Five Reasons to Oppose the Student Loan Community Proposal

We are sorry to report that legislation that would eliminate the Federal Family Education Loan (FFEL) program remains stalled in the Senate, as debate on the health-care overhaul bill continues to drag on and on. Unfortunately, the delay appears to be working to the student loan industry’s advantage. Recent news media accounts indicate that some moderate Senate Democrats are flirting with an alternative “reform” proposal that industry officials have been shopping around Capitol Hill.

But no matter how the loan industry spins it, the “Student Loan Community Proposal” does not represent real reform. On the contrary, it aims to keep as much of the status quo in place as possible. As we said yesterday, loan industry officials ultimately want to be well-positioned should the political tide shift back in their favor.

Here are five reasons that the lenders’ proposal doesn’t live up to its billing. Under the plan:

• Lenders Would Continue to Originate Federal Student Loans

Unlike President Obama’s proposal and the House student loan reform bill, the industry’s plan would allow private lenders to continue to originate federal student loans on the government’s behalf and receive a generous fee for performing this largely administrative function. The loan providers would then turn around and sell the loans to the Department of Education but would retain the right to service them for another fee. While this arrangement may be lucrative for lenders, it makes little sense from a public policy point of view. Why should the government pay lenders to originate federal loans when it can make the loans itself at a lower cost? Isn’t a primary goal of student loan reform to stop subsidizing unnecessary middlemen? This proposal simply introduces unneeded complexity to the program and requires the government to subsidize lenders for activities it can perform itself at a lower cost.

• The Government Would Continue to Set Payment Rates Arbitrarily

As we have long argued at Higher Ed Watch, one of the biggest problems with the current FFEL program is that Congress sets the subsidy rates for lenders arbitrarily through the political process. Lawmakers almost always err on the side of over-subsidizing lenders because they are afraid of the risk that someone somewhere might not get a loan if the subsidy is too low. Student loan companies take advantage of this fear and send lobbyists to Capitol Hill to make the case for big subsidies. If lawmakers resist, the loan companies do not hesitate to whip up fears that the entire program is on the verge of collapse. This is a prime example of why real student loan reform is needed.

Unfortunately, the Student Loan Community Proposal would continue to have the government set arbitrary fees and payments for lenders and servicers, at least for the first couple of years that the plan is in effect. Loan industry officials have already demonstrated just how arbitrary the fee structure is. In the initial version of the plan, lenders proposed having the government pay a $75 fee to for each loan that they originate. In the latest version, they have dropped the fee to $55, as part of a broader effort to bring down the cost of the proposal to make it more palatable to lawmakers.

• Colleges Would Continue to Choose Their Students’ Lenders

The proposal would leave college financial aid administrators in charge of choosing lenders to originate their students’ federal student loans. As a result, loan providers would continue to compete for colleges’ business — leaving the program exposed to the same types of abuses that the “pay for play scandal” uncovered in the not-so-distant past. While the proposal contains some perfunctory language to prohibit lenders from offering illegal inducements to schools to win student loan business, we know how well that worked in the past. Both the Obama administration’s proposal and the House student loan reform bill would put an end to those concerns by having the Department of Education make federal loans directly to students through their colleges.

• Lenders Would Not Have to Bid for Loan Servicing Rights

The proposal side steps an important provision included in President Obama’s proposal that aims to improve the quality of loan servicing student loan borrowers receive. Under the administration’s plan, lenders would have to enter into a competitive bidding process to win one of a limited number of servicing contracts from the Education Department (the House bill includes a similar provision but would provide a set-aside for non-profit lenders). This process would give the Department leverage to set quality servicing standards that loan companies would have to meet to win these contracts and keep them. For example, winning bidders could see their loan portfolios expand or shrink depending on their success in preventing delinquent borrowers from defaulting on their loans.

Under the loan industry’s proposal,  it would be up to colleges, rather than the government, to select lenders to service their students’ loans. This arrangement is unlikely to spur loan companies to make meaningful improvements, as colleges tend to pay little attention to the quality of loan servicing their former students receive long after they have left the institutions. This proposal would, in fact, leave the program even more vulnerable to abuse, as loan companies have an even greater incentive to woo colleges to try and win their business.

• The College Access and Completion Fund Would be a Piggy Bank for Guaranty Agencies and Non-Profit Lenders

Both the Obama administration and the House bill would create a new College Access and Completion Fund that would provide grants to states and colleges to improve their efforts in increasing the academic preparation and college awareness of low-income students. Under both plans, states would have the option of providing a share of the grants they receive to guaranty agencies that would use the money for financial literacy education and college outreach programs.

The loan industry’s proposal, on the other hand, would require the government to allocate “no less than one-third of all funding” from the access and completion grant program to guaranty agencies and non-profit lenders for conducting financial literacy programs for students. Guarantors and non-profit lenders would also receive another unspecified share of the program’s budget to carry out college outreach activities. At Higher Ed Watch, we think this is a terrible way to spend the money, given that there is little empirical evidence that these entities do a particularly good job providing these types of services.

Conclusion

As these examples show, the Student Loan Community Proposal fails to deliver the types of reforms that are needed to truly benefit student loan borrowers and taxpayers. Hopefully, Democratic Senators won’t be fooled into thinking otherwise.

Jason Delisle contributed to this report.