Direct Student Loan Triumph A Long Time Coming

As NPR and other news organizations have reported this week, the new health care law wasn't the only major legislation that passed this week. There also was a major revamping of the student loan program.

The Obama Administration and congressional Democrats passed, as part of the health-care reconciliation legislation, an end to the guaranteed student loan program in which banks made big profits while taxpayers essentially got all the risk. According to administration estimates, the federal subsidies to the private sector amounted to about $61 billion over ten years.

Lawmakers replaced it with a direct-lending program in which the federal government will take applications and directly make the loans to college students.

The financial services industry had fought the direct lending concept for years and the last year was no different in terms of their opposition. As a Chicago Tribune reporter, I wrote in 1994 about a direct-lending pilot program:

... A reform of federal student loan procedures is underway that would change all of this. Four Illinois schools are among 104 nationally helping to introduce the new direct student loan program this summer.

The streamlined approach involves applications made directly to the federal government, which disburses the money directly to students. If the program works, the U.S. Department of Education, which is overseeing the changes, hopes all eligible schools will adopt the new system within five years.

Winners in the process would be students, who receive loans quicker without the bewildering array of forms, and taxpayers, according to direct-lending advocates, including Sen. Paul Simon (D-Ill.), the program's main congressional sponsor.

Losers will be the middlemen-the banks and loan-guarantee agencies-that required all the paperwork and, through their service fees, kept costs of the traditional student loan program unnecessarily high. Understandably, banks and loan-guarantee agencies have emerged as the major opponents of direct lending.

Again, that was 1994.

Here's what happened after that according to a history of federal student loan programs on the New America Foundation site:

As part of the 1993 budget agreement, Congress passed a budget reconciliation bill (the Omnibus Reconciliation Act of 1993) that would phase in direct lending, starting with colleges that volunteered to participate and giving the Secretary of Education the power, if necessary, to require colleges to switch until at least 60 percent of loans nationwide were direct. While the law called for direct lending to replace guaranteed loans, it was silent about what would happen beyond the 60-percent mark, since that was outside of the five-year window covered by the budget.

In 1994, the new Republicans leadership in Congress targeted direct lending for elimination. However, many college and university officials were dissatisfied with the guaranteed loan system and optimistic about the new alternative. Under the guarantee system, financial aid administrators had to deal with what the Government Accountability Office labeled a "complicated, cumbersome process," disconnected from other federal aid and involving thousands of middlemen. Hundreds of institutions were already participating in the direct loan program, which operated in tandem with the other federal aid programs.

Ultimately, Congressional leaders stopped short of eliminating direct lending. Instead, they passed a law that prohibited the Department of Education from encouraging or requiring colleges to switch to the direct loan program. In theory, this maximized choice: schools could choose to participate in one program or the other. In practice, those profiting from the guarantee system could use their substantial resources to lure or retain colleges and universities, while the direct loan program was not allowed to make its own case. Not surprisingly, campus participation in the direct loan program declined.

In 2003, a team of investigative reporters at U.S. News and World Report looked into what was causing some colleges to switch back to the guarantee program. Their front-page story found that much like old-time political ward bosses, the student loan industry "used money and favors, along with their friends in Congress and the Department of Education, to get what they wanted."

The New America Foundation history, which is well worth reading in its entirety, goes on to relate how the death knell for the banks and other private companies in the student-loan business was the credit crisis.

When banks found it difficult to impossible in 2007 and 2008 to raise money in the capital markets as the financial crisis really took hold, college financial aid offices and students were thrown into turmoil.

That helped prepare the ground for what happened this week, as did the populist outrage against the financial industry for sparking the crisis, the taxpayer bailouts they received and the bonuses their officials awarded many of their executives.

If the drama associated with the passage of the health care overhaul hadn't overshadowed it, the student-loan changes would have gotten much more attention.