An Out and Back Hike on the FFELP Trail

President Obama's budget proposal, released last week, called for an end to government subsidies to banks and private loan companies making federal student loans through the FFEL Program. Instead, the government would ramp up the Federal Direct Loan Program (FDLP) under which the government lends directly to students, eliminating the "middlemen" in the FFELP. This represents a bold shift in policy from the previous administration, which favored the privately administered FFELP, and it means that Obama's administration is willing to take on the lobbying force of the private loan companies, which include heavy-hitters like Sallie Mae.

Of course, now is the time to take on banks and loan companies since they have already spent a lot of lobbying capital getting government money to just stay afloat. Also, with the recent government infusion of support for FFELP, it will be harder for its advocates to argue that it is more efficient and less expensive than the government-administered FDLP. In the past year, the Department of Education has propped up private loan companies in the wake of the credit-market freeze by offering to buy up loans, thereby providing some liquidity to the student loan market and freeing up money for loan companies to make new loans. This helps the lenders, and it also helps students by ensuring continued access to federal loans. But it doesn't do much for taxpayers, which, as Kevin Carey explained earlier, are stuck paying for two loan programs to do pretty much the same thing.

President Obama's proposal makes sense in the current credit climate, but it's nothing new - he's basically taking us back to 1965, when the FFELP was born, and is proposing to run the program as it was first envisioned - with little government support. [insert dreamy, flashback music here]

When the federal student loan program began (then called the Guaranteed Student Loan Program), the federal government provided private loan companies with an 80 percent guarantee against default and a 6 percent interest rate - to compare, there is now a 97 percent guarantee against default and a guaranteed profit called the "Special Allowance Payment", which President Obama wants to eliminate.

Policymakers in 1965 opted to administer the student loan program through private loan companies, instead of through a direct loan program, in order to attract private loan capital to the student loan market, using a government guarantee as an incentive. But, lenders were reluctant to participate and had trouble getting money to make new loans, so the government gradually ratcheted up the guarantee and the subsidies to lenders. And, in 1972, the government created "Sallie Mae" as a secondary market for student loans (for more history, see here).

Like other "government sponsored entities," such as Fannie Mae and Freddie Mac, Sallie Mae was established as a for-profit, privately operated corporation set up to increase investments in student loans. And it was successful - Sallie Mae was profitable and supported the growing student loan market. Then, as private loan capital became cheaper and easier to get in the 1990's and early 2000's, Sallie Mae went completely private - cutting off its access to government funds. The original goal of creating a loan program that used private capital (not Treasury funds) was realized, and as the Bush administration lowered subsidies and the loan guarantee, FFELP was headed toward the original 1965 vision.

And then we all know what happened - credit markets dried up and lenders were left without any money or access to Treasury funds. This is where we turn around and head back down the trail.

First, the Department of Education passed the Ensuring Continued Access to Student Loans Act, which created a type of secondary market by authorizing the Department of Education to buy up loans and create liquidity in the market. Then, the Department of Education advocated for increasing subsidies by changing the way they are calculated.

And now the Obama administration is taking us back to the very beginning, where we're deciding whether to head back down the trail using private loan companies or switch direction to the direct loan trail. Only now, using private loan companies doesn't seem like such an innovative way to leverage private capital to administer a federal loan program, instead it seems risky and unstable. If Obama's budget goes through as planned, we'll get a chance to see where the other trail takes us. Hopefully it's a little less rocky.