The Debate over Student Loan Auctions

At the Higher Education Finance Working Group policy briefing yesterday, the discussion, in true financial aid style, was lively, a little snarky**, and, at times, thoroughly confusing. One area where it did shed some light was the debate over loan auctions in the federal loan program (Inside Higher Ed writes it up here).

In the current system, Congress decides how much of a subsidy (called “special allowance payments”) the federal government will pay to lenders in the federal loan program. Critics argue that letting Congress decide that number, which impacts lender profits, allows too much political influence in the system.

Auction proponents claim that loan auctions would allow the market, and not politicians, to determine bank profits. With loan auctions, each year loan companies would bid on the ability to make federal student loans. The ‘best’ bids would be those that offer to make loans for the lowest subsidy rates.

Lenders don’t like this idea, which they claim would create too much instability in the loan market—schools would not know which lenders they will be working with from year-to-year. Lenders also claim that it would drive out smaller lenders unable to match the bids of larger lenders, and it would hurt students, who would see fewer benefits and worse service from lenders that are working off of smaller profit margins.

These are all reasonable concerns, but I’m still skeptical. Lenders usually end this argument by saying that the current system is perfectly fine, works great for everyone and should be left alone. That makes me think that the party it really works best for is the lenders, since they are the ones interested in keeping the status quo.

I haven’t seen good evidence yet that we can’t devise a loan auction that allows the market to determine subsidy rates while also protecting smaller lenders (they could bid in groups) and ensuring that lenders maintain the service necessary to keep default rates low (we could start by cutting the amount the government pays lenders on defaulted loans). There must be good policy solutions out there that balance the interests of all three parties—taxpayers, students, and lenders—better than the system we have today.

**I get a little cranky on the opinion page of yesterday’s USA Today about a mailing I got from Sallie Mae—it is misleading and points to the need for more oversight and regulation in the student loan industry.