Rethinking the Middleman

Each year, the federal government guarantees billions of dollars in loans disbursed through the Federal Family Education Loan (FFEL) Program, a public-private partnership that provides financial aid to students attending institutions of higher education. Despite the significant investment of taxpayer dollars, the actual administration of the FFEL Program is largely handled by participating lenders and a group of 35 non-federal guaranty agencies across the country. Guaranty agencies perform a number of administrative functions, such as disbursing federal default insurance provided to private lenders issuing FFEL loans, preventing loan default, and collecting or rehabilitating loans that borrowers have failed to repay.

The current role for guaranty agencies in the FFEL Program is a reflection of historical responsibilities given to them by federal policymakers when the first national student loan program began in 1965. Legislative changes and events over the past several decades have expanded the U.S. Department of Education’s financial role in the FFEL Program, rendering many of the traditional functions of guaranty agencies unnecessary. The compensation model under which guaranty agencies operate also raises concerns, as the current structure imposes unnecessary costs on taxpayers and creates opportunities for waste and abuse. Moreover, it contains contradictory incentives for guaranty agencies that reward them both for assisting struggling borrowers and for collecting defaulted student loans. Affiliations between many agencies and student loan companies pose further policy problems, as these relationships can undermine default prevention incentives for lenders making FFEL loans and make it impossible for guaranty agencies to carry out their required oversight functions as a neutral party. Unfortunately, meaningful debates about the problems inherent in the way guaranty agencies currently operate are obscured because the agencies often use excess federal subsidy dollars for college outreach or planning activities.

If policymakers wish to keep guaranty agencies in the federal student loan program, they should take several steps to update and reform the roles these agencies play. The U.S. Department of Education should take on guaranty agencies’ default insurance administrative role, ending any subsidies associated with this function and returning federal assets held in trust for this purpose. Concerns about conflicts of interest should be addressed by terminating the relationships between lenders and guaranty agencies and tasking the U.S. Department of Education with all FFEL oversight responsibility. Competing financial incentives for default aversion versus loan collection or rehabilitation should be eliminated by assigning these duties to two separate and non-overlapping groups of competitively selected federal contractors. Finally, college outreach and planning activities performed by guaranty agencies should be funded by a separate open competitive grant structure that includes an accountability framework for measuring effectiveness. Collectively, these changes would alleviate many concerns about guaranty agencies by transforming them from middlemen into useful components of a modern student loan program.

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