Last fall, my wife and I drove to Philadelphia for a long weekend. We spent Sunday afternoon wandering along famous Benjamin Franklin Parkway, the street that Rocky ran down before sprinting up the steps of the Philadelphia Museum of Art and raising his arms to the sky. There was some kind of fair going on that day, and the parkway was lined with food vendors, jugglers, and booths where various companies hawked their wares. Many of the companies seemed to be selling something involved with education, but it wasn't clear what. So I walked up to the booths, which were all staffed by friendly, attractive 20-somethings handing out free T-shirts, Frisbees and pens that light up if you twist them the right way. They turned out to be for-profit student loan companies. They were selling debt.
Debt, we are told, is a good thing. Cultural prohibitions against borrowing have caused whole civilizations to falter in the modern world. Our current maybe-recession has been pinned on the "credit crisis" – i.e., not enough available debt. Borrowing has become an ordinary, acceptable feature of American lives. We've come a long way since Franklin warned against becoming "a slave to the lender."
And few sectors have embraced debt with more enthusiasm than higher education. As the price of college has increased sharply in recent years, debt has followed. According to the College Board, total federal student loans increased by 61 percent in inflation-adjusted terms from 1997 to 2007, to nearly $60 billion per year. But that still wasn't enough to match rising costs -- the percent of borrowers maxing out on federal loans increased from 57 percent to 73 percent during roughly the same time. The private loan market (the nice people with the Frisbees) stepped in to fill the void, exploding from $2 billion in loans 10 years ago to over $17 billion today. More students are borrowing more money for college than ever before.
The logic is compelling: Given the huge earnings differential between college degree haves and have-nots, it seems like there's no amount of money one could borrow for higher education that wouldn't be worth it in the long run. Debt opens the doors to opportunity for people with no collateral other than the promise of their older, better-educated selves. College debt is an investment in their future, and it’s a chance that everyone feels good about taking.
But somewhere along the line our unreserved enthusiasm for college debt has gotten out of hand. It has masked tough choices and allowed pressing problems to remain unsolved, in a way that harms the most vulnerable students. This is partly because we tend to talk about debt in ways that obscure its meaning. We've allowed the lofty promise of higher education and the cold-blooded realities of borrowing to become confused. Sometimes we speak as if debt isn't debt at all.
Grants and loans, for example, are routinely bunched together under the common label of "financial aid," as when the College Board noted that "more than $130 billion in financial aid" was distributed last year. This isn't unusual -- everyone in higher education talks this way. And when federal loan programs were first established in 1965, it made some sense. Credit standards were far tighter then, and students had no recourse in the private market.
But the world has changed, dramatically so -- the debt vendors on the parkway are evidence of that. While federal loan programs undoubtedly give some students access to loans they couldn't get elsewhere, for many students the only real "aid" is the subsidy, the amount they save in terms of deferred or reduced interest compared to what they could have gotten in the private market. In an era of single-digit interest rates, the subsidy often amounts to only pennies on the dollar. Now that federal loans have a 6.8 percent fixed interest rate and PLUS loans stand at 8.5 percent, for some students there may be no subsidy at all.
It's true that the credit crisis has tightened the student loan market temporarily, but that's what crises are—temporary. As of this writing, the private lender Think Student Loans (they gave me a pen) is offering to lend students up to $250,000, with funds disbursed within 48 hours and online applications approved "in as fast as one minute." That's with no government subsidy – we're not going back to 1965. Characterizing student aid as the amount of the loan instead of the amount of the subsidy dramatically overstates the real assistance students receive.
The conflation of debt with real financial aid is abetted by individual colleges and universities, which present aid "packages" to incoming students that allegedly make up the difference between the ever-rising price of admission and the family's "expected contribution." For many students the "aid" consists mostly of lightly-subsidized debt -- as if paying money back, with interest, doesn't qualify as a "contribution." The easy conflation of real aid and debt also taints federal policy -- as with the recently-enacted "TEACH Grant" program, which purports to give grants (thus the name) to students who agree to teach in high-poverty schools. Yet due to eligibility restrictions, the U.S. Department of Education estimates, 80 percent of the "grants" will actually turn into unsubsidized loans.
Lenders, meanwhile, are eager to rhetorically bind their product with the greater good of higher education. Sallie Mae isn't so much lending money as "helping millions of Americans achieve their dream" while Nelnet "makes educational dreams possible" and Brazos promises to "help you finance your dreams." I don't fault the dream-weavers in the student loan industry for marketing their services, but seriously: when Capitol One tries to sell me a credit card or a car loan, it doesn't pretend to serve some ethereal higher purpose. It's hard not to see parallels in the sub-prime lending crisis, where unaffordable and sometimes predatory loans were dressed up in the rhetoric of homeownership.
Why does all of this matter? Because the rapid expansion of student debt, combined with the soft-pedaling of debt's true meaning, has served to forestall higher education's inevitable day of reckoning when it comes to price. While a few massively wealthy institutions have recently taken steps to reduce borrowing at the margins for the middle- and upper-middle class, constantly rising prices and debt to match remain the norm elsewhere
There are two main culprits here. Traditional colleges and universities, protected from competition by regulatory barriers and buoyed by public subsidies and rising demand, have managed to avoid most of the difficult choices inherent to becoming more efficient and restraining price. There are exceptions -- University of Maryland Chancellor Brit Kirwan has held down tuition in recent years by cutting operating costs, centralizing purchasing, and increasing faculty productivity (with the support of the faculty). At the same time, the Maryland system re-focused student aid dollars on lower-income students, reducing their need to borrow. Unfortunately, few other higher education leaders can make similar claims.
Governors and state legislatures, meanwhile, often treat universities and students as revenue source during economic downturns, shifting the funding burden to tuition as a means of softening the impact of fiscal crises brought about by their incompetent stewardship of the public treasury.
