Student Deadbeats vs. U.S. Taxpayers

Article published In The Providence Journal

American colleges accept a variety of financial incentives from some large student loan companies, like Sallie Mae, to steer students to borrow from them, New York State Attorney General Andrew Cuomo charged on March 15. 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.

Mr. Cuomo’s complaint will no doubt energize politicians eager to take credit for clipping the wings of private lenders who earn profits from federally guaranteed student loans.

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 risk burdens 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 these loans are largely subsidized and insured by the federal government.

Some believe that 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.

According to the Office of Management and Budget, 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 should the program be expanded.

What accounts for the difference in the 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 one of the main reasons why 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 that their public bureaucracy is slow-moving and less able to take advantage of the best practices used by 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 more costly 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 past 10 years, and economists have argued that the result has actually put upward pressure on college costs.

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

According to the College Board, the cost of attending a public college or university has increased by 86 percent, adjusted for inflation, since the 1991-92 academic year; private college costs have soared by 52 percent in the same time span. 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 went up 6.3 percent, to $5836.

It’s time to take a hard look at the reasons for escalating college costs, 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.