Obama’s Bold Proposal

The Obama administration on Thursday laid out a bold plan that would turn the Pell Grant program into a true entitlement for low-income students and pay for it in part by eliminating the Federal Family Education Loan (FFEL) program once and for all.

The proposal, which was included in President Obama’s 2010 fiscal year budget overview, is sure to create a firestorm of controversy on Capitol Hill, where the student loan industry has many friends in both political parties. Ultimately, the budget blueprint recognizes a couple of hard truths about the federal student aid system that Higher Ed Watch and our sister blog Ed Money Watch have helped expose.

First, the way the federal government is currently financing Pell Grants is a huge mess, as Jason Delisle, the research director of New America’s Education Policy Program, recently wrote. Congressional appropriators currently set the maximum Pell Grant each year based on estimates of expected demand for the grants made by federal budget officials. Because the estimates are made far in advance, they are generally off the mark. As a result, the Pell program has often been plagued by large budget shortfalls. To make up for the gaps, the Department of Education often dips into future program funds, pushing the shortfall off to the future.

In recent years, Congress has created new funding streams (through the College Cost Reduction and Access Act of 2007 and the giant stimulus package that Congress recently approved) to boost spending on Pell and increase the maximum award. These new funding sources, however, are only temporary. When they run out, policymakers will again face the tough choice of either substantially decreasing the Pell Grant (by more than $1,200) or shelling out billions of dollars more just to keep the maximum award constant.

President Obama’s budget blueprint seeks to put an end to this budgeting nightmare by financing the program entirely through mandatory funding, meaning that spending for the program would no longer be determined through the annual appropriations process. The president proposes raising the maximum Pell Grant to $5,550 for the 2010-11 academic year, and then indexing future increases to the Consumer Price Index plus 1 percentage point so that it will keep up with inflation. “To make sure that we have a highly-educated workforce and that the opportunity to go to college is not determined by how much money you have, we need to put the Pell Grant program on sure footing,” the budget overview states.

On its own, this proposal would not be too controversial. While fiscal hawks may object to creating a new federal entitlement program that will ultimately cost tens of billions of dollars a year, groups representing students and colleges have long embraced the idea. The plan, however, is certain to cause a furor in Congress because President Obama plans to pay for it in large part by eliminating the FFEL program and providing government-backed student loans entirely through the Direct Lending program. Under the proposal, the Department of Education would stop providing subsidies to FFEL lenders on new federal loans as of July 1, 2010. Lenders would continue to receive subsidies on existing loans.

That brings us to the second hard truth: credit market disruptions have made the FFEL program untenable. Only an emergency law — the Ensuring Continued Access to Student Loans Act (ECASLA) — saved the system by allowing the U.S. Department of Education to buy FFEL loans and lend federal money to lenders. In other words, the bank-based program’s survival depends almost entirely on the government providing federal capital to lenders to make the loans. Sounds a lot like Direct Lending, doesn’t it?

The federal government has gone to extraordinary efforts to help the student loan industry cope with the turmoil in the financial markets. But how long will it continue to have to do so? There appears to be no end in sight for the credit crunch, and some lenders have even floated the idea of making ECASLA permanent.

The Obama administration doesn’t see the need to keep propping up FFEL when there is a less costly, more stable alternative in place. “The Direct Loan program, which uses market processes to determine subsidy payments to servicers, has suffered no disruptions and continues to function at lower cost to taxpayers,” the budget overview states. “The Administration’s goal is to continue to tap low-cost, stable sources of capital so students are ensured access to loans.”

At Higher Ed Watch, we applaud the administration’s gutsy proposal. Now let’s just see if Congress has the guts to recognize these hard truths too.

For more details on President Obama’s 2010 fiscal year budget overview, check out this post on Ed Money Watch.