One of President Obama's major priorities is making college more affordable, and he now has an historic chance to do that by reforming the way the federal government delivers student loans. Under the current student-loan program, the government essentially bribes banks to lend to students by offering them generous subsidies and promising to take on 97 percent of the risk. As Jon Chait and Kim Clark have written, the program is purely a sop to banking interests--absorbing money that could be used to increase the number and size of Pell Grants. Obama's budget includes a provision to pull the plug on these subsidized loans, saving the government up to $94 billion over ten years, according to estimates from the Congressional Budget Office and the Office of Management and Budget, simply by cutting out the middleman (private lenders) and giving directly to students.
In the 1990s, President Clinton tried to eliminate this wasteful policy. He ultimately failed, after conservatives rebelled against a "government takeover of the student-loan program." So Clinton accepted a compromise, which created a parallel direct-lending program that students would have flocked to if not for loan companies' aggressive efforts to undermine it. (In part, this was accomplished through widespread graft, as in the 2007 student-loan scandal where college-loan officers at various universities received vacations, stock, and luxury goods to steer students to private lenders.)
This time around, however, the president has the upper hand. That's because the private program is insolvent. In May 2008, with America's financial system faltering, private lenders realized they could no longer borrow money at rates that allowed them to make college loans profitable. At that point, Clinton's direct-lending program could have taken over the subsidized system, but lenders raised unsubstantiated fears about the government's ability to oversee so many new loans. They pressed Congress for emergency stopgap legislation to prop up private student lending for the 2008-2009 school year. The bill, Ensuring Continued Access to Student Loans Act (ECASLA), has since been extended until September 2010. In order to keep money flowing to students, ECASLA allows lenders to borrow at a low government rate, ensuring them profitable loans. In addition, it lets banks sell their loans to the government--making their lending programs even more dependent on federal capital and thus even more unnecessary. When ECASLA expires, all Obama has to do is decline to renew it, and private banks' role in student lending will end.
What's more, Obama has successfully lobbied Congress to include reconciliation rules in the current budget, meaning that changes to the student-lending program will not face the threat of a filibuster by Senate Republicans. As with health-care reform and other major initiatives, this gives Obama's student-lending program a far greater chance of passage.
But direct lending has powerful opponents on both sides of the aisle. Free-market ideologues, who hold that a government program is somehow less socialistic when business is allowed to take a huge cut, and legislators who rely on political donations from the lending industry could each thwart Obama's plan. Last month Democrats, signaling their uncertainty, included a nonbinding "Sense Of the Congress" statement in the budget resolution demanding that "any reform of the federal student loan programs ... include some future role for the currently involved private and non-profit entities." And lenders attempting to stay in the game have introduced a seductive counter-plan. Sallie Mae, the nation's largest student-lending company, claims that its approach will recoup 82 percent of the cost savings proposed by Obama. (Sallie Mae has yet to release any detailed numbers. However, the New America Foundation was able to get a copy of the proposed legislative language from an unnamed source.) Sallie Mae's proposal is essentially a version of ECASLA extended indefinitely--which means that the government is already achieving most of Sallie Mae's proposed savings. In addition, Sallie Mae would strip away anti-graft provisions enacted in the wake of the 2007 student-loan scandal, and it would grant itself a de facto monopoly over student loan service contracts.
Facing pushback from his Democratic allies, Obama may be tempted to cave and accept some version of Sallie Mae's plan. But he shouldn't. It's still a huge waste of taxpayer money, it leaves the door open for private lenders to reassert themselves in the future, and it's more expensive for borrowers. Obama should make full use of his current political advantages and cut lenders out of the equation once and for all.