Student loans: the wrong cuts.

Young people in this country are feeling the squeeze. Even as it's getting harder to get a decent job without a college degree, college itself is becoming prohibitively expensive for more and more people. From 1984 to 1993, median family income increased by 3 percent, while the average cost of tuition and fees at private colleges went up 91 percent. In real terms, the median family income keeps going down while tuition--at public as well as private schools--keeps shooting up.

The story gets even worse. As tuition explodes, federal and state education money is drying up and students are bearing a larger and larger share of the tuition burden. Reflecting the need for more aid, the federal student loan guarantee program saw loans grow 57 percent between 1992 and 1994. And these loans leave students with huge debts. Paying back $50,000 at 8 percent over 10 years, for example, would mean a monthly payment of $644. This makes it impossible for many graduates to go into low-paying lines of work like teaching, and it also discourages many from seeking a college education in the first place.

Meanwhile, a host of financial institutions have been making a mint off struggling students. Until recently, the federal government did not actually loan money to students directly; rather, it guaranteed private loans. The system proved expensive and wasteful. Private lenders made huge sums of money while doing little work and taking no risk. And service to students was decidedly not a priority.

In 1993, President Clinton decided to do something about it. Under his plan, which passed in Congress that summer, the government went beyond merely guaranteeing bank loans. Students were given the option of borrowing money directly from the Treasury. "Direct lending," as this program is called, quickly became wildly popular among students and schools, in part because the government streamlined the process to reduce paperwork. It has also saved taxpayer dollars by cutting out the middlemen.

The crucial element of direct lending, though, is the option of what's called income-contingent loans, which lets students pay off their debt as a percentage of their income, rather than set, monthly sums. Tying debt repayment to income was Clinton's original goal in reforming the student loan program: He wanted to encourage college graduates to take low-paying jobs in public service.

The benefits of direct lending, then, are connected both to government reform and to the broad social good. As a reform, it has injected competition into a student loan system once monopolized by lethargic private lenders. The social good is that by allowing flexibility for students repaying their debt--something that banks were unwilling to do--the government encourages post-graduate jobs in Teach for America and the Peace Corps, as opposed to just Wall Street and Madison Avenue. For these reasons, student loan reform is an all too rare success story in the federal government's recent history. "It's the best thing since microwaveable brownies," Colorado State University student Anthony Gallegos raved in U. S. News & World Report.

Sound like a good candidate for a round of bipartisan back-slapping? It would seem so, but despite direct lending's clear successes, Republicans in Congress are moving to limit sharply--or eliminate entirely--the program, which would also spell the end of pay-as-you-can loans. The financial institutions who were once making out like bandits have been lobbying hard to get back the business they've lost. And the GOP is inclined to give it to them, even though it's a bad deal for everyone else. Instead of doing more to fix the student loan program, Republicans seem intent on breaking it again.

Federal Loan Follies

Since 1966, the Federal Family Education Loan Program (FFELP) has helped more than 40 million Americans through college. But the program carrying out this admirable mission also developed a reputation as one of the federal government's most inefficient. The program cost billions to run--most of which went not to students but to quasi-governmental corporations that had learned to scam the system. For years, the loan program was denounced from both sides of the aisle as wasteful; it prompted a constant stream of investigations and warnings from the General Accounting Office. In 1991, for example, loans lost to default cost the federal government $3.6 billion.

The trouble was inherent in FFELP's basic design. Until Clinton's reforms, the government did not actually lend money to students, but rather coaxed banks to do so--by both guaranteeing loans and offering subsidies. Because the banks had very little incentive to get the money back once they'd loaned it--they'd get their money regardless, whether from the student or the government--"guaranty agencies" were created to police the banks. These guaranty agencies, state-chartered but privately owned, had three jobs. When a bank asked the government for reimbursement, claiming that a student had defaulted on the loan, the guaranty agency would: (1) find out if the bank had made a "good-faith" effort to collect; (2) if it had, pay the bank with money it was holding on behalf of the federal treasury; and (3) finally, pursue the loan itself, in a last ditch effort to save the federal government from swallowing the cost of the loan.

But there were serious problems with this plan. For one, guaranty agencies were literally guaranteed the contract by law, so they never had to bid for the work or worty that they'd get axed for poor performance. Worse still, the guaranty agencies actually had an incentive to do their job poorly. If they reported a lazy bank for failing to try to collect a loan, they got no reward. But if they ignored the banks, and went after all the loans themselves, they got to keep 27 percent of the money they recovered.

Not all guaranty agencies were corrupt; many did their jobs honestly and well. But there were enough bad apples--and enough other loopholes that allowed private companies to make a killing off the student loan program--that the federal government found itself wasting taxpayer dollars that were supposed to be helping young people go to college.

When he assumed office, Clinton pushed to reform this system, both to improve the program's efficiency and to give students the option of paying their loans back as a percentage of their income. Since the government was assuming the risk anyway--and since the maze of banks and guaranty agencies had proven to be a nightmare of waste and abuse--why not lend money directly from the federal Treasury? This would require the government to come up with the cash for loans. But there was potential for long-term savings, since taxpayers wouldn't have to pay interest subsidies to the banks or fork over a 27 percent cut to guaranty agencies. Clinton's idea was to have the IRS--which would have the necessary data on income--handle loan collections.

In a compromise with Congress, the bill the President signed implemented direct lending only partially. The Department of Education would have to compete with the private loan providers--banks and government--chartered groups like the Student Loan Marketing Association (Sallie Mae)--for much of the business. Direct lending would be capped at 5 percent of the total loans in the first year, but eventually anyone who wanted to could participate.