Debt has been an enabler for both groups. By grabbing money from the future income streams of students and parents, colleges and policymakers have managed to put off hard choices today.
The consequences of these bad actions have largely been hidden from public view. Student loan default rates have been a non-issue since the early 1990s, when federal policymakers cracked down on unscrupulous fly-by-night colleges that were abusing the system. But the most commonly-used measures -- the institutional two-year default rates that were established after the scandals -- are seriously flawed. As my colleague Erin Dillon recently noted, the average time to default is four years. While widely-reported 2-year default rates hover below 5 percent, the 10-year default rate for low-income students is more than 15 percent. For students who borrow more than $15,000, it's more than 20 percent. For black students, it's nearly 40 percent. These numbers, moreover, are for students who graduated from a four-year college. Default rates for drop-outs, of which there are many in higher education, are substantially worse. But since colleges get paid up front, and the federal government guarantees most lenders' loans, there are few incentives for those institutions to care.
The tectonic shift toward debt-financed higher education reinforces the notion that college is a fundamentally private good -- exactly the wrong message in a time when the nation's collective prosperity is increasingly tied to competition for information-age jobs that can cross national borders with ease. It has embroiled college financial aid offices in embarrassing scandals. It limits the life choices of debt-burdened graduates, and can devastate the financial futures of those who default. It fuels inefficiency, price escalation and public disinvestment in higher education while transferring scarce resources from families and students to financial giants' bottom line. Debt in moderation is the right choice for some students, some of the time. But it's no substitute for efficiently-run universities supported by real aid policies for students in need. Higher education debt has grown into far too much of a good thing.
Some choices, like whether to take a crushing amount of debt to go to your first choice college or settle for second best, are difficult.
Other choices, like whether to cut a wasteful government program that is prone to corruption and then use the savings to make college more affordable for low and middle income students, should not require much deliberation.
Yet student loan giant Sallie Mae, other lenders, and several members of Congress have come out against common sense reforms to the federal financial aid system proposed in President Obama’s budget plan. Of chief concern to critics is Obama’s decision to eliminate the Federal Family Education Loan Program (FFELP) and funnel all lending to students through the existing Direct Loan Program (DLP).
The president’s plan will save taxpayers $94 billion over 10 years by ending pointless subsidies to loan companies and using government funds to lend directly to students. Because loan repayment is guaranteed by the federal government, private lenders assume very little risk under the FFELP and yet are rewarded handsomely -- a subsidy that makes little economic sense. Much of the savings from the move to direct lending would be used to increase the maximum Pell grant award to $5,550 for the 2010-11 school year, and make the Pell grant a mandatory government program guaranteed an increase -- inflation plus 1 percent -- every year.
There are other important reasons to make the change. For one, the FFELP program is prone to corruption. A 2006 audit of the student lender Nelnet by the U.S. Department of Education’s inspector general revealed that the company had received more than $1 billion in taxpayer subsidies by gaming the system. Another investigation in 2007 led by New York Attorney General Andrew Cuomo found that lenders were lavishing gifts, payments, and other inducements on college financial aid officers in order to encourage them to recommend their loans to unwitting students.
Beyond its susceptibility to nefarious practices by loan companies, FFELP is also less reliable for students. In fact, Congress was forced to put the industry on life support -- by purchasing FFELP loans in order to provide struggling companies with fresh capital -- late last year.
So, what is the holdup?
Naysayers are voicing fears that eliminating lender subsidies could result in job losses. These concerns are, at best, overblown; a large work force will still be needed to process loans under the direct loan program, and companies like Sallie Mae can still have a role in servicing loans made through the program. Further, if Sallie Mae is so concerned about the job security of its employees, perhaps it should do some soul searching: Despite announcing losses of $213 million in 2008, the company paid its CEO more than $4.6 million and its vice chairman more than $13.2 million -- plus use of the corporate jet.
Seeing their golden egg slipping from their grasp, lenders are proposing a compromise that they claim will achieve up to 82 percent of the savings of a direct lending plan. The problem with the plan is that even if it does deliver on its promises, it will still result in over $17 billion in wasteful spending. To put it in perspective, this amount is equal to the cost of awarding more than 3.4 million young people the 2009-2010 maximum Pell grant award.
The student loan industry’s influence in this debate cannot be separated from their extensive campaign contributions to federal lawmakers. For example, The Hill newspaper recently reported that during the last campaign cycle, Rep. Howard P. (Buck) McKeon (R-Calif.), the senior Republican on the House Education and Labor Committee, received $20,000 in donations from major loan companies Sallie Mae and Nelnet, the most of any representative. Responsible members of Congress should be more concerned about supporting policies that will allow us to live up to President Obama’s pledge that “by 2020, America will once again have the highest proportion of college graduates in the world.” With the Lumina Foundation for Education estimating that by 2025 we will face a shortage of 16 million college-educated workers, this call to action must be heeded immediately.
Our country faces too many challenges for us to be providing pointless corporate welfare to loan companies. Our generation is inheriting a climate crisis, an economic crisis, a health care crisis, and a persistent crisis of severe economic and racial inequality. If Congress plays pork barrel politics rather than investing in the potential of America’s young people, then they are setting us up to fail at a time when failure is not an option.
Pedro de la Torre III and Carmen Berkley
Pedro de la Torre III is a senior advocacy associate at Campus Progress. Carmen Berkley is president of the United States Students Association.
Not long ago, one of the authors of a recent Inside Higher Ed Views article, “Aid for Students, Not for Banks,” proposed the creation of “State/Federal Partnerships for College Access and Completion Rates,” arguing that there are “too few programs addressing” these issues.
If the Obama administration’s budget proposal to eliminate the Federal Family Education Loan Program succeeds, there’ll be even fewer. That the author of is unaware of the extraordinary work done by guaranty agencies and lenders in the areas of college awareness and access speaks volumes of the quality of the debate around the administration’s proposal – and the need for more careful examination.
