streams for the borrower. So if you go back to the consumer, they have two minimum payments they have to make the loans.

So it is again, it's a debt management issue. We have to factor in if we're going to give them multiple loans, then we have to make sure that the information is there for them to be able to manage those multiple payments and a stream of payments at the later time.

The other point on the back end benefits, I think it's really important, is the College Board made a proposal of eliminating the subsidies up front on these loans for the borrower and actually placing the subsidies on the back end.

This may actually be a more efficient way of targeting those subsidies over the life of the loan. And in that way, you can actually almost separate.

One of the problems we have actually, when we talk about special allowance payments co-mingled in there, is the borrower benefits. And if you could separate those two things out, you actually have a clearer view of what the cost of the program is to the federal government.

Because the benefits to the borrowers are one thing and the cost of capital is another. And you could actually separate those by going with this back end benefit.

And basically what you've created is, you have a delivery vehicle, the loan, for benefits that you may or may not want to provide the borrowers over the life of the loan. So it may be an effective way of dealing with it. So to expand those types of life of the loan benefits.

McGuire: I want to be respectful of my panelists' time, so last question. It's a quick one. There's a woman back there. Keep your hand up so she can find you.

Reba Rafioli: Reba Rafioli with Career College Association. I'm just curious that you had brought one revenue estimate from the administration for going to direct lending and CBO has a much higher limit of revenue raiser impact.

Why the difference and what's in your calculations versus what they didn't put into their calculations?

Shireman: I haven't looked at in enormous detail. My general understanding, and don't take this as the bible on exactly this, is that economic assumptions are different.

So I think the easiest example to give is that if you assume, as CBO does, that the economy does not recover as well as ONB assumes the economy recovers, then people continue to be very eager to loan money to the federal government, but not the private sector.

So the amount we have to pay in commercial paper plus an increment in FFEL, is going to be high. The amount that the government borrows, and that gap between the governments's cost of borrowing and private costs. That's one type of, one way that economic assumptions can have an impact on the difference between the costs of the two programs.

Fleming: Just one word on that. I think the lending community would tar and feather me if I didn't mention this at some point. So I think that's actually a pretty spectacular example of why federal budget forecasts tend to be wrong.

And this isn't a slight against CBO or ONB, it's just that any time you try to prognosticate the future; it turns out to be a very difficult challenge.

You have to make certain assumptions. Any one of those assumptions could be wrong. And that's why, over time, neither program has scored exactly what it was anticipated to score over time. Direct lending has a little bit worse of a track record in that it's tended to cost a little bit more than people think.

FFEL tends to go the other way, that it costs a lot less. Currently, the federal government is making money on FFEL. When a year ago or two years ago, that wasn't the case.

And so you can see in the FY09 budget, the subsidy cost estimate for a direct loan was actually higher, for the first time maybe ever, in the ONB budget then is was for a FFEL loan. And it didn't take long for that to change, because the interest rate environment changed subsequently to the publication of the FY09 budget.

But you can see, the turbulence in interest rates, inflation rates, and any number of assumptions that go into these budget forecasts, can change. And every time they do, that makes the future analysis of the future prognostication incorrect.

So the bottom line, I guess, is that today CBO may said that a shift to 100% direct lending means that we'll save 94 billion dollars. In three months time, that could change completely.

And there's no way to know. I don't think any of us up here, if we could predict the future, we'd be in different jobs. But if we can't predict the future, we have to go with the best of analyses, and those analyses change over time. Then we're always going to run into the scoring problems created by the federal budget process.

McGuire: OK, well I'd like to thank our panelists today, our guests, and encourage all of you to read HigherEdWatch.org.

Transcription by CastingWords