Please Don’t Make Us Bid on PLUS Loans!

Are private student lenders and their allies in the financial aid world thankful for the credit crunch? If they can use the market turmoil as an excuse to torpedo the PLUS loan auction set to begin this year, they may very well be.

The student loan industry and their friends in the national and state associations representing financial aid administrators are calling on Congress and the Obama Administration to postpone or eliminate the new pilot auction program, arguing that current financial market disruptions would make it unworkable. They also argue that the program, which would use market forces to set student loan subsidy rates for lenders making federal PLUS loans to parents, won’t reduce costs for the government.

Policymakers should bear in mind a few key points when considering the loan industry’s latest cries.

Credit market disruptions have made the whole Federal Family Education Loan (FFEL) program structure untenable. Only an emergency law — the Ensuring Continued Access to Student Loans Act (ECASLA) — saved the system by allowing the U.S. Department of Education to buy FFEL loans and convert them into direct loans, as well as to lend federal money to FFEL lenders. The auction as designed may very well be an awkward fit within this new FFEL paradigm.

Yet, where there is a will, there is a way… to make the auction work. The ECASLA programs are a perfect example of how creative policies have been implemented to ensure the FFEL program continues to function in the face of credit market turmoil. These policies, however, are possible only because of the cooperation and support of the student loan industry, the Congress, and the Administration.

We don’t doubt that these groups could find a way to make the auction work under the new FFEL structure and credit market environment. For starters, Congress could enact legislation increasing or removing the arbitrary cap on the subsidy bids lenders are allowed to make under the pilot auction program.

Policymakers should know, however, that such cooperation is unlikely, as the loan industry opposed any auction even before Congress had drafted its first proposal in early 2007. In fact, the lenders’ concern about credit market conditions is largely a smokescreen. Lenders fear an auction because they would have to bid for the federal subsidies that they receive for making FFEL loans. This would require that they tip their hand and show the federal government and taxpayers what an appropriate subsidy rate really is. Moreover, the least efficient lenders would be squeezed out of the program. (Gee, imagine that.)

The industry’s claims regarding auction costs savings are also a straw man. The auction program isn’t so much about reducing costs as it is about getting student loan lobbyists and the Congress out of the business of setting subsidy rates. This model for setting loan subsidies is a terribly inefficient policy and one that we have criticized in a number of posts (available here, here, and here). Bear in mind, even if the auction increases costs for taxpayers, it is still superior to the existing subsidy setting approach.

The FFEL program wasn’t designed to work under current credit market conditions. But the loan industry, of course, didn’t argue that we should abandon the FFEL program or “postpone” it. Instead, they helped Congress and the Bush Administration design a solution. Why then should the auction be postponed or abandoned?