July 18, 2005

Competition = Savings in the Loan Programs

Competition between the federal government’s two student loan programs has saved the government money and eliminating either program would increase costs and hurt efficiency, a study released today argues.

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The political warfare over the Federal Family Education Loan Program, commonly known as the guaranteed loan programs, and the Federal Direct Student Loan Program has heated up in the last year after several years of relative dormancy. While plenty of lawmakers on both sides of the aisle would still, if they had their druthers, kill one or the other, an uneasy truce has emerged in which both sides grudgingly acknowledge that competition has benefited students.

But fighting continues over the programs’ relative cost to the government, and over federal policies that are perceived as giving one program or the other a competitive edge. In March, for instance, a group of mostly Democratic lawmakers introduced a bill that would use money saved by ending subsidies for lenders to reward colleges that shifted into the direct loan program. But Republican lawmakers have asked the Government Accountability Office to conduct a study, due in the fall, of the “hidden costs” of direct lending.

Into this fray comes the study by the Educational Policy Institute, “Reframing the Student Loan Costing Debate: The Benefits of Competition.” The bulk of the 40-page report, which was prepared by Fred J. Galloway, associate professor of education at the University of San Diego, and Hoke Wilson, a senior analyst at Macro International, is a balanced recounting of the torturous saga of how the two loan programs got where they are today.

The basic gist of the argument is that until the U.S. government created the direct loan program in 1993, the government was unable to get the banks, lenders and other for-profit and nonprofit companies that play a role in the guaranteed loan program to control their costs to students and to the government. The U.S. Education Department could not “steer the behavior of its financial partners in a socially, and not individually, optimal direction,” the authors write. “Given the obvious importance of student loans to the economic health of our nation, it comes as no surprise that those controlling access to the loan capital — typically lenders and guarantors — could some times assert their own self-interest over that of federal taxpayers.”

The study does not suggest that the direct loan program — in which the Education Department provides loans directly to borrowers through their colleges, bypassing the lenders and guarantors that dominate the guaranteed program — has been an unqualified success. “While it is true that ED currently manages about 30 percent of all student loans through the DLP, [its] management of the program has been plagued with problems, especially in the areas of loan origination, reconciliation, and consolidation, and we argue that much of its success can be attributed to shortcomings in the FFELP,” the authors write.

Those two conclusions lead the authors to conclude, philosophically, that neither loan program “can be anything more than stagnant or wasteful in the long-term; however, by operating in competition with each other, the two student loan programs continue to push one another towards supplying the best possible product at the cheapest possible price.”

The study aims to back up that conclusion by offering statistical analyses designed to “investigate the real costs associated with the student loan programs.” Many other experts have sought over the years to gauge the comparative costs to the government of these two complex programs, and almost any analysis can be picked apart by accountants or economists as leaving out important variables or factors.

(This one is no exception. One advocate for the direct loan program, Robert Shireman of the Institute for College Access and Success, whom the authors asked to review their study, said he had asked for access to their data and had not received it. Without that, he said, “it’s not possible to determine whether the budgetary analysis makes any sense.")

But the authors of the EPI study say that the two “autoregressive, moving average time series models” they used show that introducing the direct loan program “lowered the average annual cost of running the loan programs by $685 million per year,” including an annual average savings of $620 million in the guaranteed loan program.

Such a conclusion, the report’s authors say, “provides some ammunition to those who would argue that the Direct Loan program is inherently cheaper than the Federal Family Education Loan program.” But supporters of the direct loan program shouldn’t get cocky, as the report quickly adds: “While this may be true in the short term, adoption of a system wherein government becomes the sole supplier and administrator of the student loan program is doomed, in the long run, to at least the same level of inefficiency and upward price-ratcheting as was the case for the FFELP.”

The report concludes: “We urge legislators and educational policy makers to come together to preserve the competitive structure that now exists, and to work hard to make the competition as fair and equitable as possible.”

John Dean, special counsel to the Consumer Bankers Association, which represents lenders, said his constituents “welcome the conclusion that competition is good for taxpayers and students.”

— Doug Lederman

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