Direct Lending On the Rise

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

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

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

Despite the dire warnings from the loan industry and their allies at the National Association of Student Financial Aid Administrators, the transition by schools to Direct Lending has gone extraordinarily smoothly. This is true at even the largest colleges, like Pennsylvania State University, which has disbursed more than $100 million in Direct Loans for students this semester. “It was a big undertaking making a decision in March to be disbursing through Direct Lending by July 1,” Anna Griswold, Penn State’s financial aid director, recently said. “I think the fact that we accomplished our entry into Direct Lending in four months speaks volumes about the program.”

Even once fierce skeptics of the Direct Loan program are now embracing it. “I was quite apprehensive about this switch. I have been in this business for 25 years and have been a strong advocate for FFEL. I do not resist change but this was a BIG switch for me,” Walter O’ Neill, the assistant vice president for financial aid at Roosevelt University, recently wrote on an online message board for financial aid administrators. “I can honestly tell you that it was one of the smoothest and trouble-free conversions that I have experienced.”

Much of the credit for the smooth transition goes to the Bush administration, which despite its close ties to the loan industry, has lived up to its promise to manage the operations of the program effectively.

And Direct Loan advocates can take heart — they will soon have a staunch ally in the White House. Early in his campaign, Obama proposed eliminating the FFEL program and providing federal loans entirely through the Direct Loan program. It is not clear whether or not he will follow through with this proposal or not as he has remained silent on this proposal ever since the credit crunch hit. This is probably not a fight he’ll want to pick early in his presidency, with all the other daunting challenges awaiting him.

As we have stated previously, we hope that the Obama administration will lead the way on student loan reform to make sure the programs are operating as efficiently and effectively as possible. There are still deep-seated conflicts of interest built into the FFEL program that need to be uprooted (see the relationships between guaranty agencies and lenders, for example).

We would also urge the incoming Democratic administration to make sure that the Direct Loan program doesn’t rest on its laurels. If the Education Department drops the ball — as it did toward the tail end of the Clinton administration — and lets service to schools and students suffer, colleges won’t stick with it.

The tables have turned for now. But if we’ve learned anything from the resurgence of Direct Lending, you can’t take anything for granted.