A False Alarm

Over the last several months, the student loan industry and its allies on Capitol Hill have led a campaign to persuade the news media and policymakers that Congress went too far last year when it cut taxpayer subsidies to lenders that participate in the Federal Family Education Loan (FFEL) program. The lenders and their friends argue that the subsidy cuts and tightening credit markets now are leaving students in jeopardy of losing access to federally guaranteed student loans. Don’t believe it.

[slideshow] During debate last week on legislation to renew the Higher Education Act, for example, Congressman Howard (Buck) McKeon (R-CA), a friend of Sallie Mae and the student loan industry, sounded an alarm. “The impact of these cuts have yet to be fully realized, but already borrower benefits have been curtailed, lenders have left the program, and workers have lost their jobs,” he said. “The consequences of program cuts are being exacerbated by a crunch in our financial markets that has produced a loss of liquidity, an increase in financing costs, and uncertainty about the future viability of the federal loan program.”

McKeon didn’t mention that JP Morgan Chase bank, for example, is making so much on federal and private student loans even after Congressional action to redirect excess taxpayer subsidies from banks to increased financial aid for students that Chase is voluntarily cutting interest rates and fees on federally-backed student loans and private student loans. He also didn’t mention that any curtailed benefits charitably supplied by banks in the past have been redirected by Congress into massively larger Pell Grants and reduced undergraduate Stafford loan interest rates. And he didn’t mention, that there is zero risk of federal student loans not being available to any student at any accreditated institution of higher education.

But McKeon we understand. He’s got a political job to do. Respected media outlets like The Wall Street Journal that fall for this scare tactic we can’t excuse. In a news article last week, The Wall Street Journal speculated that students with less-than-stellar credit “will likely have a harder time getting a government backed federal loan, as lenders tighten their standards and pare back their offerings in response to the credit crunch and recent legislation.”

The fact such a distinguished newspaper as The Wall Street Journal would perpetuate such patently false claims about federal student loans caught our attention and convinced us we need to address head on the lenders’ arguments.

(1) Are Students with Poor Credit in Danger of Losing Access to Federal Loans?

Absolutely Not. Federal Stafford student loans are universally available to students, no matter what their credit scores. In fact, banks are forbidden from denying federal loans to students because of their credit records. Some lenders, like Sallie Mae, have said that they plan to stop offering subprime private, non-federal college loans to students at trade schools. But as we’ve said before, this is actually good news, as disadvantaged students with poor credit ratings should never have been stuck with high-cost private student loans to begin with.

(2) But Haven’t Some Lenders Announced That They Will Stop Offering Federal Loans?

Yes, but only a few and so what? About a half-dozen of the thousands of lenders that participate in the FFEL program have said that they will stop offering federal loans, or limit their participation in the program. The College Loan Corporation, which began as a marketer of consolidation loans, is the biggest lender to drop out so far.

Frankly we don’t find this news to be surprising or alarming. For years, the government, with its overly generous subsidies to lenders, propped up loan companies that did not operate as efficiently as they could have. In the end, this is a business, and lenders should compete to see which companies can deliver government-backed loans at the cheapest cost to taxpayers.

(3) Is it True that Students Don’t Have Any Alternative but to Borrow Federal Loans from Commercial Lenders?

No, there is an alternative. Students can obtain federal loans directly from the government through the Direct Loan Program. More than 1,000 colleges currently participate in direct lending, and the program now accounts for about 20 percent of the total student loan volume.

A major advantage of direct lending is that the government does not disciminate between and among borrowers. So if lenders begin to redline — refusing to provide loans to students at community colleges or trade schools, for example — colleges can always switch to direct lending to ensure that federal loans remain available to their students.

Another big advantage of direct lending is that the government funds the loans directly from the federal Treasury. As a result, it doesn’t sell loans to investors through the securitization market, which is extremely shaky right now, to finance its loans, as do some commercial lenders.

Conclusion

To be perfectly clear, the sky is not falling on federal student loan availability — no matter what the loan industry and its supporters on Capitol Hill claim. Don’t be fooled by attempts to conflate the private student loan and federally-guaranteed student loan marketplace, even if false claims appear as fact in The Wall Street Journal.

In its frenzy to report on the subprime mortgage crisis’ impact, old media is getting the student loan issue wrong and alarming parents. Hopefully, other news outlets won’t be so easily fooled. Federal student loans are universally available. They will continue to be. And as of this moment, private student loans are widely available well. But the latter could change.