Debunking Student Loan Industry Myths

In their fight to maintain the Federal Family Education Loan (FFEL) program, loan industry officials have made a lot of dubious claims about the dangers of direct lending. Jason Delisle, the research director of New America’s Education Policy Program, took on these arguments in remarks he made yesterday at an event here on “The Future of Federal Student Loans.” The commentary below is excerpted from Delisle’s remarks (with a few tweaks for the sake of clarity).

Here are the lenders’ arguments and Delisle’s responses:

Claim: Having the government make all federal student loans directly will substantially increase the national debt.

Response: The argument that the loan industry is trying to make here is that because in the Direct Loan program the government is lending directly, it has to borrow to make the loan. So in that sense, when it issues a $2,000 loan, the federal government borrows the $2,000 from somebody else to make the loan. And in that regard, yes, the national debt is going up. But when a lender makes a loan on behalf of the government in the FFEL program, the federal government is on the hook for 97 percent of the principal of the loan. So, essentially the risks and obligations to the taxpayer of both of those loans are nearly identical. And to suggest that somehow we don’t have an increase to the national debt when the bank makes a loan that taxpayers are on the hook for is totally absurd.

To take it one step further, what you could then argue is that we could eliminate all of the national debt tomorrow if we had banks issue treasury bonds for the federal government, and we just kept them on their books. The federal government is still on the hook for all of it. But it’s not on our books anymore. It’s gone. And that’s essentially what this argument is saying — direct loans increase the debt and the FFEL program doesn’t. It just doesn’t make any sense.

It’s also important to remember in this debate that, according to the Office of Management and Budget, the Congressional Budget Office, and a lot of budget experts, the Direct Loan program is cheaper and, therefore, has less of an impact on the national debt.

Claim: The FFEL program is more efficient than direct lending because it relies on private entities to make the loans.

Response: I’m receptive to this because I think generally that’s the case when you involve the private market, it is more efficient. But because the student loan programs are designed in such a strange way, especially the FFEL program, the efficiency of the private market is never really brought to bear. The subsidies that are paid to lenders are set by Congress. There is no competition in the private market for those subsidies. We don’t say to lenders, “Compete on the subsidy and then we’ll take a low bidder and we’ll find out how much efficiency is really there.”

We don’t do that. Congress just makes up a subsidy where we basically pick up an index and add a little bit more to it. Right now it’s 1.79 percentage points. Why 1.79? I don’t know. It’s really just made up. It is members of Congress sitting around saying, “What do you think? 1.8? 1.9? 1.4?” And then the student loan lobbyists come in and say, “No, it’s got to be 1.65, 1.62” and we settle on a number.

Now to the extent that lenders are very efficient in making loans, they still collect the same subsidy as everyone else. So all of the benefits of efficiency accrue to themselves through higher profit margins, which is not necessarily a bad thing. We want companies to be profitable. But to turn around and make the argument that this efficiency somehow benefits the federal government and taxpayers under the FFEL program is totally absurd.

And the irony of the efficiency argument of involving private lenders is that it actually might be less efficient. Think about the draw on the private sector. Lenders making loans in the FFEL program are actually carrying out a government program. So this is really government activity done by a private company. But we’ve enlisted literally thousands of lenders to do this. And these lenders send out thousands of people in sales forces to go out and try to market the loans, which by the way, the terms of the loans are set by the federal government already, so there’s very little room to differentiate the product.

But we still have thousands of companies sending out sales forces, spending money on advertising for a government activity that private lenders have taken on. As a Republican, I immediately think, if you have that kind of complexity in a government program, imagine the oversight that you need to make sure no one is doing anything incorrectly, or doing anything improper, which we know has happened several times in this program.

And in fact, it’s the complexity that makes this program kind of scandal-prone. We had the 9.5 percent bond scandal. We had the pay-for-play scandal. And who knows what other ones may be lurking out there that we haven’t discovered yet because the program is so complicated.

Claim: If Congress gets rid of FFEL, students will be denied generous borrower benefits.

Response: You hear this a lot in the debate. But remember, the terms of the loan for the borrower are set in statute. The interest rate is fixed at 6.8 percent for the borrower. The length of repayment is 10 to 20 years or longer if you have a lot of debt. So all of that is set in law.

What people are talking about when they say that the lenders provide borrower benefits is that they provide a little bit more. A little big more than what’s set in law. What lenders are doing is saying, “The subsidy I’m getting from the federal government is generous enough that I can pass a little bit more of that onto the student in the form of better benefits.” The most common benefit a few years ago that lenders gave students was a percentage point interest rate reduction for on-time repayment.

But you don’t need to preserve high subsidies for lenders in the hopes that they’ll pass these benefits on to borrowers. Remember, all the terms of the loan are set in statute. So if borrower benefits are so important to members of Congress — and you’ll hear them on the Senate floor or on the House floor saying. “We need to preserve the borrower benefits” — they can write them into law.

If they want a 5.8% interest rate for all students, they can write that into law and all students will get it. Now lenders say that when the Direct Loan program provides extra borrower benefits, it costs something, but when the guaranteed loan program provides these borrower benefits through lenders, it doesn’t cost anything.

Well, it does cost something. It’s the lender spending a little bit extra of the subsidy it gets from the federal government to create a more generous student loan. So the money is all coming from the same source, it’s coming from the taxpayers through a subsidy.

So the Direct Loan program and the guaranteed loan program can provide the exact same terms for borrowers and the same generous level of benefits. Congress just needs to write it into law, like it does for the base set of benefits.

But I’ve found that most of the members of Congress who are arguing that we need to preserve high lender subsides in the hopes that maybe they’ll pass that along to students aren’t offering any legislation to actually write the borrower benefits into law. They’d rather pass it through a lender and hope that the lender gives it to a student, which I think is not the best way to go if you really want students to have better terms on their loans.

Claim: If you move to 100 percent Direct Lending, you will sacrifice customer service, which is far superior in the FFEL program.

Response: The argument they’re making is, “The Direct Loan program is run by the federal government so it’s got inferior customer service, and the guaranteed loan program is run by private lenders and it’s got superior customer service.”

Again, as a conservative and Republican, I’m a little bit receptive to that, because private lenders do have a little bit different incentive to provide really good customer service in that they are competing for the students’ business for the loan, and they may be competing for further business for different products. So if you have your student loan from Citibank, and it’s the only product you have from Citibank and you call them and they never answer the phone, when you want a mortgage or insurance, you may not go with Citibank. So there is a little bit of disciplining that goes on that may not go on with a government-run servicer.

But it’s not quite so black and white, because in the Direct Loan program, the federal government contracts with private servicers, so again, they don’t have the same competitive discipline that I just described in the Citibank example, but they are competing for a contract from the federal government. And in fact, some of the same private servicers run both loan programs.

But let’s just assume for a minute that the FFEL community and its supporters are right–that there is much better customer service in that program than in the Direct Loan program, for both students and financial aid offices. But what’s that worth? How much more should we pay for it?

Better customer service costs you more. Is it worth a $1 billion dollar more each year? $5 billion? We don’t know, and no one talks about it in those terms. I think it’s really important to ask that, because that’s the trade-off.

I really doubt that it’s worth $94 billion over 10 years [CBO’s recent estimate of how much the government will save if FFEL is eliminated]. That’s quite a large trade-off to be making for slightly better customer service.