Ending the bank-based federal student loan system in 2010 was all about cost savings. Taking subsidies banks received to make loans and putting them toward increasing the maximum Pell Grant award was a sensible policy. And students would be unaffected because they could always borrow straight from the U.S. Department of Education.
But the White House announcement today of a "student aid bill of rights" shows that having the government make all federal student loans directly has substantial benefits beyond just cost savings. Ending the fight about how to make loans has made it possible for the Department to exercise greater control over critical issues of debt collection, servicing, and repayment that it could never really influence when banks issued loans.
Student loan servicing epitomizes the way today's federal loan structure allows the Department to do more about quality for the borrower. Under the bank-based system, loans were made by hundreds if not thousands of public companies. Each had its own website, loan payment portal, way of disseminating information, etc. Spotting problems with lenders would be difficult and borrowers could get confused about whether their loan was federal or private. By contrast, the private companies that service loans today are contractors whose incentives and business practices can be shaped by the Department. So now it can do things like mandate a single payment portal for all federal loan borrowers--one of the changes announced today.This will fix an ongoing problem where borrowers think their loans have been sold because servicer websites either minimally include the Department's logo or don't mention it at all.
Having servicing carried out by a set of contractors also allows the Department to require changes to business practices when it identifies problems. It already started this process last year through the negotiation of new contract terms that place a stronger emphasis on preventing default and delinquency. That continued today with new requirements for servicers to provide enhanced disclosures to struggling borrowers, being clearer about loans being transferred, and how payments on multiple loans must be treated.
The same is true for defaulted borrowers. Under the bank-based system, defaulted borrowers ended up in the hands of guaranty agencies--quasi-public or private nonprofit entities that would work on collecting the loan (and profit handsomely off doing so). ((Loans held by guaranty agencies could eventually end up with the Department's collection agencies, but only after several years of attempting and failing to collect on them.)) Their compensation was set in statute, and attempts to voluntarily change payment structures yielded only a couple of participants. This meant the Department could not do anything to adjust terms to better encourage default reduction or anything else.
By contrast, defaulted loans today end up in the hands of private collection agencies that operate through contracts. Just like the servicers, these contracts can be changed by the Department. They can even be cancelled, as five companies, including Navient (nee Sallie Mae) found out last week.
Today's fact sheet suggests the Department wants to go further down the road of improving debt collection, though exactly what that means is unclear. We do know that the Treasury Department will be experimenting with a small pilot of roughly 2,000 borrowers to see if it can do this work for less money. And the new competition for these debt collector contracts is also ongoing.
Are any of these changes earth-shattering? No. Nor can they address the upfront problem of how much debt students accumulate in the first place and where some of the schools where they are allowed to take on loans. But that's OK. There's no single thing that's going to fix all of these issues.
Instead, these changes matter a great deal because they represent the Department taking greater ownership over the loan program. It shows the agency looking beyond the question of getting dollars out the door--the traditional role it played--to longer-term questions of the repayment experience for borrowers. This focus on debt collection, servicing tactics, and related issues are things that would never have been addressed in a world where most of these efforts took place in diffuse private companies or strange entitled middlemen.
Getting these things right takes time. It involves shifting the way a government agency and hundreds of employees operate. And that's before you even start thinking about the delightful world of federal procurement. But these are the kind of good government improvements that are the next logical steps to make the loan programs work better. And that's only possible in a 100 percent Direct Lending world."