Clearly, battle lines have been drawn. Advocates for the proposal have quite effectively stoked populist rage against the organizations that make and service student loans. But just as any fair-minded person should be wary of claims that are “too good to be true,” they should be equally wary of charges that are “too bad to be true.” It should count for something that the picture being painted is unrecognizable to the overwhelming majority of the nation’s financial aid administrators and student loan borrowers.
Finally, does anyone seriously think the lives of borrowers will improve with the government not only becoming the (only) banker, but also needing to make large profits on loans in order to fund the proposed Pell Grant expansion?
As Congress moves forward with abbreviated consideration of the proposal under budget reconciliation, the student loan community implores policymakers to weigh two questions:
Are the projected cost savings from eliminating FFELP real? The short answer is No.
The Office of Management and Budget claims that the proposal will save $46 billion over 10 years; the Congressional Budget Office, $94 billion.
That the government’s budget agencies produced such divergent estimates ought to be reason enough for healthy skepticism.
But real grounds for skepticism exist. This year OMB revised its cost estimate of about 10 years' worth of FFELP loans. It said it was $18 billion too high. Since 2004 FFELP’s costs have been chopped by $23 billion.
Did the Direct Loan program get cheaper? Nope. OMB has revised its cost estimates upward by $12 billion. That amounts to a $30 billion swing.
In other words, the cost savings projected could very well vanish. Congress could wind up eliminating the more cost effective program.
Finally, the government’s cost estimates are problematic in other ways. For example, the department’s growing costs for administering direct loans would not be counted. These and other flaws have been well documented by the CBO, OMB, Congressional Research Service, and PricewaterhouseCoopers, among others.
Healthy skepticism is warranted for another reason. “Subsidy costs are estimates about an uncertain future and could be manipulated,” a 2004 OMB memo explained. “There is pressure on occasion to manipulate the estimates.”
Apart from whether the savings are real is what they actually represent: The government profiting on its low, low borrowing costs (close to 0 percent), while the borrower rate is as high as 6.8 percent.
The second question that should be weighed is, “Are there elements of today’s FFELP that are worth preserving?”
One of its greatest strengths is its accessibility: wherever Americans with dreams of going to college live, whether it’s on the plains of Nebraska, in the mountains of West Virginia or on the bayous of Louisiana, there’s almost always a nearby lender, bank or credit union that makes federal student loans.
And, almost always, the guaranty agency that serves the community sponsors college nights and other college awareness programs, as well as financial aid workshops. These programs have helped countless numbers of low-income and first-generation college students.
Another strength is the program’s default prevention activities, which have given FFELP lower lifetime default rates. Beyond the numbers is the personal aspect: the thousands of men and women who work for guaranty agencies really care about doing a good job -- and that job is to help borrowers manage repayment and avoid default.
A third strength is the program’s continuous innovation. Lenders have invested millions of dollars in developing more convenient processes, such as eSignature, and improving customer service. Consider this: almost every major processes and convenience used by the Direct Loan program was invented by FFELP’s private sector participants.
Finally, FFELP has to be one of the government’s most small “d” democratic programs. Not only do schools get to choose which program to participate in, students get to choose their lenders. With respect to schools, they’ve always preferred FFELP by overwhelming majorities – even today after years of budget cuts and during the current credit crisis.
The administration’s proposal is not a win-win for college access. There will be losers. College awareness and default prevention services will vanish. It will cost jobs and eliminate choice and competition. It will add a trillion dollars to the national debt within a dozen years.
This is no ordinary “budget” proposal. It will affect the “going to college” process for families for years to come. Even though it’s on a legislative fast track, it’s not too late for Congress to slow this train down. As is being done with health reform, all the stakeholders should be convened to explore ways to preserve the best of the current system and build a better one for the future.
President Obama’s proposal to end the Federal Family Education Loan Program and make all federal student loans through the Direct Loan Program has gotten a lot of media attention. But for all the talk about budget numbers and politics, the views of college financial aid administrators have been largely lost in the shuffle. All FAOs have their own, differing reasons for choosing a particular federal student loan program for their institutions, but I’d like to explain why I favor the FFEL program and why my college will stick with it.
It comes down to this: FFELP provides outstanding service to students and our college and helps our students avoid defaulting on their loans, and competition -- between FFEL lenders and between FFEL and direct lending -- has provided for choice and, ultimately, excellence.
In the ‘90s, when direct lending was authorized, many of my friends moved to direct lending, for reasons I understood. Their decisions were based on solid logic and were in the best interest of their institutions. I supported their decision, and continue to support an institution’s right to select the program that is in the best interest of the students they serve. Processing issues were abundant in the FFEL program at that time; today, however, the processing concerns are gone. Banks are responsive to students and schools. If needed, I can intervene and get things done for my students. The automation we pushed for in earlier years is now in place, and the infrastructure used in the program is solid.
Students are the primary beneficiaries of the simplicity and strong service of the FFEL program. Providing them with options to submit paper applications or to e-sign their promissory note without having to visit the financial aid office makes their life easier. In addition, the automation and verification of eligibility for FFEL funds expedites the delivery of funds to students. Students are confident the funds they receive are accurate and that their promissory notes are securely maintained.
As a community college, we have the responsibility to ensure that our students understand the potential impact borrowing will have after graduation. With the help of our guarantor partners we have implemented financial literacy seminars for all student borrowers. Each new borrower must attend a seminar before their loan funds are released. The materials for this program are provided by guarantors, who are there in person to help make the presentations to our students. The support we receive helps us educate our students about loans and ultimately makes them better consumers of financial products of all kinds. Current budget cuts and reduced manpower would make it impossible to continue a program like this without the support of our partners. In addition to financial literacy, we also receive information on exit interviews and repayment options that are vital to keeping students in repayment and out of default.
