Profits vs. Purpose

This article in yesterday's NYT underscores the need for market-sensitive subsidy payments in the federal loan program--or a wholesale shift to the Direct Loan program. The NYT reports that 2-year colleges are worried that their students will have a harder time finding student loans in the next few years. Because it's more expensive now for banks to lend money, private loan companies are less interested in supplying higher-risk, less-profitable loans to community college and career school students.

That's a perfectly reasonable response from a for-profit company, but the purpose of the federal loan program is to ensure that exactly these types of students--those who are too high-risk to find loans on the private market--can receive money for college at a reasonable rate. If private loan companies are unwilling or unable to do that, then we need some fundamental changes to the federal loan program.

One option is to make subsidy payments, which the federal government pays to loan companies to encourage them to participate in the federal student loan program, more sensitive to changes in the credit markets. Subsidy rates would be higher in credit markets like today's, giving lenders sufficient profits to encourage them to lend to all students, and it would be lower when credit markets are better and profits are bigger.

But historically loan companies have resisted this type of subsidy system, preferring to rely on lobbyists and political donations to get subsidy rates that would allow them profits today and even bigger profits when credit markets improve. If they continue to resist a market-based approach to establishing subsidy rates, the best alternative may just be to switch entirely to the Direct Loan program, in which the federal government lends directly to students. Under this system, the government won't have to worry about paying excessive subsidies and all students will be guaranteed loans from the same lender.

If loan companies want to access to student loan business in the future, they'll need to come to the table with some ideas on how to make a profit while also ensuring that the purpose of the federal loan program is fulfilled.