The Democratic-led House of Representatives, in a 253 to 171 vote on September 17, easily passed landmark legislation that would bring an end to the long-standing Federal Family Education Loan Program (FFELP), the program initiated by the Higher Education Act of 1965 to offer college students federally guaranteed student loans via private lenders.
As the measure awaits a Senate vote scheduled for October 15, representatives for the FFELP student loan industry along with prominent Republicans have been stepping up their attack on the key mandates of the bill, which they say will not only cost students and schools the competitive pricing and choices in student loans offered by the private sector but will saddle taxpayers with billions of dollars in new costs.
Federal Student Loans: FFELP vs. Direct Loans
Under the existing FFEL program, the government pays private FFELP lenders a subsidy for the federal student loans these lenders originate in essence, paying a third party to act as a middleman in issuing government student loans.
In 1992, the Clinton administration launched a second federal student loan program the Federal Direct Student Loan Program which issues federal college loans directly to borrowers through the U.S. Department of Education, with no third-party involvement from a bank or other FFELP lender.
Should the House-approved bill, known as the Student Aid and Fiscal Responsibility Act of 2009 (SAFRA), pass the Senate and become law, the FFEL program will be dismantled and all federal student loans will become Federal Direct loans, made directly through the federal government rather than through third-party FFELP lenders and banks.
Supporters of the legislation say that the elimination of FFELP subsidies will generate billion in savings to taxpayers over the next decade. The bill allocates billion of this estimated savings to expand the federal Pell Grant program for low-income college students and to fund several other education initiatives at what supporters say is no additional cost to taxpayers.
President Obama has been a vocal backer of the bill, maintaining that FFELP subsidies funnel government money to banks and away from students.
Ending this unwarranted subsidy for big banks is a no-brainer for folks everywhere, Obama said in a recent speech at Hudson Valley Community College in New York.
Critics: Talk of Student Loan Savings Ignores Obvious Costs
Critics of the SAFRA measure, however, are challenging this much-publicized billion in savings figure. In a piece for The Hill, Representative John Kline from Minnesota, ranking Republican on the Education and Labor Committee, argued that the projected billion in savings ignores long-term, standard risks, failing to allow for interest-rate fluctuations and default risks on college loans.
The purported savings, holds Kline, are in large measure actually new earnings the federal government will take in from student loan borrowers paying the government a higher interest rate than the government's cost of funds (Student Lending Faces Government Takeover, TheHill.com, Sept. 14, 2009).
Since borrowers' interest rates on federal parent and student loans are fixed, as market interest rates rise from their current recession lows, the government's cost to fund direct student loans will rise while earned borrower interest remains the same meaning that the projected savings (that is, in Kline's view, earnings) will shrink.
The anticipated cash flows to the government on which the savings figure is based will also be much more constricted if defaults are higher than projected and default rates in the Federal Direct Student Loan Program will surge, say critics.
FFELP lenders have traditionally serviced a higher percentage of community college and career college students than the Direct Loan Program. These students tend toward higher default rates on their college loans, regardless of whether they are FFELP or Federal Direct borrowers. As the Education Department takes on more borrowers from community and career colleges, the argument goes, the Direct Loan Program will also be absorbing these borrowers' higher tendency to default on their student loans, which would eat into the projected billion.
Additionally, Kline notes that the SAFRA bill only covers the cost of some of its proposed education spending for five years, after which taxpayers will be facing either program cuts or increased taxes in order to continue funding these new and expanded education initiatives. Moreover, Kline revealed in his piece for The Hill, the nonpartisan Congressional Budget Office has recently acknowledged that the proposed Pell Grant expansion will actually cost .4 billion more than originally projected an amount that isn't covered by the current billion allocation within the student loan bill.