For many years lenders, guarantors and servicers have been active participants in financial aid awareness activities. These organizations devoted considerable financial resources and man hours to help financial aid professionals educate families about federal financial aid programs. From creating publications to high school financial aid nights and community-wide events, students throughout my state and nationwide have benefited from this support. When they apply for financial aid early because of this advice, needy students often receive more grant assistance and reduce or even eliminate their need for loans. In addition to financial aid awareness activities, lenders, servicers and guarantors also offer substantial training opportunities to financial aid staff. The loss of training opportunities could be detrimental to my staff and ultimately to the students we serve.
Default prevention and aversion are critical issues in the community college sector. At the institution I serve, our selection of lenders, guarantors and servicers is based on their company default rates and their default rate at our school. The basic due diligence requirements of the Federal Government in default prevention and aversion simply are not good enough to prevent defaults with the community college sector. Our lending partners must offer exceptional customer service and go well beyond the basic federal requirements for our students. We conduct a thorough review to ensure that our students are well served. We are confident that the people serving our borrowers understand the issues that young, inexperienced student borrowers face. Competition between lenders, guarantors and servicers has pushed them well beyond the basic measures to reach and assist these young borrowers
With the loss of competition that would come from the Obama proposal, we must ask ourselves if this level of commitment to default prevention and aversion will continue. If we are forced to move to direct lending and find ourselves dissatisfied with the default prevention and aversion efforts, what are our choices? Who will help us reach our borrowers? Will our schools have to pay for an outside company to do what our guarantors, lenders and servicers have done free all these many years?
For our students, customer service is vital. They must receive correct information that they can understand the first time they call. Students need help -- someone to hold their hands because they are in a learning curve. They don’t want to wait on the phone for 30 minutes for help and they won’t. By selecting lenders committed to creating long term relationships with student borrowers, we have found that they go the extra mile, and sometimes two, to ensure students are treated well and receive the information they need. The clarity of the information provided from the first day the loan is issued until the student finishes repaying their loans can make a difference for a population that is naïve in their approach to borrowing, credit and responsibility. Notice I didn’t say ignorant because that isn’t true. They do, however, need guidance as they move through this pilgrimage of learning about financial responsibility.
One of the great benefits of FFELP is the ability of the student, and where it is appropriate, their parent to decide with whom they want to do business. Students in direct lending are not given this choice, a clear distinction between the two programs. While we provide a list of lenders that have acknowledged they work with community colleges, a student is free to select any lender willing to issue their loan. The student – not the school or the government -- controls the choice of lender and has the opportunity to evaluate benefits offered by that lender. If a student has a solid relationship with a bank, he or she will often pick that bank as the lender for the student loan.
Competition has fostered excellence in FFELP and DL. The innovations were a direct result of the push to stay viable and technologically advanced so that schools would select or continue to use that program Until recently When lenders also competed for borrowers which led to lower loan costs for our students The default prevention and aversion efforts we enjoy in the FFELP program represent efforts on the part of business partners to meet our demands and compete for marketability. Technology improvements in borrower interface are the result of competition between FFELP and DL. Our students have certainly benefited from that competition.
While the media has focused on the profitability in the FFELP program, little has been said about the fact that the federal government must fund Federal Pell Grant Program increases off the backs of student borrowers. The government borrows money at very low rates, much lower than those available to lenders, yet the government would continue to charge the same interest rates as FFEL lenders. Under the current proposal the federal government isn’t providing any breaks to the students and is actually making more off the program than lenders ever could. Wouldn’t it be appropriate for the USDOE to set interest rates based on the student’s expected family contribution? Or offer borrower benefits that help students during repayment based on their income? Or perhaps set an interest rate that is more in tune with financial markets and allow lenders to compete?
I support FFELP because of the benefits it provides students, parents and institutions. My institution and our students have been well served by this program. Times are changing. I can only hope that the Congress will find a way to maintain a worthy program that has benefited students for decades. And maybe, just maybe, financial aid administrators at over 4100 institutions that currently use FFEL will have an opportunity to be heard.
We are on the front lines every day. And we care about our students.
Bill Spiers is director of financial aid at Tallahassee Community College.
An overwhelming consensus has been developing that the Federal Family Education Loan (FFEL) Program should be ended, and all federal student loans should be made through the Direct Loan Program, where students borrow directly from the federal government. The main justification for this is that direct lending costs less than FFEL, where students borrow money from private financial organizations, typically with some federal subsidy. Proponents cite new figures indicating that the government stands to make a lot of money on the switch, money that will be used to fund more Pell grants.
As someone who likes the idea of bigger Pell grants, and thinks that the FFEL subsidies are a waste of taxpayer money, I can certainly appreciate the goals of these proponents.
But a closer look at their argument leaves me quite worried. Advocates are pointing to a figure of $94 billion that could be saved. This number is derived from the subsidy rate calculations of the loan programs produced by the Congressional Budget Office (CBO) through a process known as “scoring.” Proponents are using the CBO figures to argue that shutting down FFEL will save massive amounts of money -- a strange argument given that a former head of the CBO has explicitly warned against drawing such conclusions.
The warning appeared in "Budget-Scoring Barriers to Efficient Student Loan Policy," a paper prepared for and presumably financed by groups of lenders. The author was Douglas Holtz-Eakin, the former head of the CBO. The paper describes the reasons why the CBO subsidy rate calculations are not sufficient for making policy decisions. Such decisions should be based on a cost-benefit analysis. Though no fault of its own, the CBO has a good handle on neither of the required totals.
To begin with, the CBO does not even look at the benefits of the programs. Advocates are assuming that both programs have the exact same benefits, which is highly questionable, given what Holtz-Eakin terms “a plethora of anecdotal evidence that private sector lenders offer a portfolio of un-priced borrower benefits (fee waivers, rate reductions, etc.), credit counseling, expedited delivery, superior information technology, college access in initiatives and other enhancements and programs not offered by the [DL], but not easily quantified.” It is also possible that DL provides greater benefits. The point is that we should not assume both programs have the same benefits.
