Will a Trickle Become a Flood?

On Friday, Mercyhurst College became the latest of a handful of colleges and universities to announce that they would switch to the federal government's direct student loan program from the lender-based guaranteed loan program. Mercyhurst joined Pennsylvania State and Northeastern Universities in publicizing their shifts, citing a desire to, as Mercyhurst put it in a news release, "shield its students from recent upheaval in the student loan market."

Are these decisions anomalies, or the start of a major trend?

More likely the latter than the former, is the consensus among financial aid officers and other experts. They predict so with caution, because the situation in the national financial markets and its impact on the student loan industry is so fluid. And so far there has been negligible movement from the guaranteed loan program to the direct loan program, although increasing numbers of colleges (in the dozens) have since January 1 taken the administrative steps necessary to enable them to participate in direct lending should they decide to switch.

But even officials affiliated with the guaranteed loan industry say they believe many colleges are reconsidering their participation in the program and that if numerous other lenders stop providing federal loans in the coming weeks and months, as some analysts predict, significantly more institutions could make the move to direct lending. On Monday, Brazos Higher Education Services Group, the nation’s 23rd largest student loan provider, became the latest lender to announce plans to suspend making federal loans, at least until the credit markets strengthen.

"If there are enough additional dramatic changes in lenders’ participation, there are a lot of schools that at the very least would submit paperwork" to enable them to participate in the direct loan program, and ultimately may pull the trigger and make the switch, said Mark Kantrowitz, publisher of Finaid.org, which monitors the financial aid programs as closely as anyone.

Tale of Two Loan Programs

The government has had two programs for making federal loans since 1993, when Congress and the Clinton administration created the direct loan program as an alternative to the guaranteed loan program (known formally as the Family Federal Education Loan Program), in which banks and other lenders make loans to students that are guaranteed by state and nonprofit agencies. The direct loan program garnered as much as a third of the total federal student loan volume in its first few years, but over the last decade has seen its market share shrink to about 20 percent of total federal student loan volume. In 2006-7, 5,381 colleges and universities participated in the guaranteed loan program, and 1,075 in the direct loan program, according to Kantrowitz.

The existence of the two programs and their relative prominence have been a topic of at times bitter (and tiresome) partisan fighting between (pardon the oversimplification) Republicans who generally favor the private capital markets and Democrats who have argued (with repeated federal studies to back them up) that the government can do the job more cheaply. Both parties have engaged in jockeying (and sometimes legislating) to give a leg up to their program of choice, allowing one program or the other to offer benefits not available in the other, and backers of the guaranteed loan program have often criticized the service available in direct lending. In recent years, though, a relative truce has emerged in which many lawmakers say (and some may even really mean) that having both programs is a good thing, ensuring competition that improves both of them.

This article is not about the relative merits of the two programs. The situation created by the recent travails in the capital markets has in some ways changed the usual conversation in Washington, because lawmakers in both parties and the Bush administration's Education Department are agreed that the government needs to ensure that the direct loan program is prepared to provide loans to student borrowers if significant numbers of banks and other lenders in the guaranteed loan program are unable to raise the money to do so. Education Secretary Margaret Spellings and aides like Sara Martinez Tucker have repeatedly assured Congress and others that the direct loan program can at least double its volume without any problem and that the department is taking steps to ensure the program's ability to handle any emergency load.

But Spellings and others have also insisted that what is happening now -- or may be beginning to happen -- does not in any way reflect an inability of the lender-based guaranteed loan program to provide loans to students. While numerous lenders have in recent weeks announced that they will no longer originate federal loans, Spellings and college leaders have taken great pains to make clear that other lenders are stepping in to fill the breach, and that the guaranteed loan program remains not only viable, but vital and competitive. (Concerns about the availability of private student loans are growing, though, as the National Association of Independent Colleges and Universities said its survey of private colleges showed significantly reduced access to private loans for some institutions, and a majority of colleges finding that at least one of their providers of federal loans have left the market.)

Even the handful of colleges that have announced their plans to abandon the lender-based program for the direct loan program say they did not believe that they would be unable to find lenders to provide loans for their students.

"We still feel there’ll be a lot of FFELP lenders around," said Patrick McTee, director of financial aid at the University of Colorado at Denver, which is switching its health sciences campus to the direct loan program. McTee said Colorado considered making the switch for the health sciences campus, which was in direct lending until two years ago, after CollegeInvest, which had provided the institution with a line of credit for need-based scholarships through the controversial federal "school as lender" program, would no longer be able to offer that extra aid.

