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Following the 2016 election and with the Higher Education Act’s impending reauthorization, prominent lawmakers and interest groups have proposed expanding private lenders’ roles in the government student loan program. More specifically, they seek to restore the federal program to how it operated before the Obama administration’s reforms in 2010.
Under that system, the government mainly insured the loans that private lenders made to students via a guaranteed loan program, also known as the Federal Family Education Loan (FFEL) program. Today, however, the government makes all the loans itself using its own funds through the Direct Loan program. Nevertheless, the Direct Loan program and the defunct FFEL program are really two different designs of the same government-backed student loan program that entail the same kinds of financial risks for taxpayers.
Despite private lenders’ roles in the FFEL program, policymakers designed it such that it offered none of the benefits private markets usually provide. Confusion and misinformation about that key point abound. FFEL program supporters erroneously claim that reverting to the FFEL program would produce budgetary savings. They also mistakenly imply that it reduced risk for taxpayers and students by restricting lending to only credentials that provided a positive return on investment or by varying terms based on the risk of each loan. They also assert that the complete switch to the Direct Loan program in 2010 led to record levels of outstanding student debt and defaults—a claim with no causal basis.
In turn, the first part of this report provides a detailed look at the defunct FFEL program and the existing Direct Loan program, including how each one evolved since the federal student loan program’s inception in 1965. The second part addresses the misinformation that undergirds proposals to return to the FFEL program.
Following the 2016 election and with the Higher Education Act’s impending reauthorization, Republican policymakers will likely consider reforms to the federal student loan program. Currently, the government dominates the student loan market, originating an estimated 90 percent of all student loans each year through its federal Direct Loan program.1
Some lawmakers and interest groups have proposed expanding the role of private capital and private lenders in the government loan program. Mostly, these proposals have been vague. But a few key lawmakers have been more specific, indicating that they would like to restore the federal loan program to how it operated before the Obama administration’s reforms in 2010.
Under that system, the government mainly insured loans that private lenders made to students through a guaranteed loan program called the Federal Family Education Loan (FFEL) program. Today the government makes all the loans using its own funds through the Direct Loan program.
Prominent politicians have indicated their support for a guaranteed loan program. Last year the media reported that President Donald Trump’s campaign was “planning on moving the government out of lending and restoring that role to private banks, as was the case before President Barack Obama fully shifted loan origination from private lenders to the government.”2
Rep. Virginia Foxx (R-NC), the Republican chairman of the House Committee on Education and the Workforce, said following the 2016 election that she wants to reverse a Democratic Congress’ decision in 2010 to make all federal student loans through the Direct Loan program.3 Likewise, the 2016 Republican Party platform stated that “the federal government should not be in the business of originating student loans . . . [and] private sector participation in student financing should be restored.”4
Private lenders, and the trade associations representing them, also say the government loan program should make more use of private capital. In laying out its postelection agenda, the Consumer Bankers Association said “banks should play a bigger role in the federal student loan program because of the benefits private lenders bring to the table.”5 A trade association representing student loan companies wants to restore the FFEL program because “the prior system of a public‐private partnership for funding and administering student loans was and would still prove to be a more beneficial approach for students, families, and taxpayers.”6
Thus, the most specific proposal so far to expand private lenders’ roles in the student loan market is to reinstate the FFEL program, which would likely replace or compete with the government’s Direct Loan program. That might seem to some an effective way to harness the efficiencies and innovations that private lenders can offer students and taxpayers.
A closer look at the FFEL loan program reveals that it involved private capital in name only. The program was designed to shield lenders from risk using taxpayer dollars, preclude lenders from restricting access to only the most creditworthy borrowers, and prohibit lenders from using prices (i.e., interest rates) to provide signals to borrowers about the quality of different educational choices. In other words, the FFEL program offered none of the benefits one might associate with private markets. Moreover, efforts to restore it distract from alternative policies that would actually bring the benefits of private lending to bear in the student loan market
To inform policymakers and others in the policy community about how the FFEL program cannot accomplish the goals its proponents endorse, this report provides a detailed look at that now-defunct program. It explains how FFEL operated and why it was even more heavily subsidized—and costly—than today’s Direct Loan program, despite the role private lenders played in it.
The brief is organized into two sections. The first section provides a history of the government’s FFEL and Direct Loan programs, an explanation of why policymakers designed each program in different ways, and a discussion of why they ended the FFEL program in 2010. The second section challenges the myths and misinformation about the loan programs that today are fueling proposals to return to the FFEL program.
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