Moreover, the CBO does not look at all the relevant costs. As Holtz-Eakin summarizes, the CBO figures do “not capture the economic cost of the loan programs. This is not a secret. The [CBO] itself has acknowledged the fact” in a 2005 report stating that “the subsidy calculations … are not designed to fully capture the economic costs to the government … nor do they capture all of the effects of the programs on federal spending and revenues.”
The CBO provides some of the most authoritative, objective and accurate estimates on a wide range of budgetary issues. Thus, if you are going to take issue with their numbers, you had better have a good reason. While I am not qualified to offer a detailed critique, as the former head of the organization, Holtz-Eakin is, and he’s offered a number of reasons to doubt the usefulness of the estimates.
As he explains, these programs are required to be scored according to the Federal Credit Reform Act (FCRA). But the fact of the matter is that DL and FFEL “do not receive equal treatment under federal budget scoring rules.” While the switch to FCRA removed a bias in favor of FFEL, it instituted one in favor of DL. A few of these differences in treatment that lead to bias are explored below.
To begin with, there are risks that are not accounted for by budgetary scoring. The two big ones are interest rate risk (the uncertainty about what rate the government can borrow at) and market risk. Market risk is a broad category that accounts for uncertainty due to fluctuations of the economy. For instance, will the recession push up default rates? While these are real risks with real costs, those costs are “not captured by federal scorekeepers.” This puts FFEL at a disadvantage since they face the cost of insuring or hedging against these risks, while for DL, these risks and costs are simply ignored.
Then there is the risk of programmatic failure (DL had to shut down in 1997, and without FFEL to fall back on, students would have incurred substantial hardship) and indirect taxes (FFEL lenders pay significant corporate income taxes), neither of which is reflected in the budgetary scoring.
The differences that have been getting the most attention are administrative and guarantee costs. These costs were generally not included in the scoring, but some estimates by the OMB and CBO indicate that these costs for FFEL are higher than previously thought. What doesn’t seem to get mentioned is that while taking these costs into account is appropriate, this is a relatively minor source of difference in program cost.
Most importantly, according to an earlier CBO report, the key way in which the programs are treated differently is that for the DL program, “principal and interest payments are discounted at a different, and generally lower, rate than the borrower pays. The result is a net budgetary gain to the federal government that does not exist in the FFEL program.” This gain reflects the fact that the government expects to borrow the money for DL at low rates (0.76 percent in 2010) and charge students 6.8 percent.
This substantial gain would be reported for any program that borrows at the Treasury rate, and lends at a higher one. But that doesn’t mean it’s a good idea. To understand why, note that the exact same logic -- that the government can borrow more cheaply than it lends -- could be used to argue that the government should take over all lending in any market.
Consider an analogy to mortgage lending. Just as with FFEL, there are private lenders that have received subsidies from the government (we’ve already provided Fannie Mae and Freddie Mac $200 billion, and are on the hook for losses on their $5.2 trillion combined portfolio). By the logic of the pro-DL advocates, this subsidization is much more expensive than if the government provided the mortgages in the first place, so why not have the government take over all mortgage lending? I don’t know of anyone who thinks the government should be the only provider of mortgages, but there seem to be quite a few who think such a policy is a good idea for student loans.
In spite of these concerns about the relevance of the CBO figures in comparing the costs of these programs, advocates of switching to DL continue to rely on them. If this is how policy is to be made, then perhaps we haven’t quite put faith based initiatives behind us after all. In the words of former CBO director Holtz-Eakin, “When the budgeted cost of a federal program fails to reflect its actual economic cost, policy decisions regarding that program are likely to be skewed. The federal student loan programs provide a case study.”
Andrew Gillen is the research director of the Center for College Affordability and Productivity.
An unintended consequence of making access to college an entitlement readily available to all high school graduates is that serious study in high school has become optional, even for those intending to go to college. Without an incentive to study diligently, many students are disengaged in high school and, as a result, underprepared for college. Some freshmen arrive at college thinking that having fun is the main reason they are at college and that the pursuit of knowledge should be available for when they have nothing better to do.
This situation came about relatively recently, partly the result of a change in the meaning of financial aid. Until World War II, financial aid referred to traditional scholarships that were awarded to academically meritorious students who mostly also were needy. The G.I. Bill, which financed college for discharged veterans of World War II, foreshadowed broader programs of federal grants and loans -- 20 at present from the federal government, 17 from the Department of Education and 3 more from other federal agencies -- that essentially universalized "financial aid." Few of them require better than mediocre previous or current academic achievement. As a consequence, about 30 percent of incoming freshmen at four-year colleges and over half the freshmen at two-year colleges are assigned to remedial courses in writing, mathematics, or other courses.
Nevertheless, federal grant programs, though supplemented by state and private grant programs, were never able to cover the financial needs of the millions of college students whose families could not afford the rising costs of attending college. So Congress established several loan programs, some indirect loans whose federal subsidies made attractive to banks, credit unions, and other financial institutions, and some financed directly by the Department of Education. Unlike Pell Grants and other federal grant programs for college students such as work-study programs for needy college students, which do not have to be repaid, loans must be repaid with interest after graduating from or leaving college.
Repayment is a problem for student borrowers. Many of these loans are subprime -- toxic in the same sense that some mortgages were toxic. They are even more likely to be subprime than mortgages are; the only collateral is usually the student’s future earning prospects after graduating, presumably enhanced by what he or she has learned at college. Student borrowers who do not learn enough from their educations to get jobs that permit then to repay what they have borrowed are likely to default on their loans, leaving taxpayers liable for them.
