Student Loans: Should We Bypass the Banks?

Few Can Afford College without Borrowing Money

Keble College, a constituent college of the University of Oxford

Keble College, a constituent college of the University of Oxford

The cost of higher education is spiraling skyward. At some private schools it now exceeds $50,000 a year. Lagging government support has resulted in steep tuition increases at public universities as well. Little wonder then that educational loans have become as indispensable to college students as low cost loans and extra cash are to the working class.

Different Types of Student Loans

There are three general types of student loans: private loans made by banks and other lenders without any involvement of the government, federal direct loans made by the government itself; and federally guaranteed loans made by banks and other lenders and insured by the government. Additionally, colleges and universities sometimes make educational loans, usually in partnership with banks or other financial institutions.

In the case of federally guaranteed loans, the government pays subsidies to the lenders who make the loans and then guarantees up to 97% of the loans. Lenders are thereby protected from almost all losses on the transactions. The interest rates on federal direct and federally guaranteed loans are fixed rates established by Congress. Private loan terms are typically less favorable than those of government loans, and interest rates on private loans can change over time.

A History of Problems

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In recent years, the student loan industry – which finances tens of billions of dollars of educational expenses each year — has been beset with difficulties that have attracted publicity and debate. In 2007, several state attorney generals and lawmakers in Washington exposed questionable dealings involving the endorsement of particular private lenders by college financial aid offices and the siphoning of student-loan applicants to those lenders.

In 2008, the industry was badly shaken by the credit crisis, which threatened to cut off the supply of student loans from private lenders by making it impossible for them to sell loans.  Many student-loan lenders depend on being able to sell the loans they make in order to raise funds for new loans. Investor interest in buying student loans dropped off almost entirely, and it fell to the federal government to keep the industry afloat by stepping in and buying federally-guaranteed loans.

Squeezing Out the Banks

The Obama Administration has now proposed abandoning the guaranteed student loan program entirely so that all federal educational loans would be made directly by the government. Proponents of this change claim that over the next ten years it would save $94 billion in subsidy payments to lenders, which could then be used for Pell grants to students in financial need.

Highly Technical Banking Services . . .

 In the recent subprime mortgage crisis Fannie Mae and her good friend Freddie Mac were placed in conservatorship by the US Treasury.

In the recent subprime mortgage crisis Fannie Mae and her good friend Freddie Mac were placed in conservatorship by the US Treasury.

The proposal has ignited a particularly fractious political battle. Although they collect hefty fees on loans that are virtually risk-free, private lenders under the subsidized loan program, like Sallie Mae, Bank of America and Citigroup, argue that they provide valuable services in marketing, customer relations, billing, default prevention, and collection of delinquent loans.

Or a Risk-Free Ride

Critics, however, say that because of the financial crisis, the government is directly or indirectly financing almost all federal student loans and there is no reason to continue a program that was originally intended to inject private capital into the education lending system.

A Few Million Dollars Per Banker . . .

For lenders, the stakes are huge. According to a New York Times report, despite losing $213 million in 2008, student lender Sallie Mae paid its chief executive and its vice chairman a total of $17.8 million in cash and stock. The company, which did not receive money under the federal bailout system and is not subject to pay restrictions, also disbursed cash bonuses of up to $600,000 to other executives.

Or a Few Hundred Dollars Per Student

Under the president’s proposal, the additional Pell grant money that would be available to an individual student probably would not be more than a few hundred dollars. But the money would be distributed to a large group of needy students for whom a little more money may make a big difference.

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