For decades, the federal student loan program has paid private lenders and banks a subsidy for loans they make to college students. But the Obama administration wants to bypass banks and have the federal government lend the money directly to students.
Because of last year's student loan crisis, some schools have already switched to direct lending. And consumer banks are not happy about it.
Switching Amid The Credit Crunch
In the last 10 months of 2008, $8 billion worth of student loans dried up, as some of the nation's biggest banks and state guarantors of student loans either scaled down or stopped making loans altogether. Across the country, students and their parents didn't know what was going on.
"At the rate many lenders were leaving the program, how certain could parents be that that lender might be there for them that year? But what would happen the following year?" asks Anna Griswold, director of financial aid at Penn State University.
Her answer? Nobody knew. But at the time, 40,000 students were in danger of losing access to federal loans. Eventually, other lenders stepped in, and most students got their money, says Griswold.
What Penn State did was switch from the Federal Family Education Loan Program, which depends heavily on private lenders, to the direct lending program run by the U.S. Department of Education. "It was very clear and a no-brainer as to what made the most sense here at Penn State," Griswold says.
Penn State was not alone. In the past year, more than 500 colleges have made the switch — for good reason, according to Robert Shireman, deputy undersecretary at the Department of Education.
"We can be sure that parents [and] students who need loans will have them available when they need them, and we won't have a last-minute problem of a lender pulling out because of something that happened in the stock market or in credit markets," says Shireman.
Reliability, says Griswold, is the biggest difference now that Penn State is a direct lending institution. The switch was simple, she says.
For students, little has changed. The financial aid office certifies a student's eligibility for federal aid online, processes the application and sends it to the Department of Education via a secure system online.
Competition And Choice
Opponents of direct lending say the Penn State example does not address a bigger issue.
"To me it boils down to competition and choice," says John Dean, special counsel to the Consumer Bankers Association.
He says about 2,000 private lenders and banks today participate in the federal student loan program. Replacing them with a single lender — the federal government — would destroy competition and choice. Besides, says Dean, colleges have had the option to switch to direct lending since 1994, so why have 8 out of 10 schools chosen not to?
"They obviously think that customer service is going to be better," says Dean.
Shireman disagrees. He says this is all about creating a more efficient, cheaper way of lending money to students.
"We can't afford to spend the money for an institution to choose something that costs taxpayers more," Shireman says.
Shireman says once private lenders are out of the picture, the $8 billion to $10 billion in subsidies the government has been paying them will go back into federal aid for students.
The House of Representatives has already voted in favor of direct lending. It will come up soon for a vote in the Senate, where passage is less certain. But the administration is so confident it will pass that the Department of Education has drawn up plans to issue all loans through the direct lending program beginning next summer.