Health care understandably dominated the headlines leading up to — and beyond — yesterday’s historic House vote. It’s important to remember, however, that the reconciliation legislation also includes major reforms in the way that the government supports student loans.
Under current law, federally supported loans are made both direct from the government and through private lenders. The government loans are direct loans (i.e., the government lends directly to students). The private loans are guaranteed by the government (i.e., private organizations lend to students and the government guarantees the lenders against the risk of default). The health/revenue/education legislation will eliminate the private lending channel. (The market for non-government private loans will continue to exist.)
Opponents have denounced this change as a government takeover of the student loan market. That makes for a great soundbite, but overlooks one key fact: the federal government took over this part of the student loan business a long time ago.
In a private lending market, you would expect lenders to make decisions about whom to lend to and what interest rates to charge. And in return, you would expect those lenders to bear the risks of borrowers defaulting. None of that happens in the market for guaranteed student loans. Instead, the federal government establishes who can qualify for these loans, what interest rates they will pay, and what interest rates the lenders will receive. And the government guarantees the lenders against almost all default risks.
In short, the government already controls all of the most important aspects of this part of the student loan business. The legislation just takes this a step further and cuts back on the role of private firms in the origination of these loans.
That step raises some interesting questions about the costs of the current system (see this post), possible benefits of the current system (some colleges and universities appear to prefer working with private lenders), and the potential budget savings of cutting out the middle man (which appear to be large but somewhat overstated in official budget analyses).
But it hardly constitutes a government takeover.
Loans are supposed to be avoided at all costs since they are normally paid back with an attachment of an interest. Borrowing a loan is like gambling hence a person needs to watch out and make the best moves. This means that only the organized ones can stand a chance to survive in the world of loan taking.
Dear Professor Marron,
I read your recent postings regarding the overhaul of the student loan program with great interest. I have had difficulty finding any analysis of the legislation. There is support for the measure on both ends of the political spectrum and I would like a better (economic?) understanding of the initiative. I am inherently skeptical of supposed government efficiency and admire local governments which find private outlets for delivering services. Essentially, the local government recognizes that certain activities are not a core competency and seeks a more efficient outlet through business process outsourcing. (For example, I purchase my state fishing license each year through private businesses.) With respect to the student loan legislation, I understand your point that the previous system did not operate by market forces but I still have a number of questions regarding the supposed efficiency. Exactly what fees are paid to local banks to originate the loans? How do these fees compare to other fees to, say, originate a car loan? How is the overhead accounted for since, obviously, banks don’t build new offices to handle the incremental student loan business? If 8,500 to 31,000 jobs will disappear from the private sector, how many new jobs will be created in the public sector and what are the comparable salaries (and long-term commitments) of the private versus public positions? Will the government need to invest in new buildings and equipment and how will these overhead costs be accounted for? Of course, I have other questions but I wondered whether you could comment on the efficiency claim. Markets, I believe, can be efficient and ethical when allowed to operate under a minimal set of transparent controls. Further, to your point, the markets can adapt to unanticipated disruptions within the flexibility provided by the controls.
Thank you again for the helpful commentary,
David Reasner
Been reading for a few days now. It was very good and solid information. BTW, I love your site design as well. I enjoyed reading it and hopefully you will write more soon. Do you have a newsletter? How do I subscribe to the blog itself?
Find out exactly how much money you’ll be borrowing and how long you want to spend paying it off. Paying off loans quickly is more advantageous to you since the longer your loans have outstanding balances, the more you’ll pay in interest in the long run.
This is socialism, the government will not do the work better. Direct loans are easier to keep track off.
Very good post. You have my full support