(Page 2 of 2)
Clinton's proposal to expand direct lending is more complicated. The system it would replace--government guarantees of loans by private banks--is itself horribly flawed. The largest federal loan program, the Stafford Loan, was created in 1965 and, until recently, provided four out of every five student-loan dollars nationwide. The Stafford program gives private lenders a "special allowance," set 3.1 percentage points over the 91-day Treasury bill rate, to pay for the interest on loans issued to college students.
Stafford loans are insured against default by a guaranty agency and reinsured by the federal government. If a student defaults and the private lender fails to collect the debt, it is fully reimbursed by the guaranty agency, which, in turn, is fully compensated by the federal government if it fails to collect the unpaid balance. Not surprisingly, few participants in this process have any incentive to reduce defaults, which occur about one-fourth of the time.
The selling point of Clinton's direct-lending scheme, passed as a pilot program last year, is that it would eliminate the private middlemen and have the Education Department issue loans directly to students. The administration claims this will save the government billions of dollars a year, but we won't be able to gauge that for another six to eight years, when the loans start to come due. Without waiting for the results of this experiment, Clinton wants to increase dramatically the number of loans directly issued by Washington.
The payoff of direct lending may not be known, but we can guess using common sense: Why should we expect the federal government to be a better lender than a private bank? Indeed, when the Senate Subcommittee on Investigations for Governmental Affairs investigated the Education Department's handling of student loan-guarantee programs a few years ago, it found that the DOE "failed to efficiently or effectively carry out its responsibilities....It is not an exaggeration to say that we have heard no testimony or seen any document that suggest that the Department of Education has done even an adequate job in managing and overseeing its student loan responsibilities." Giving the department more responsibility is not likely to improve this sorry record.
It is probably true that, federal loan programs or no, the vast majority of students would still need to borrow some money to attend college. I see no reason why these loans shouldn't be made by private lenders who, without government guarantees, are simply making a business decision to invest in the future earning potential of students.
Would the lack of government guarantees mean that the market in student loans would completely dry up? It's unlikely. Banks, after all, make money by lending, and the fact that the overwhelming majority (more than 75 percent) of student loans are repaid on time indicates that promising students are good risks.
The withdrawal of federal guarantees would force lenders to seek out students (or students' parents) who are likely to repay their loans. If private lenders prove reluctant to reenter the market for student loans, colleges and universities could prime the pump by making loans themselves and then selling the loans on secondary markets for maintenance and collection, as some private colleges already do today. Or schools--who have more ready information about their students than banks are likely to--could simply make loans themselves, earning interest on their endowments while funding their students.
This shift to private-sector lending wouldn't mean that only accounting and engineering majors would get loans. A responsible student majoring in an "impractical" subject--say, art history--may be a better risk than a less-devoted student working toward a "practical" degree.
Clinton's plan to make tuition payments tax deductible seems less objectionable on face value. But simply making tuition tax deductible, the Clinton approach would still artificially encourage families to buy higher education rather than other goods and services, leaving colleges and universities with no strong incentive to deliver more bang for the education buck.
As Clinton was inside San Francisco's Hyatt Regency Hotel that February 14, whipping lobbyists for higher education largess into a frenzy, several hundred people protested outside the hotel against Clinton's multibillion-dollar loan-guarantee plan for the Mexican peso. Why should we back loans so risky that banks won't make them? the demonstrators argued. In a few years, if Clinton's college aid plan makes it into law, we may well have another loan-guarantee fiasco to worry about.