The student financial aid system was created by Congress not as an integrated system but in pieces: to do a variety of things for a variety of reasons. One major objective was to help youngsters from low-income families gain access to higher education. In the light of our egalitarian ideals, limiting educational preparation for good careers to children fortunate enough to have educated, affluent parents seemed immoral. A second reason for promoting college access for youngsters from low-income families is that, as Jefferson argued, persons of extraordinary talent may be born in humble circumstances, and giving them educational opportunities might enable the American economy to be more productive. The knowledge explosion during the 20th century demonstrated that ideas are extremely important to the "creative destruction" that a market system needs in order for the economy to grow. Institutions of higher education are where many new ideas are developed by adults through research and transmitted to youngsters through teaching. Politicians are referring to this economic growth function when they speak euphorically about student grants and loans as "investments." Realistically speaking, however, only a few federal grant programs -- and none of the loan programs -- seek out top-notch students who will presumably contribute most to the productivity of the American economy; others aim only to make accessible the college experience for children of lower-income families. The existing system is an uneasy compromise between these two objectives.
It is an uneasy compromise partly because promoting access for youngsters from low-income families sometimes conflicts with the meritocratic ideal of educating youngsters most capable of making great intellectual contributions to knowledge. A better compromise could be made to realize these two objectives by targeting the grants and loans devised by the federal financial aid program to needy students studying diligently in order to prepare to go to college. Instead they were set up mainly as incentives simply to go to college, prepared or not. Congress apparently assumed that the colleges would screen admissions appropriately or perhaps Congress was afraid to appear elitist by imposing meritocratic conditions. Thus, federal aid to college students removed most financial barriers to attending college. Applications increased as high school students heard the message that college attendance led to well-paid, interesting careers, and was now affordable. Many colleges expanded facilities and lowered academic standards for admission; virtually any high school graduate could get into some college. Students might have had an incentive to work harder in high school if they had had to demonstrate academic achievement both to gain admission to college and to obtain financial aid to cover expenses while enrolled. The unintended consequence of failing to set this requirement is students graduating from college without good job prospects, a problem made worse in an economy where the unemployment rate has now risen above 10 percent. The predictable result is a growing rate of student loan defaults.
I am about to propose to change federal loan programs to college students but not to change federal educational grants to college students. Why the difference? Both suffer from the same drawback; they entitle mediocre as well as able students to obtain federal financial aid. A different approach is justifiable because federal loans have much worse consequences for both students and taxpayers than federal grants.
Consider grants first. As gifts from American taxpayers that students do not have to repay, it is true that grants are a complete loss to taxpayers if students do not make contributions to American society as a result of going to college. On the other hand, grants involve less than half as much money as loans in the aggregate as loans. And even individual cases of defaulted loans, accompanied as they are by interest and penalties, can be very large burdens both to American taxpayers and to individual student borrowers. In a November 2009 case decided by a panel of five New York State judges who ruled against admitting a student borrower to the New York bar, the panel said, “His application demonstrates a course of action amounting to neglect of financial responsibilities with respect to the student loans he has accumulated since 1983.” The student owed nearly half a million dollars. This admittedly unusual case shows the advantage to both students and taxpayers of grants over loans. Because there are strict limits to the annual grants that students can receive from the Department of Education in any academic year, students cannot attend college whose costs are way beyond their means.
With the help of Pell and other grants, students can afford a community college even if they cannot get loans rather than an expensive private college, especially if they live at home and commute. Students who start at community colleges and are successful academically can transfer to four-year colleges for their junior and senior years. In other words, student grants ignore academic merit even though everyone knows that students who have not done well in high school are unlikely to do better in college. These grants are an expression of American society’s willingness to make higher education available even to students who are poor risks. Giving Pell Grants is a societal bet -- though a long shot -- that mediocre students are late bloomers and can do better scholastically in the future, not that mediocrity is acceptable in itself.
This bet is riskier for loans, and consequently I recommend that loans be treated differently. Congress and the President should start to require the Department of Education to make student loans contingent on the best available evidence of the student’s prospects for repaying them, such as good job prospects based on high school and college grades, curriculum in which they enrolled, and their credit ratings. Defaults would still occur. Predicting the earning potential of college students is chancy. However, many young people would almost certainly be saved from financial ruin, and American taxpayers would almost certainly not have to bail out as many subprime student loans.
As theologians have said, we mean well and do ill and justify our ill-doing by our well-meaning. The unintended consequences of good intentions apply to our system of financial aid to American college students, as it did to our providing mortgage money to borrowers who could by no stretch of the imagination have kept up payments on their mortgages.
To sum up: Federal grants give mediocre students a chance to become late bloomers. Loans, however, are expected to be repaid, and mediocre high school students with bad credit ratings are likely to default on their loans, causing serious financial problems for themselves and financial complications for the American economy. Targeting loans to students with good prospects for repaying them is more prudent financially and makes more sense educationally. Some illiterate high school graduates have already sued their high schools for educational malpractice; disappointed college graduates may follow suit. Some diplomas are "tickets to nowhere."
By now, most prospective college freshmen have already found out which colleges they’ve been admitted to, and the grueling process of refreshing e-mail accounts and camping out by the mailbox has ended. But for many of these students, the worst anxiety begins now, as the reality of paying for college sets in. The U.S. college loan system has recently undergone important changes, with the goal of easing the burden on graduates, but serious problems remain. Those facing high debts may still find themselves struggling to make payments, and confused about their options.
It is of great interest to note that this predicament was addressed and solved in Australia in 1989 – through income-contingent repayment systems that go beyond anything in the United States. The system has been effectively copied in many other countries. The U.S, system remains fraught with problems even though the solution has been transparent for over 20 years.
To finance the staggering costs of education, students in the United States have increasingly relied on both federal and private loans. The debt burden facing recent graduates during what are often their least financially fruitful years has serious consequences. For those students who make it to graduation, the reality of impending repayment obligations may cause them to choose higher paying jobs instead of lower paying jobs with high social value, such as teaching and social work. Students who find themselves overwhelmed by their debt burden or unable to make payments may default on their loans, harming their credit and fueling the need for government-funded collection costs.
