Is Now the Right Time to Convert to an All-Direct-Loan Program?

Paul Basken’s article, “Complexities Grow for the Student Loan Bill as Senate Action Finally Draws Near,” provides an insightful update on the challenges that the Administration will face in eliminating the bank-based Federal Family Education Loan (FFEL) program and converting to the government-run Direct Loan (DL) program. The ironies associated with this effort are numerous. As Paul points out, on one hand the Administration is trying to garner support for another jobs bill, yet on the other, it wants to eliminate an entire industry. On one hand, the Department of Education is complaining about the horrible behavior of FFEL lenders, yet on the other, they will hire a few of them to be the contractual servicers of the loans issued by the Department under the DL program. On one hand, the president is telling all young people that they should complete at least a year of college, but on the other, the interest rates charged to students and parents in the DL program are well above current market rates. Students who borrow through the unsubsidized Stafford program (which serves the majority of student borrowers) are paying nearly 7 percent in interest, and parents who borrow through the PLUS program are paying at a rate of approximately 8 percent.

Nobody would take a mortgage at 8 percent today, yet Congress and the President don’t think twice about charging hard-working, middle class families 8 percent for the money they borrow to help their kids get an education. That is shameful. While students and parents can frequently negotiate with a FFEL lender to secure a loan at a reduced interest rate or lower origination fees, the Direct Loan program provides no such flexibility and all borrowers are forced to pay the interest rate set by Congress, regardless of the current economic outlook or market rates.

It is disconcerting that every time we turn around the CBO reports a different number for the “savings” that will be realized if we move to an all-DL system. It is even more troubling that OMB and CBO cannot agree on a figure. I hope everyone understands that the savings are not primarily the result of the elimination of lender subsidies, but instead are a reflection of the amount of money the government will earn by collecting interest and fees from borrowers. Instead of being called “savings” the CBO score should be referred to more accurately as “earnings” since the government will earn a considerable amount of money on the backs of students and parents. That is, of course, assuming that graduates can find jobs and actually repay their loans, rather than defaulting on them. The projected “savings” are tentative at best, and overstated given the methodology used by CBO to calculate costs.

It is also important to understand that the CBO score does not include administrative costs associated with issuing and servicing the significantly increased Direct Loan volume. As Paul points out in his article, the Department of Education has already announced that it will be hiring some of the very lenders it complained about to service the loans issued through the Direct Loan program. In other words, the Department of Education isn’t getting out of the business of paying lenders, but is instead doing it through different contractual arrangements. They want to pick the winners and losers among today’s lenders.

But even if we were to agree that the proposed switch to an all DL program is the right thing to do, what concerns me most about the transition now is that the U.S. government will have to borrow much of the money required to issue loans being made to students and parents who participate in the program. According to the New America Foundation, while the first year cost of a $3000 FFEL loan is $88, the first year cost of a $3000 DL is $2995. At a time when we are borrowing nearly 50 cents of every Federal dollar spent, it seems unwise to spend $2995 when, instead, we could spend $88, especially if we have to borrow part or all of the $2995 from China. The CBO score does not take into account the cost of borrowing money to issue loans, which will ultimately reduce and possibly even eliminate the “savings” associated with the conversion to an all DL program. And it isn’t like we are using the “savings” to pay down the debt. We are using the “savings” projected by the CBO to support additional spending in another program – the Pell Grant program that has already received a $10 billion bonus from the American Recovery and Relief Act and is, nonetheless, running a deficit of its own. If the projections are wrong, we could find that we borrowed money in one program to justify deficit spending in another.

Last month, Congress had to raise the cap on the Federal debt so that the government could continue to issue Social Security checks and VA benefits. The conversion to an all DL program means that we will have to borrow hundreds of billions more dollars in the short term to issue Direct Loans (the “savings” are realized over the repayment period, which can be 10 years or more). This borrowing is in addition to the borrowing we will do to keep the government running, keep unemployment benefits flowing, repay the Social Security trust fund, and support two wars.

The conversion to the DL program is yet another effort to collect money from one group (the students and parents who will pay the government very high interest rates in the DL program) to redistribute it to another (Pell recipients). Despite the fact that the Pell program is a worthy one, some might call this budgetary slight of hand yet another middle class tax.