The Real Scandal of Student Loans

Robert B. Reich

April 11, 2007

The emerging scandal over college financial aid administrators that have cozy relationships with companies that lend students money to attend is only the tip of a much bigger scandalous iceberg.

Take a close look at the whole system of federally-subsidized college loans and you'll see a system designed to give banks and private lenders a fat taxpayer subsidy they don't deserve.

The Federal government subsidizes college loans in two different ways, giving colleges and universities the option of which way to go.

The first way is for the federal government to lend students the money directly. Students get a good deal because the government, being the government, can raise funds at a lower interest rate than can banks or other private lenders. The government then lends those funds out to students at a rate lower than students could get if they got an ordinary loan.

The alternative is for the federal government to subsidize student loans indirectly by guaranteeing banks and other private lenders that if a student doesn’t repay the loan, the government will. The government also gives banks and private lenders additional subsidies to ensure they get a profitable return on any student loan they make.

Obviously, this second alternative is a great deal for the banks and other lenders. They get a guaranteed return on a no-risk loan. But it’s a lousy deal for American taxpayers. According to a study by the Center for American Progress, taxpayers pay about $7 more for every $100 lent by the private lenders than they do on direct government loans.

That amounts to billions of taxpayer dollars each year. Billions that could be saved if the direct loan program was the only program. Billions of savings that could be put, for example, into Pell Grants for needy students.

So here’s the multi-billion-dollar question. Why does the federal government continue to provide colleges and universities the option of going with the more expensive program when the government can offer direct loans more cheaply? Why is it that some fifteen years after the direct student loan program was first established, more than three-quarters of student loans still come through the more expensive system?

Let me hazard a guess. Because the banks and other private lenders have enormous political clout in Washington. They also have clout within colleges and universities.

This is the real scandal of student loans, and it's got to stop. There’s no good reason for the federal government to waste taxpayer money by subsidizing banks and other private lenders when government direct loans are cheaper.