Recently, policies have been enacted in the hopes of alleviating some of the debt burden facing graduates. A 2007 law created a new repayment method for federal loans, Income Based Repayment (IBR), which in theory allows graduates facing economic hardship to tie their loan repayments to their future income and allows borrowers to defer payment during years in which their incomes fall below a certain threshold. IBR caps graduates’ repayment obligations at 15 percent of their discretionary income, in theory, and forgives remaining debt after 25 years of consistent repayment. The Reconciliation Act of 2010 made IBR more generous for students taking out federal loans after 2014.
These developments are encouraging, but this new approach does not go far enough to relieve the incapacitating debt burden experienced by many graduates. The convoluted nature of the federal lending system and the limitations of these reforms call into question the extent to which people will make good use of IBR. As such, it is very likely that the expected improvements in college access and loan default reduction will not be fully realized.
The process of qualifying for IBR requires substantial administrative effort to prove economic hardship. Navigating this process and understanding the multiple repayment options that exist is very complicated, and will prove unworkable for some borrowers. IBR cannot offer the greatest comfort to graduates concerned about sudden changes in post-graduation income, as the period of time in which a borrower can apply for IBR is only 45 days at the beginning of each year. Consider what has to be done by graduate debtors with respect to IBR when events in their lives change. IBR allows for lower payments than a standard repayment plan when the borrower’s income is above a certain level. Eligibility is determined by calculations that consider both a measure of the borrower’s tax liability, called “Adjusted Gross Income” (AGI), and 150 percent of the poverty line. Both AGI and poverty line calculations can be affected by many different factors, meaning that IBR eligibility calculations can also vary considerably over time.
For example, the AGI changes if a debtor experiences an income change (for example, through promotion, salary cut, or job loss). The poverty line calculation is affected if a debtor gets married or separated, has a spouse whose income changes, or experiences a change in the size of his or her household (eg, from having a child). When each of these (commonplace) changes occurs, graduates must provide their lender(s) with convincing income documentation (payslip, letter from employer, bank statement, etc). Each year, lenders will assess income and family size to adjust the IBR repayment accordingly. A typical person moving, changing jobs, getting married or having children will have to do this each time, and separately for each of their lenders.
Perhaps even more problematic is the fact that although debt remaining after 25 years of loan repayment is meant to be forgiven, the amount of this remaining debt is still treated as taxable income, undermining the goal of assisting those borrowers who face the most difficult economic situations. Additionally, while IBR is a more reasonable repayment method in concept, its implementation may do little to address the expensive inefficiencies associated with the complicated federal lending system. The creation of a more efficient lending system devoid of unnecessary complications and expensive collection agencies could create even more cost savings and free up more funds to help those students with the greatest financial need realize their professional goals.
The data on the incomes of American college graduates suggest strongly that a significant proportion of students with debt will be in a position that requires IBR action. For example, we have calculated that 40-70 percent of those who attend college can expect to have the relevant income and poverty level sometime in the 10 years following graduation. If, as expected, college graduates find the income-based repayment process confusing and daunting, they may remain in a standard repayment plan in which those with relatively poor financial circumstances will find themselves allocating substantial proportions of their incomes to loan repayment. We have calculated, for example, that those ending up in the bottom quarter of young graduate income earners with average student debt of $20,000 would need to devote around 30 percent of their incomes to service the debt. A significant proportion of college dropouts with debts of just $10,000 will have to allocate over 25 percent of their incomes towards this end. For many, this will lead to significant burdens and even default.
This important U.S. problem seems very odd to outsiders. In Australia, for example, student loans do not cause these sorts of collection problems because they are repaid not on the basis of regular set amounts, but instead depend directly and automatically on a graduate’s income as recorded by income tax authorities. This is an example of an automatic income contingent loan, a concept which was thought up, independently, by two Nobel winners in economics, Milton Friedman and James Tobin.
Australia led the world by introducing automatic student loan repayment in 1989, paid through the income tax system. The policy was designed to achieve all the protections inherent in the current U.S, moves toward income-based repayment, and to do so without the complicated administrative arrangements or detailed planning that characterize IBR. Student borrowers don’t have to clear any hurdles when they experience low incomes.
The Australian system is known as the Higher Education Contribution Scheme (HECS) and it works as follows: when students enroll in college they may elect to pay their tuition later in a way that depends on their future incomes. Eighty-five percent of students take up this option. The debt is recorded with the Australian Internal Revenue Service and is taken from a graduate’s income, at a maximum of 8 percent of incomes, but only when incomes exceed about U.S. $35,000 a year. If the former student is in poor circumstances, for example from being unemployed or in a low-paying job, no payments are required, and no action is needed by the debtor to prove these circumstances. There are no poverty line recalculations, no need to adjust repayments with marriage or separation or the birth of a child; it is all automatic and simple. When Australian college debtors’ incomes recover, their repayment amounts increase, yet never to more than 8 percent of incomes.
The very simple facts about the Australian versus the U.S. loan systems are that in Australia there is no default because of low income, people with debts face no repayment hardships and graduates do not have to take high income jobs in order to be able to afford repaying their loans. And all this happens with no action needed by Australian graduates, and with no required expertise or information needed on how to master complex and demanding administrative arrangements.
The success of HECS has encouraged a quiet international revolution in college loans, away from the U.S.-style and toward the Australian. New Zealand adopted a similar plan in 1991, South Africa in 1991, the UK (partially at first in 1997 and now in full swing), Hungary in 2003, and similar efforts are planned for Malaysia, Ireland and other countries in the near future. All the evidence is that these systems have worked well and the government gets back the vast majority (85 percent) of the debt without defaults or repayment hardships from low incomes.
It seems that U.S. college students are being left behind in terms of international reforms of loan arrangements. Automatic loan collection offers distinct advantages over current U.S. approaches, and given the demonstrated success and fairness of these systems in other countries, the time seems right to debate the issue in earnest in the United States.
