- The Washington Times - Saturday, April 28, 2007

New York State Attorney General Andrew Cuomo on March 22 announced a civil lawsuit against Education Finance Partners, a student loan company based in San Francisco, for offering colleges incentives to steer student borrowers toward the company’s loans.

American colleges accept a variety of financial incentives from some large student loan companies to steer students to borrow from them, according to Mr. Cuomo. Such goodies include substantial cash payments, free trips to resort destinations for campus financial aid officers, and company-manned call centers to answer students’ financial aid questions. Institutions that have accepted such incentives include Long Island, Boston, Clemson, Baylor and Drexel Universities.

“We believe these revenue-sharing agreements are really no different than kickbacks,” Mr. Cuomo charged at a news conference.

Senate Health, Education, Labor and Pensions Committee Chairman Edward Kennedy, Massachusetts Democrat, sent a letter to several other large student loan companies, including Sallie Mae, Citibank, Bank One and Bank of America, demanding information about their financial relationships with colleges.

These actions will no doubt energize politicians eager to take credit for clipping the wings of private lenders who earn profits from federally guaranteed student loans.

The Bush administration has proposed reducing the amount the government insures private companies against defaulted loans and increasing the fees companies must pay. But for an industry that operates on slim margins such measures would likely reduce competition and hurt students when companies simply pass these increased costs on to their customers.

Others propose more direct lending by the government. But such a shift could increase the taxpayers’ burden and drive up the overall costs of college.

As many taxpayers may not be aware, the U.S. Department of Education operates two competing loan programs, and the taxpayers bear the risks of both. Under the William D. Ford Direct Loan Program, the department makes and administers loans directly to borrowers. Under the Federal Family Education Loan (FFEL) program, private companies provide the capital and administer the loans, but the loans are largely federally subsidized and insured.

Some believe one way to rein in costs would be to scale back the FFEL program and expand the Ford Direct Loan program, thereby cutting out the middleman and potentially reducing costs.

But the devil is in the details — or, in this case, the defaults. The default rates under the Ford Direct Loan Program are higher than under the FFEL program, and the gap is widening. When a college grad defaults on a federally insured student loan, the taxpayer is on the hook for most of the balance.

The Office of Management and Budget says the 2007 projected weighted average default rate under the FFEL program is 11.7 percent; under the Ford program, it is a whopping 16.65 percent. Already 3.1 million Direct Loans are expected, and the increased burden to taxpayers would be significant if the program were expanded.

What accounts for the different default rates? Private companies have both the incentive and the ability to be innovative in keeping track of borrowers, enabling them to prevent and recover bad debts.

Students are a poor credit risk. They typically have limited credit histories, no secure jobs, and an immature sense of responsibility. That’s a main reason the federal government insures student loans.

But private companies are often better equipped than government agencies for keeping track of their customers. Government bureaucracy is inherently less efficient. Even the most diligent civil servants are hamstrung by the fact their public bureaucracy moves slowly and less able to take advantage of the best practices of the most successful private companies. Giving a federal agency more direct responsibility, in student lending or anything else, is likely to make its inherent inefficiencies costlier to taxpayers.

Federally insured student loans now provide 30 percent of all payments for college tuition costs. That loan market has more than doubled in the last 10 years, and economists have argued the result actually put upward pressure on college costs.

Four decades of experience have shown expanding the taxpayers’ burden while reducing students’ responsibility doesn’t make college more affordable.

The College Board says the cost of attending a public college or university has risen 86 percent, adjusted for inflation, since the 1991-92 academic year; private college costs have soared 52 percent in the same time. Tuition and fees for the current academic year at private, four-year institutions reached $22,218, up 5.9 percent from last year. Prices at public, four-year institutions rose 6.3 percent, to $5,836.

It’s time to take a hard look at the reasons college costs escalate, including rapidly rising federal student aid, and to pass policies that pressure colleges to decrease tuition — and not simply shift the taxpayers’ burden from one shoulder to another.

Leslie Carbone is an adjunct scholar at the Lexington Institute.

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