The Big Shakedown

Blog Post
May 21, 2008

We've been asked our reactions to the Department of Education's announcement yesterday shoring up the student loan market. Higher Ed Watch has two main thoughts.

First, Congress' response legislation to the student loan credit scare and the Department's implementation announcement yesterday puts to bed any question of loan availability for this fall. Every student will be able to get a federal student loan. We continue to note, however, that no student has gone without a federal student loan to date, and that in addition to the thousands of lenders still making federal student loans, two fail safe systems were in place before yesterday's action to ensure that no student would go without access to a federal student loan in the future. Still there was panic for this fall and spring, and it now should be gone. That's a good thing.

Second, with yesterday's action, the Federal Family Education Loan (FFEL) program and the Direct Loan program are increasingly starting to look alike. Now we will have FFEL loans made with government capital, government ownership, and a fee paid to the lender for origination and servicing. That's essentially a Direct Loan.

Instead of paying the origination and servicing fee via a competitive contract as is currently done with the Direct Loan program, the Department of Education is now paying FFEL lenders the spread between two arbitrary federal subsides plus a fixed (and what appears arbitrary) $75 per loan plus remission of an up-front fee lenders pay the government for each new loan. The federal government will loan capital to the lenders at a rate equal to commercial paper plus 50 basis points. And the federal government will guarantee that lenders receive commercial paper plus 179 basis points in interest and subsidy payments. That 129 basis point spread (179 - 50 = 129) plus the $75 per loan payment goes to lenders for origination and initial servicing and not much else. Think of it as an arbitrage operation between two federal subsidies with a $75 fee on top plus remission of an up-front fee lenders pay the government for each new loan. In return for the spread and payments, the federal government gets administration by for-profit and non-profit lenders of a quasi-direct loan program.

The bottom line: Basically, the lenders played chicken with politicians and media and won. The phenomenon and the response show why the student loan system needs an overhaul. You can't have the government and families vulnerable to a lender shakedown. And it's inefficient as well as subject to corruption for government officials to decide in behind closed doors negotiations with lenders what the precise amount is to pay them for originating and servicing loans. A market mechanism or competitive bid should determine that taxpayer cost -- as is done with the Direct Loan program.

The good news is the solution embraced yesterday is another step toward bringing together the two main student loan programs. They're increasingly starting to become one. Hopefully, it will hasten an end to the ideological war between FFEL and Direct Lending and speed adoption of a more rational and secure federal student loan system.