Blinded by the Right

Actually, the final bill was in many ways an improvement over what Clinton originally wanted. Setting up dual programs--both the Education Department (through direct lending) and private lenders (through the old system) would make loans to students--is a tried and true method of maintaining efficiency. Sure enough, when the government implemented a simplified application process and a speedier transfer of funds, private lenders followed suit. Forced to compete with direct lenders, Sallie Mae, which holds more student loans than any other lending agency, now offers all kinds of new repayment options for students. The same benefit was evident in the early years of the Tennessee Valley Authority, which acted as a yardstick to keep private utilities from gouging their customers.

The great disappointment of the battle over student loan reform was the loss of the IRS collection plan. As Steven Waldman recounts in The Bill, this idea died not due to corporate lobbying--which was fierce--but because of congressional turf battles. In the current political climate, there's little chance of reviving this idea. But it is a reform to keep pushing, since it would vastly simplify the process of tying loan payments to income.

So if these reforms were so smart, why do Republicans insist on rolling them back? Is it that they can't stand the idea of President Clinton--or activist government--doing something right? Or are they caving to private lenders, who prefer the old system of inefficient monopolies because they made more money that way?

The answer is "both." "It's pretty ridiculous to turn the Department of Education into some big lending institution, and the government has not exactly proved itself adept at this," says an aide to House Education and Opportunities Committee Chair William Goodling, clearly playing the anti-government card. "This is not something most Americans are comfortable with."

To make their point, Republicans cite figures that depict direct lending as vastly more expensive than the old system of banks and guaranty agencies. But their calculations are screwy. The Republicans changed the scoring rules for student loans, instructing the Congressional Budget Office (CBO) to count the administrative costs of the direct lending program--but not the guaranteed loan program. In other words, the CBO had to take into account all the costs associated with overseeing direct lending, while excluding, for example, $160 million in annual subsidies to guaranty agencies that existed in the old program.

The Republicans' new accounting method by itself wouldn't be objectionable if the CBO applied it equally to both programs. But this way, the direct lending program is portrayed as much more expensive than the old guaranteed loan program. In fact, the original CBO estimate showed direct lending could save $12 billion over five years. That estimate may have been inflated because CBO didn't account for administrative costs (the Republicans did have a point on that), but the existence of at least some savings is undeniable. Since direct lending eliminates all the subsidies to banks, guaranty agencies, and other intermediaries, it is bound to bring significant savings. "As long as it is necessary to provide a profit to induce lenders to guarantee student loans," Federal Reserve Board member Lawrence Lindsey wrote recently in a letter to GOP Senator Spencer Abraham, "direct lending will be cheaper."

The best system would have direct lending and private banks compete, so that each could keep the other in line. The Republican solution, on the other hand, is to give the private-lending industry back its monopoly and then make it very difficult for the government to prevent abuse. Goodling's proposal would cut administrative funding for loan programs by two-thirds. Some of these cuts account for staff reduction in the direct lending program. But they would also force scalebacks in the Administration's ability to oversee the banks and guaranty agencies. Over seven years, those cuts could precipitate anywhere from $1.5 billion to $4 billion in new waste and fraud, according to reports by the GAO and the Education Department.

The conspicuous beneficiaries of these changes would be the guaranty agencies and banks, both of which showed their strength in the 1993 student loan debate and came back with a vengeance this year. Republican proposals explicitly forbid the Education Department from cutting subsidies to the guaranty agencies. Republicans have also thwarted the Administration's effort to take back a $1.8 billion fund that the guaranty agencies are sitting on--taxpayer money originally designated to repay banks for student loan defaults that the agencies now use to invest and make profit.

Less Competition, More Waste

Republicans claim to be seeking free market efficiency. But with student loans, they are moving toward a system with less competition and more waste. A provision in Goodling's bill would forbid the Education Department from advertising to students the option to transfer a private loan to the government, and thus get the benefits of paying back as a percentage of income. Lenders had complained they were losing business-25,000 loans have been switched over since 1993. But they were only losing business because students saw a better deal elsewhere.

If Gooding's bill passes, who will pay for these anti-reforms? Students, most likely. Although the government requires income-contingent payback options for all student loans, private lenders have shown great resistance in the absence of government competition, and enforcing the rule is difficult. The bottom line is that pay-as-you-can loans simply aren't feasible without direct lending. Private lenders don't want to do anything that might lose them money, and with the government removed as a competitor, they'll have no incentive to offer complicated payback plans. That means fewer graduates doing noble or necessary--but low-paying--work.

The other potential loss for college students is the cutbacks in subsidies that they now receive to ease the loan burden. Republicans have put the in-school interest subsidy--which pays interest on loans while students are in school, so they can complete their studies before having to worry about loans--on the blocks. Under Republican plans, the average student debt under the Stafford Loan program could increase by more than $1,400 for a four-year undergraduate, and more than $10,000 for a four-year graduate student, according to the Education Department. Again, it's not just that students will be left with big bills. Many will be scared off from college in the first place.

The Republican proposals on student loans are indicative of their ideological world view and the true nature of their political loyalties. GOP fondness for the "private sector" is defended on the grounds of efficiency and fairness: Citizens should receive the best services possible and bloated government bureaucracies often can't deliver. But, in this case, reducing government presence means worse service, and a worse deal for taxpayers as well.

With the student loan program, Republicans have an opportunity to prove that they are truly interested in fighting government waste and protecting the working class--just as they have always claimed. Instead, they are choosing to act as patrons for rich financiers, assuming no one will call them on it.

It's not too late to prove them wrong.