Life After Sallie

There have been numerous news reports of the “tightening” credit markets and their potential impact on student loan availability. The majority of federal student loans are made through private banks and if these banks can’t find investors to buy their loans, they don’t have money to make new loans—hence, a problem with student loan availability (to be clear, there is currently no problem with federal student loan availability). This problem isn’t actually new to student lending and the federal government solved it almost forty years ago.

When the federal student loan program first began in 1965, it faced the same “tight” credit market—not because of turmoil in global credit markets, but because banks were having a hard time finding investors who wanted to buy risky student loans. To solve this problem, the federal government created Sallie Mae.

For over 30 years, Sallie Mae provided a needed secondary market for student lending. But then things changed. Growing profits from student loans and a greater willingness among investors to buy student loan debt, combined with pressure from Republican lawmakers, resulted in Sallie Mae separating from the federal government. Sallie Mae fully ended its secondary market operations—and its relationship with the federal government—in 2004. Sallie Mae then proceeded to expand and become the biggest seller of student loan securities—the precise market that is seeing such trouble right now.

Privatizing Sallie Mae left the federal student loan program without any direct access to treasury funds and completely reliant on private credit markets. In the 1998 reauthorization of the Higher Education Act, Congress established the ‘lender of last resort’ program to provide assurance that students would have access to loans, even if there were no banks to provide them. The program authorizes guarantee agencies, non-profit entities that help administer the federal loan program, to step in and make the necessary loans, and gives them access to treasury funds. (The legislation also specifically requires Sallie Mae to act as a lender of last resort, as part of its repayment for receiving governmental benefits for the first 30 years of its life.)

This program has never been used. And as Secretary Spelling’s comments at Friday’s hearing before the House Committee made clear, we’re not really sure how effectively the lender of last resort program will operate—the ability of guarantee agencies to administer the program, whether electronic processing of loans is possible, and whether the federal treasury can make the needed funds available. Fortunately, we also have the Federal Direct Loan program, which enables the federal government to loan directly to students and to access treasury funds as needed.

The privatization in federal student lending has certainly led to some improvements, making it easier for students to get loan funds, improved loan servicing, and lower costs for many students. But what the past year has made clear is that the federal student loan program, just as it did back in 1965, needs direct involvement from the federal government. A loan program that receives the benefits of the federal government (a guarantee on defaults, low interest rates to students) but without the necessary oversight from the Department of Education and without readily available treasury funds, is much too vulnerable to the risky and sometimes unscrupulous behavior in the private market.