The recent credit crunch that destabilized the mortgage market and leaked to student loans, along with a heightened public awareness of the impacts of student debt, has brought to light the very real need for student loan reform. As we watched the events of the past few months unfold, the higher education community has been forced to face the fact that the dislocation in the credit markets could pose a real threat to the delivery of student aid. While Congress, the Department of Education and the student loan industry have worked together to ensure the continued availability of federal student loans in the immediate future, we must examine ways to improve our student loan system in the future for students and taxpayers alike.
The drumbeat for student loan reform has been building slowly, but steadily, for several years now. Starting in 2006, the Secretary of Education’s Commission on the Future of Higher Education called for the simplification of the entire federal aid process. In 2007, regulators and policymakers questioned relationships between student loan lenders and the college financial aid professionals who recommend them to students. Then in 2008, more than 100 lenders stopped or curtailed making federal student loans due to slashed subsidies and market conditions that resulted in shrinking profit margins. Finally, newspaper headlines across the country are now reflecting the warning signs that students’ capacity for managing debt is reaching a breaking point.
With a growing appetite for change among the public, policymakers and aid administrators alike, now is the time to examine a new proposal for a single, robust, neutral student loan program. A program that uses both private lenders and the federal government as sources of capital should be the cornerstone of that reform, harnessing efficient standardization, competitive borrower benefits, taxpayer-cost effectiveness and true consumer choice.
To understand where our federal student loan program is headed, we must first understand where it’s been. For over 15 years, the Congress, college financial aid officers, and the higher education financing industry have been locked in a polarizing struggle between two competing federal student loan programs: the Federal Family Education Loan Program (FFELP) and the Direct Loan Program (DL). The major focus of the debate is which program scores less in the federal budget. Unfortunately, for both sides, FFELP vs. DL is a death match where only one can survive. Rhetoric has smothered rationality and real dialogue on how to make the two programs actually work together has been impossible.
Objective observers all agree that the competition and interplay between the two programs have been beneficial to schools and borrowers, each program forcing the other to improve service, systems, and even pricing. The efficiency and standardization of DL’s single delivery system, the consumer choice and service competition of the “market” of multiple lenders, and the debt management/default prevention activities of the guarantors in FFELP have all been major competitive drivers improving both programs. In spite of the obvious advantages and synergies of the two programs, and the advantages of the competition to the consumer and schools, the programs are still being operated by Congress and the U.S. Department of Education (ED) as, at best, separate. Each program is now affiliated with a political party, further polarizing the issue.
To return the federal loan program to its primary mission, it is time to move from FFELP vs. DL to FFEL and DL. A much-needed reform program should focus on:
--The consumer and their rights and needs
--The delivery system
--The pricing for private capital
While the student loan debate has raged, education debt levels have more than doubled. Borrowers have an obligation, but society does as well, to help the borrower manage that debt over the life of the loan. Education loans create a 10 to 25-year relationship between the borrower, the lender/servicer, and the federal government. Unlike grant aid, the long term nature of the loans, and the obligations and relationships created by it over the life of the loan, make the education borrower, in every sense, a “consumer” rather than just a recipient. The borrowers’ consumer needs for access to information, timely and responsive advice and service, and mediation of issues are real and critical to the program’s success.
One of the basic rights of a consumer is choice. The education loan consumer should have the right to pick who they want to deal with over the next 10 to 25 years, whether it is the federal government, a guarantor, or a private lender. So far the dialogue has been just about federal cost. There needs to be a balance between taxpayer costs and consumer rights.
Thus, one of our goals should be to squeeze unnecessary costs, whether public or private sector costs, from the student loan programs, and use some of those savings to better assist borrowers in successfully completing their education financing by assuring that they have the information they need to manage and pay off their loans. Debt management and default prevention is something that should be measured and for which guarantors, as neutral third parties, should be held accountable.
