Congress Embraces New America's Loan Auction Proposal

The education committees in the House of Representatives and the Senate have now both embraced a proposal by the New America Foundation and Higher Ed Watch to use an auction mechanism to set the subsidy levels that the government provides private lenders to make federal student loans.

The committees take different approaches to introducing market mechanisms into the Federal Family Education Loan (FFEL) program, but both panels recognize that the federal subsidies lenders receive have been set arbitrarily and are excessive.

From the inception of the federal guaranteed student-loan program in 1965, Congress has set the subsidy rates through the political process (i.e. after listening to bank lobbyists), without consideration of supply and demand in the marketplace. At first, policy makers needed to provide significant amounts of subsidies to attract lenders to participate in the federal loan program. Banks were reluctant to take part because they feared lending to students who were not credit worthy.

But those days are long gone. In fact, they were long gone 20 years ago, and maybe even 30 years ago. "Today, thousands of lenders participate, and the largest, Sallie Mae, is so profitable that a group of investors recently offered to buy it for $25-billion -- more than 30 percent above the value of its stock," Sen. Edward M. Kennedy (D-MA), the chairman of the Senate Committee on Health, Education, Labor, and Pensions, said in a written statement when he introduced the Higher Education Act reauthorization and reconciliation legislation that included the auction proposal. [Disclosure: The Editor of Higher Ed Watch used to work for Senator Kennedy.]

Students and taxpayers have paid a heavy price for the government's generosity. The oversubsidization of private lenders has led to widespread corruption in the loan industry, as Higher Ed Watch and others have documented over the last several months. Using excess taxpayer subsidies, loan providers have romanced financial aid administrators and other college officials to become the exclusive or semi-exclusive lenders on their campuses.

The purpose of the wining and dining and stock gifts in large part has been about locking out competitors who can offer more favorable deals to students. The loan firm MyRichUncle learned this lesson the hard way. Despite providing one of the most generous deals available on federal student loans, the company has found that many colleges have refused to certify their loans.

The time for change has come -- and it's not only Democrats, like Mr. Kennedy, who are leading the charge.

In the House, Rep. Tom Petri (R-Wisconsin), a fiscal conservative, has championed the idea of creating a pilot auction. Last week, the House Education and Labor Committee unanimously adopted his plan, which would require the Departments of Education and the Treasury to test the concept of using loan auctions to set lender-subsidy rates, as part of the larger budget reconciliation bill.

On Wednesday, two Republican stalwarts on the Senate education committee -- Sen. Lamar Alexander (R-Tenn) and Judd Gregg (R-NH) -- spoke out in favor of using auctions to set lender subsidies. In fact, Mr. Gregg complained that Mr. Kennedy's proposal to create a pilot program in which lenders would bid for the right to make federal PLUS loans to parents and graduate students didn't go far enough. "Obviously, lenders aren't that excited about doing a full-fledged auction, but that's the best way to get at the proper price," Senator Gregg stated.

The idea of injecting auctions into the guaranteed loan program has also made its way into the presidential campaign. Sen. Chris Dodd (D-CT), who is running to be his party's candidate for president, said last week that he would soon introduce a proposal that would require lenders "to compete for the right to make or own federal student loans through a government-run auction."

In the coming weeks and months, the loan industry is going to try to sell "the sky is falling" horror scenarios about how student-loan auctions will harm students and destroy the FFEL program. We should expect no less, as lenders fight desperately to hold on to their excess subsidies.

We are confident that the Treasury Department, working with the Education Department, will design an auction that will work well. Almost any horror scenario can be prevented with a well-designed student loan auction.

Most importantly under the House and Senate Committee plans, from the borrower's perspective, statutorily set loan terms would not change. Banks with winning bids would be required to make the same government-guaranteed loans that are available today.

Yes, a loan auction might reduce the number of lenders, but the difference wouldn't be significant. According to the Education Department, 32 lenders control 90 percent of the market, and one, Sallie Mae, already owns about 50 percent of all outstanding loans in the FFEL program.

Besides in the event of poor service, colleges that don't like the winning bidders would retain the option of shifting to the government's own Direct Loan program, which provides the same loans under the same terms and conditions as the subsidized bank alternative. And if borrowers are upset with the winning bidder's service, they could refinance with another lender, as millions who hold consolidated student loans already have.

When you listen to the stories lenders tell, just remember that the real horror story is the system we have now, in which bankers and other student-loan lenders amass huge amounts of wealth off of the backs of taxpayers and financially needy students who are falling deeper and deeper into debt. And lenders use the wealth they have accumulated to buy off colleges and lock out competitors offering better deals.

Higher Ed Watch congratulates the House and Senate Committees for embracing the student loan auction concept that we have helped champion. Done right, student loan auctions are quintessential good government.