Bruce Chapman and Yael Shavit
Bruce Chapman is professor of economics at Australian National University. Yael Shavit will be starting Yale Law School in September.
In February 2009, at a meeting of the American Council on Education, I challenged a group of university presidents and other leaders of higher education to focus on the need for greater innovation in higher education. I encouraged those leaders to heed the lesson offered by George Romney to the auto industry in the 1970s to innovate or lose their advantage: “There is nothing more vulnerable than entrenched success,” he said. I followed up in October 2009 with an article in Newsweek entitled "The Three-Year Solution: How the reinvention of higher education benefits parents, students, and schools."
The response has been pleasantly surprising.
Over the past year and a half, a growing number of institutions of higher education came forward with proposals to offer three-year degrees to their students. Here are a few examples:
Grace College, in Winona Lake, Ind., is offering an accelerated three-year degree in each of its 50-plus major areas of study. Dr. Ronald Manahan, Grace's president, cites the cost of college as a driving force behind the decision. “We have listened to people’s concerns about [the cost of] higher education and we are answering them,” he said.
Chatham University, in Pittsburgh, Pa., is offering a three-year bachelor of interior architecture without summer classes, allowing students to get into the job market a year earlier. School officials have reconfigured the four-year degree by cutting Studio classes from 14 weeks to just seven, and when compared to similar programs, these students graduate two years earlier.
Texas Tech University, in Lubbock, Tex., is offering an accelerated three-year medical degree, rather than the usual four. The program is aimed at making it easier and more affordable for students to become family doctors.
As institutions of higher education look into the possibility of offering a three-year degree, some have run into federal policies that seem to interfere with their ability to innovate. For example, this May I received a letter from Jimmy Cheek, chancellor of the University of Tennessee-Knoxville, describing a potential obstacle to a three-year degree surrounding student loans.
Here’s the issue: Under the Higher Education Act, student loan limits are tightly set to prevent over-borrowing by students. Federal annual loan limits and lifetime loan limits establish a maximum amount one can borrow under the federal student loan program. The annual loan limits are designed to pay for two semesters per year (see chart below).
Example: Scheduled Academic Year
Scheduled Academic Year 1
Fall 2010 and Spring 2011
Scheduled Academic Year 2
Fall 2011 and Spring 2012
Scheduled Academic Year 3
Fall 2012 and Spring 2013
Scheduled Academic Year 4
Fall 2013 and Spring 2014
For most institutions of higher education, and most students, this works and makes sense. But 3-year degree students often take a third semester’s worth of classes over the summer. The federal limits appear to prevent students from obtaining a loan to pay for those summer courses.
Fortunately, there is a solution. Working with the Congressional Research Service, and the staff of the U.S. Department of Education, my office has identified an option that exists under current regulations to give flexibility on these loan limits to institutions of higher education and students. Instead of following a standard “Scheduled Academic Year” as outlined above, an institution of higher education offering a three-year degree could award loans to students through a “Borrower-Based Academic Year," per the chart below:
Example: Borrower-Based Academic Year
Scheduled Academic Year 1
Fall 2010 and Spring 2011
Scheduled Academic Year 2
Summer 2011 and Fall 2011
Scheduled Academic Year 3
Spring 2012 and Summer 2012
Scheduled Academic Year 4
Fall 2012 and Spring 2013
This option would use the same annual loan limits and lifetime loan limits, but compress them to match the student’s academic schedule. Compared to the typical “Fall-Spring” academic year over each of the four years, a three-year degree program could use a “Fall-Spring, Summer-Fall, Spring-Summer” structure to allow for a compressed academic schedule.
I have been told that this “Borrower-Based Academic Year” option is currently not well used because it is administratively complicated for institutions to offer both “Scheduled Academic Year” and “Borrower-Based Academic Year” loan structures at the same time for individual students. But for an institution that offers a comprehensive three-year degree program involving a number of students, this seems to make sense as a way of helping students in that program afford the tuition and fees.
I have asked Chancellor Cheek to let me know if this option would work for the University of Tennessee, or if more flexibility needs to be added. When Congress last reauthorized the Higher Education Act in 2008, we made several changes to the Pell Grant program to allow that funding to be used on a year-round basis. There is no reason students should not have that same flexibility with their student loans.
It is my hope that more institutions will explore innovative ways to provide a high-quality postsecondary education. The three-year degree is one idea for some well-prepared students, but it is vital to our competitiveness as a nation that we develop other ideas to improve the efficiency of higher education and expand access to more Americans.
Institutions of higher education are rightly feeling pressure from parents, students, state and local leaders, the business community, Congress, and the Obama administration to do a better job of providing more Americans with a quality college education at an affordable price. That pressure will likely grow more intense every year as more jobs require higher education, advanced certificates, or technological skills from their applicants.
Some have asked whether all colleges and universities should be required to offer a three-year degree. My answer is a resounding no. Just as the hybrid car isn’t for everyone, all students and all institutions won’t want a three-year degree. The last thing we need is more federal mandates on higher education.
The strength of our higher education system is that we have 6,000 independent, autonomous institutions that compete in the marketplace for students. It is that marketplace that needs to develop the new ideas for the future -- and not become a victim of its own “entrenched success" -- so that our students, and our country, can continue to thrive.
Senator Lamar Alexander
Sen. Lamar Alexander (R-Tenn.) is chairman of the Senate Republican Conference and a member of the Senate Committee on Health, Education, Labor and Pensions. He served as U.S. secretary of education under President George H.W. Bush and as president of the University of Tennessee.
The Education Department's proposal to start charging a variable interest rate instead of a fixed, low rate to borrowers who combine multiple federal student loans into one is a "viable option for reducing federal costs" in student loan programs, the U.S. Government Accountability Office said in a February letter to Republican lawmakers, who had requested the review.