Indeed, the role and financing of the “guarantor” community should be refocused away from the origination process to early awareness and information, debt management and default prevention, and loan rehabilitation for all borrowers, including those with Direct Loans. Essentially, guarantors would no longer insure the lenders, but instead help guarantee the borrowers’ success. Since loans may be securitized or sold to any party, including ED, the guarantor provides the borrower a stable, neutral third-party relationship over the life of the loan. Guarantor fees and incentives should be focused on the relative success of the borrowers in their portfolio as measured by Loans in Good Standing and these results should be published and available to the consumer. The consumer should be allowed to select the guarantor that they believe would best provide those services over the life of the loan.
In the late ‘80s, it was the inefficiency of the multiple loan delivery processes developed by individual lenders and guarantors, and the lack of standardization between those systems, that was a primary impetus for the creation of DL, a single, efficient delivery system solution for schools. As the competition between the programs grew and the private sector began improving their systems, standards were developed that excluded DL. Within FFELP vs. DL, and in FFEL itself, the delivery systems became a market tool that can be used to restrict the range of consumer choice.
The process of programmatic convergence should first focus on developing a single, robust, lender/capital neutral, origination platform. This system should be developed by ED, lenders, schools (FFELP and DL), guarantors and school financial aid management system (FAMS) providers. The system may be a federal system or a mutual benefit corporation and should accommodate and communicate data and disburse loans for multiple lenders, including ED, and should be the required process for all federal loans. This development eliminates the loan distribution process as a possible point of market control.
Had there been a single, federal loan delivery system already in place, the recent dislocation in the credit markets would have posed very little threat to the delivery of loan funds to the students. Also, a single system would lower the cost of entry into the student loan markets, opening the market to more lenders and capital sources. With one delivery system, capital becomes fungible, allowing small lenders to compete, side by side, with large lenders. Also, with a single system in place, Congress should require all schools to place ED, with its Direct Loan brand, and at least two other lenders on their preferred lender list. Effectively, the consumer could pick any lender (including ED) on any campus and be assured that the funds would be delivered efficiently and on time. This is ultimate consumer choice.
The last priority is the setting of the interest rate provided to the private lenders/capital in the FFEL program. Congress sets the rate charged to the student, which is the same for both DL and FFEL. Historically, Congress has periodically set the subsidy rate (special allowance payment), but this has always politicized the process. If it is the private-public partnership that allowed the student loan program to develop into a viable student loan market, a mechanism has to be developed that provides a reasonable, risk-rated return. The question is how. The answer should be provided by the private sector. Auctions have been suggested but these would be operationally cumbersome and ignore completely consumer rights. Most recently, Federal Reserve Chairman Ben Bernanke has suggested a mechanism that would track the spread between two relevant measures of the cost of funds to lenders and use those as a mechanism to determine the appropriate lender return. Ultimately, capital markets in conjunction with Congress, ED and loan providers should develop a proposal that uses the cost of the DL program as a benchmark; satisfies the needs of the federal government and the consumer; is market based; and provides an appropriate role for private capital and market competition.
2008 has turned into a watershed year for the student loan industry. The recent threat of an unprecedented disruption to student loan access has brought forth not only a rapid response from lawmakers, the administration and the industry, but also a rallying cry for a broad and thorough review of the entire federal student aid system. The time is right to convene “Clean Slate” working groups to tackle reform.
Working group activities should include:
--Creating a structure and laying the groundwork for regulation or legislation to unify our federal loan programs into one
--Integrating an R&D approach to setting student loan policy
--Researching and publishing position papers on key issues
--Providing a web-based clearinghouse of information
In a bid to retain America’s competitiveness in an increasingly global economy, it is imperative that our nation invest in the proper education, training and support for its citizens. We must develop a unified student loan program with an eye toward efficiency, affordability, accountability, and sustainability. It’s time to break the deadlock and restore America’s higher education finance system as the true support mechanism for college access.
What do you think of a single unified federal loan program? Join the conversation on ASA’s Policy Perspectives blog at http://www.amsa.com/blogs/policyperspectives.
Paul Combe is the president and CEO of American Student Assistance and Steve Biklen is the former president and CEO of Citibank's Student Loan Corporation.