This year marks the 40th anniversary of the guaranteed student loan program for college students. The program, created by Lyndon Johnson as part of the Great Society, has made college affordable for thousands of students. But it also has had a scandal-plagued past, with billions of dollars of unpaid loans and massive taxpayer losses and has contributed to the runaway inflation in college tuitions.
In theory at least, student loans are supposed to be paid over time once the students graduate and start working. Through the 1970s and ‘80s, the student loan default and delinquency rates were scandalously high. Tens of thousands of financially successful professionals walked away from their loans with relative impunity. Stories of highly paid doctors, engineers and lawyers defaulting on loans were commonplace. It was as if these deadbeats believed loan repayment to be optional. Taxpayers got socked with a multibillion-dollar tab.
Fortunately, in the Reagan years, credit reforms were made to strongarm the participating banks and collection agencies to clamp down on student loan scofflaws. Consequently, the program’s monetary losses have declined.
But just as the program began improving its business practices, the Clinton administration in 1995 launched a new program called the Direct Student Loan Program. This allowed students to apply for student aid directly from Uncle Sam and thus bypass private lenders altogether. This was supposed to cut costs be eliminating the middle man and leveraging the government’s lower borrowing costs.
In reality, the program was a kind of “privatization in reverse.” Rather than contract out lending to professional borrowers, the government decided to play the roles of banker, credit agency and debt collector all at once under the Education Department.
It turns out this was about as good an idea as the “Charlie’s Angels” sequel. The government is a lousy banker. It does a poor job of assessing and pricing risks, managing funds and collecting on debts. Big surprise: The program’s net losses have sky-rocketed. Since 1997, the Direct Student Loan Program has increasingly lost money for taxpayers every year.
In 2003, the most recent year for which data are available, the program’s net costs exceeded $2.8 billion. The U.S. General Accountability Office estimates the loan program has a cumulative net balance of minus $10.7 billion: It bleeds money.
An original program fan, former Federal Reserve Board member Lawrence Lindsey, recently conceded: “I once argued that the cost to the taxpayer of having the government lend directly to students would be less than the cost of guaranteeing student loans issued by the private sector. But the direct lending program has been losing more money every year.” Some 500 colleges have stopped participating in the program because of shoddy management and financial losses.
But why are operating losses and failure to meet performance standards never reason enough for Congress to end a federal program? Ironically, now that the program is a demonstrable failure, Massachusetts Democratic Sen. Ted Kennedy now has a plan that essentially would bribe schools to use the FDLP. He would increase Pell Grants to FDLP-enrolled colleges.
It is hoped House conservatives will recognize a scam when they see one. The House Education Committee, headed by able reformer Rep. John Boehner, Ohio Republican, is expected to decide the fate of the Direct Student Loan Program in the next few weeks. Mr. Boehner should put the taxpayers’ interests first, and end this money-losing operation. Private banks are best able to run a loan program.
In addition to mothballing the inefficient direct student loan program, the U.S. government must clamp down better on unpaid student loans. By some estimates, there are more than $10 billion of unpaid student loans that could be collected and repaid into the Treasury to reduce federal debt.
Moreover, the federal government should impose more stringent income tests on students, and especially their parents, to ensure loans are issued only to students who have a financial need. Finally, market, not subsidized, interest rates should be imposed on the students to provide an incentive for quick repayment. Studies have shown most college graduates will have enough income — certainly well above the median — to pay back the loans at a true market interest rate.
Were Congress even half-serious about cutting the federal budget, a good start would be reforming the student loan program. Its record of protecting taxpayer dollars is deplorable.
The Clinton Direct Student Loan program especially has a decadelong legacy of mismanagement. It belongs in a category of feel-good Clintonite programs like Americorps and Goals 2000 that were advertised as ways to make government operate more efficiently but never lived up to the hype.
Stephen Moore is president of the Free Enterprise Fund and a fellow at the Cato Institute.