Cut the Middleman Out of Student Lending, Report Says

Washington — The 35 guarantee agencies that work with lenders, borrowers, and the U.S. Education Department to administer bank-based student loans have evolved into inefficient middlemen that waste taxpayer money, the New America Foundation said today in a policy report released just as Congress prepares to debate a student-lending plan that could eliminate the need for guarantee agencies.

The agencies, intended to insure banks against default losses and thereby encourage them to offer better rates on student loans, have become largely administrative bodies, according to the nonprofit group’s report. The federal government now reimburses lenders when borrowers default on their student loans.

The report also says that guarantee agencies, which received $1.57-billion in federal subsidies or payments in the 2008 fiscal year, operate under contradictory regulations: They receive a fee for helping borrowers avoid defaulting on their loans, but they earn a larger fee if they let borrowers default on their loans and then collect or rehabilitate them. In the last fiscal year, guarantee agencies received $177.3-million from the federal government in default-aversion fees, and $948.8-million from the federal government for collecting or rehabilitating defaulted loans.

The report recommends that Congress create a separate organization for preventing defaults or collecting on defaulted loans. One organization cannot do both, the report concludes.

It also recommends that Congress reimburse lenders directly when borrowers default, rather than channel that money through a third party.

President Obama has proposed ending bank-based federal student loans and moving entirely to direct government lending, a plan Congress is preparing to debate in the coming weeks. Mr. Obama says the plan will save taxpayers billions of dollars each year, while some Congressional Republicans have said the plan will cost more than 30,000 jobs and prevent colleges from choosing among competing loan programs.

“The private sector plays an important role in student lending, from the investment of private capital and technological innovation to the financial education services and customer service,” Rep. John Kline of Minnesota, the top Republican on the House education committee, said this month in an interview with The Chronicle. —Austin Wright