"That prompted us to take a look at the two programs, and when we did, direct lending came out on top for us because of stability."

Officials at Northeastern tell a similar story. Philomena Mantella, senior vice president for enrollment and student life there, said the university had been contemplating a switch to direct lending for some time. The price advantage that lenders in the guaranteed loan program have typically been able to offer to borrowers, in the form of discounted fees and other savings, began to evaporate last summer, she said, as the credit markets tightened and lenders began restricting those discounts.

More recently, said Seamus Harreys, Northeastern’s dean of student financial services and career services, university officials started coming across increasing numbers of student borrowers whose loans were with lenders that were exiting the federal loan program. “On almost a weekly basis, we’ll process a loan, and get a call from a guarantor saying that this lender is no longer active,” said Harreys.

A full 20 percent of Northeastern’s students will have to find a new lender for the 2008-9 academic year, creating “a high degree of uncertainty” for students and their families. “Students and parents should not be spending a majority of their time dealing with the finances” of college,” Harreys said. “We want to find something stable, and direct lending is a safe harbor for our parents and students.”

Added Mantella: “Disruption does have a negative value.”

Despite the highly publicized shifts of institutions like Penn State and Northeastern, they are anomalies to date. An Education Department spokeswoman said that since January 1, 59 colleges have enrolled to be eligible to offer loans through direct lending; of those, 17 are new to the federal student aid programs, which means that 42 currently offer loans through the guaranteed loan program.

It’s unclear how many of those institutions will end up actually making loans through direct lending and/or leaving the FFEL program, as Penn State, Northeastern and Mercyhurst say they plan to. But if significant numbers of them did, it would represent a major uptick of movement into direct lending, which saw a net gain of two institutions in 2004-5 and a net loss of six colleges in 2005-6, according to Kantrowitz.

So far there are few signs of a stampede. Financial aid discussion lists have been relatively quiet on the subject (far quieter than at times in the past when advocates for the two programs fiercely battled over their relative merits). And even partisans of the direct lending program say they have not been hearing much from institutions contemplating a switch.

Roberta Johnson, director of student financial services at Iowa State University and chair of the board of the National Direct Student Loan Coalition, an advocate for the program, said she and her members have “not been hearing much at all” from peers seeking information about direct lending.

She said she believed the institutions likeliest to be contemplating leaving the guaranteed loan program for direct lending now were those large institutions (like Colorado-Denver) that may be seeing the financial benefits they’d been gleaning from the school as lender program evaporate and for-profit colleges whose officials may be seeing their students’ access to federal loans restricted as lenders become more selective about who they loan to, avoiding institutions with higher default rates.

Kantrowitz and others said they believed many institutions were in intense internal discussions about their options, with “a lot of the concerns waiting just under the surface, simmering,” Kantrowitz said. Most traditional colleges are just now entering the season where they’re packaging their financial aid for next year, and so they are just learning the extent to which their students are finding their loan providers to have left the business.

The ultimate prompt, Kantrowitz and others say, is likely to be the behavior of the credit markets and the response of student loan providers to it. If significantly more lenders flee the guaranteed loan program, as some FFEL advocates anticipate will be the case (citing the combination of the credit crunch and the reduced profitability of federal loans because of subsidy cuts imposed by Congress) and significantly more colleges find, as Northeastern did, that lots of students are faced with searching for new lenders, more institutions may embrace the certainty and stability that the direct loan program provides, even as some continue to have worries that the program’s service might wane if significantly more colleges flocked into it.

One other somewhat unexpected development could arise, if Colorado-Denver’s approach is any indication. While in most cases a college chooses to participate in either the direct or guaranteed loan program and its students are stuck with that option, McTee, the financial aid director at CU-Denver, said his institution plans by 2010-11 to have its campuses offer both direct lending and FFEL to its students, once it implements a new Peoplesoft computer system that is designed to run both programs.

While lots of student aid officials might blanch at the prospect of administering two student loan programs given the headaches that can come with just one, McTee notes that New York Attorney General Andrew Cuomo and consumer advocates have emphasized the need for students to have their choice of lender, as federal law requires.

“If it’s so important, as Attorney General Cuomo has alleged, that students really have true informed choice, let’s really give it to them,” McTee said. Having direct loans and guaranteed loans on the same campus, he said, “is to give true choice.”