History Repeating Itself

Congress, the White House, presidential candidates, and student loan companies have all proposed ideas on how to ensure that recent problems in the credit markets don’t limit college-bound students’ access to federal loan money. Tight credit markets, in which investors are wary of buying any type of bundled debt, have made it difficult for student loan companies and banks to find new money to lend. While there haven’t been any instances to date of students being unable to get federal student loans, lawmakers are rightfully concerned about the possibility and are looking for ways to prevent it.

Sallie Mae, the nation’s largest student loan company, has been pushing to allow the Treasury department to purchase bundled student loan debt. Student loan companies would then have access to cheap capital, giving them money to lend and making federal student loans more profitable. The problem with this solution is that we’ve already done it, and it worked well until the company responsible for using Treasury funds to ensure market liquidity—Sallie Mae—decided it could make more money by only going through the private markets.

When Sallie Mae privatized, part of the deal was that it would act as a “lender of last resort” for students who could not get access to federal student loans. The provision was part of Sallie Mae’s repayment for years of taxpayer support and access to cheap Treasury funds. Now that the time has come for Sallie Mae to act as a lender of last resort, it’s not in a position to do so and has come back to the government asking for more Treasury funds. That’s not how Sallie Mae’s privatization plan was supposed to work—the goal was to save the federal government money by transitioning Sallie Mae into a fully private company.

The federal student loan program has a history of providing incentives to student loan companies to ensure their continued participation in the loan program—that’s why loan companies get subsidies and loan guarantees, and why the federal government created Sallie Mae in the first place. But these incentives also have a history of going awry as market conditions change and loan companies use loopholes and lobbying to increase profits (note the 9.5 percent loan scandal).

The House has already passed a bill aimed at addressing potential problems in the student loan market, including increasing the federal limits on student loans by $2,000 and giving the Department of Education the authority to buy student loans in order to free up money to make new loans. This last provision includes the caveat that any loan purchases must not incur any cost to the federal government—a good and important goal. But, as history has taught us, student loan companies are good at figuring out how to get the best deal out of these types of changes to the student loan program. This means that clear responsibility for oversight of the program and legislative language that leaves few loopholes will be critically important to ensuring that, once credit markets recover, student loan companies aren't reaping all the profits while taxpayers are holding the bag.