Republicans Should Rethink Plans to Privatize Student Lending
Americans are concerned about rising college prices and student debt levels, and the Republican Party has proposed a solution: bring the private market back into student lending.
Prior to 2010, most federal student loans were originated by private lenders under the Federal Family Education Loan Program (FFELP). But Congress eliminated that program in 2010 and all subsequent loans were originated and administered by the U.S. Department of Education. Since that time, many Republicans have called for a return to market-based federal student lending.
But there’s just one problem with that: FFELP didn’t function at all like a market. Under FFELP, the federal government set the terms for how private lenders were to issue loans. Lenders did not screen borrowers based on creditworthiness and they did not offer better terms to borrowers who were more likely to repay their debts – two hallmarks of competitive lending. Instead, they offered loans to anyone who met prescribed eligibility criteria and offered terms that were dictated by legislation. In fact, the chance of being repaid mattered little to these lenders because the loans were guaranteed by the government such that they were repaid even if borrowers defaulted.
The lenders did all of this in exchange for a fixed payment from the Department of Education. The payment amount, which was pegged to a benchmark interest rate, was also set by legislation. Unfortunately, the payment amount was never quite right, which led to a number of problems so severe that they required a legislative fix.
During the years leading up to the Great Recession, the government payment to lenders yielded such significant profits that some lenders were offering kickbacks to financial aid officers in exchange for sending students their way. These abuses were stopped when the payment was adjusted downward in 2007, but that fix didn’t work for long. By the fall of 2008, FFELP lenders were in Washington asking for more money to keep them in the business of making these loans. The fallout of the early stages of the mortgage crisis led Congress to quickly pass legislation to keep FFELP lenders from quitting the program.
Policymakers that want to inject more market discipline into federal student lending should find better ways to do so than returning to a failed policy that created more problems that it solved. We suggest three such ideas for Congress to consider when it takes up the overdue reauthorization of the Higher Education Act next year.
First, Congress could dramatically scale back the existing federal lending program to focus on undergraduate students. These are the students for whom guaranteeing access to postsecondary education is most important. But out of the roughly $100 billion of loans made by the government each year, $30 billion go to graduate students and another $10 billion to parents of undergraduate students.
Scaling back or eliminating federal lending to graduate students and parents of college students would create an opening for private lenders. This would almost surely reduce lending to students who attend graduate programs that are unlikely to produce a large enough economic return to justify the cost and risk. But such an outcome may be more desirable than taxpayers being on the hook for loans to graduate students that go unpaid or are forgiven under current policy.
Second, Congress could establish a regulatory framework to support innovation in alternative financial products such as income share agreements (ISAs), in which students agree to pay a share of their future income to investors that finance their college tuition. ISAs are likely to remain a niche product, but could play a role in expanding access to higher education financing for some students, such as those who need to borrow more than the federal limits. They could also substitute for federal lending to graduate students if the availability of loans to graduate students was scaled back.
Finally, Congress could improve the market for higher education by increasing the availability of data on college quality. If we want consumers to “vote with their dollars,” then we need to arm them with the information that they need to make good decisions, such as better access to information on the outcomes of previous students who attended particular programs of study. A market without information is no market at all.