The Volokh Conspiracy - The Student Loan Market:

Lost in the shuffle among health care cost debates, the future of Fannie and Freddie, Ginnie Mae, the FHA, and so on, the student loan market is quietly shifting to become a federal government monopoly. The Wall Street Journal notes this in an editorial today, September 12, 2009, "The Quietest Trillion." The title?:

The furor over President Obama's trillion-dollar restructuring of American health care has left his other trillion-dollar plan starved for attention. That's how much the federal balance sheet will expand over the next decade if Mr. Obama can convince Congress to approve his pending takeover of the student-loan market.

The Obama plan calls for the U.S. Department of Education to move from its current 20% share of the student-loan origination market to 80% on July 1, 2010, when private lenders will be barred from making government-guaranteed loans. The remaining 20% of the market that is now completely private will likely shrink further as lenders try to comply with regulations Congress created last year. Starting next summer, taxpayers will have to put up roughly $100 billion per year to lend to students.

The private student loan market has been around for decades, so a natural question is how did it come to this? According to the Journal's editorial:

For decades, loans carrying a federal guarantee have been the most common way of borrowing for college. After raising money in the private capital markets, lenders made the loans, paying a fee to the government for each one. The government covered most of the cost of defaults while allowing the private lenders to make a regulated return.

The system broke down after Congress in 2007 legislated a return so low that no private lenders could make money holding these assets. To keep the money flowing to student borrowers, the government began buying the loans from private originators last year. But this larger federal role was intended to be temporary, with an expiration date next summer. The news from Washington now is that rather than scaling back federal involvement, the pols want the U.S. Department of Education to be the exclusive banker to America's college students.

Again according to the Journal editorial, the problem of having the government become the direct lender is that student default rates go up drastically - even though under current law, student loans are not, for example, generally dischargeable in bankruptcy. There are other questions not addressed in the WSJ editorial - how does the federal government plan to repackage those loans, and do what with them? If the credit quality deteriorates, is the federal government on hook not just for the unpaid student loans but for any losses on downstream securities based on them?

The government has been claiming lower default rates than private lenders, but most government loans have been to students at four-year colleges. The private lenders have serviced a higher percentage of students at community and two-year colleges, where defaults are more common regardless of lender. If the feds are now making and owning all such loans, expect default rates to soar. When the government hires contractors to collect on its loans, it pays them for simply calling the borrower, regardless of the result. Private lenders, on the other hand, make money from a performing loan and have a greater incentive to do careful underwriting and aggressive collection. The government will nonetheless start spending these illusory "savings" immediately, and this spending is certain to top official estimates.

This has been a topic of discreet discussion at universities among senior administrators, I think we can safely assume. How could how students pay for school not be? Mostly staunch Obama supporters, in my experience, these administrators and university leaders nevertheless have a strong suspicion that the federal government direct supplying university tuition funds will be followed by interventions in university management. Starting with price controls on tuition - it is not exactly a secret that subsidies aimed to aid student tuition bills largely wind up in school hands as tuition increases. Discussion among university administrators I know has centered on how to diversify revenue streams on the assumption that the federal government will try to control costs at the universities, in part to make up for losses by defaulting ex-students (or by defaulting ex-students at other institutions, such as two year colleges or technical schools where default rates are far higher; some of the issues here are akin to the insurance pool issues of health care reform, such as pooling of otherwise sharply different risk pools). (cont. below fold)

(show)

The commonest dream - promoted, in part, by the fact that the next couple of years are the top of the baby boomlet, and then a long fall-off in students - is to find students abroad. Asian students, wealthy enough and eager enough to want to get a US university credential - that is one much discussed. The university as tourist industry, or export industry-at-home, however you want to see it. My law school has been fantastically successful at it, long before other schools understood the model of foreign LLMs. For that matter, my law school is almost certainly the only school in the world - heck, in the United Federation of Planets - that manages, through its summer program, to make money on human rights. (Yes, you heard that right. Don't look so shocked - or get any bright ideas - my dean reports that it is a lot, lot harder than it looks, even when you are in DC.)

Then there are other questions as to whether, over time, a federal government directly paying the bills for student education might start intervening not just in cost questions - price controls - but forms of "educational industrial policy." After all, it happens anyway in lots of different areas, directly and indirectly through federal funding for medical schools, or research grants for various areas of science and technology, and has been a chief characteristic of the large research university post-WWII. Why not start doing a little social engineering at the undergraduate level in the social sciences and humanities? Make some decisions based on the rational criteria of what jobs are going to be needed - nurses, e.g. - and steer undergrads that direction not just subsidizing nursing school, but further by, say, starving the classics or philosophy department? Imagine the Congressional debate over what to do with the economics department - or athletics?

If one believes, in other words, that he who pays the piper, etc., then one way or another, such a radical shift in funding over the next decade is likely to have far reaching consequences for university education. Not all of them necessarily bad, I suppose (and I admit, as a tenured professor, autonomy of the university is second in my priorities only to its ability to raise tuition and give me a cut) - but far reaching in any case.

(hide)

	[Kenneth Anderson, September 12, 2009 at 1:13pm] Trackbacks The Student Loan Market: Lost in the shuffle among health care cost debates, the future of Fannie and Freddie, Ginnie Mae, the FHA, and so on, the student loan market is quietly shifting to become a federal government monopoly. The Wall Street Journal notes this in an editorial today, September 12, 2009, "The Quietest Trillion." The title?: The furor over President Obama's trillion-dollar restructuring of American health care has left his other trillion-dollar plan starved for attention. That's how much the federal balance sheet will expand over the next decade if Mr. Obama can convince Congress to approve his pending takeover of the student-loan market. The Obama plan calls for the U.S. Department of Education to move from its current 20% share of the student-loan origination market to 80% on July 1, 2010, when private lenders will be barred from making government-guaranteed loans. The remaining 20% of the market that is now completely private will likely shrink further as lenders try to comply with regulations Congress created last year. Starting next summer, taxpayers will have to put up roughly $100 billion per year to lend to students. The private student loan market has been around for decades, so a natural question is how did it come to this? According to the Journal's editorial: For decades, loans carrying a federal guarantee have been the most common way of borrowing for college. After raising money in the private capital markets, lenders made the loans, paying a fee to the government for each one. The government covered most of the cost of defaults while allowing the private lenders to make a regulated return. The system broke down after Congress in 2007 legislated a return so low that no private lenders could make money holding these assets. To keep the money flowing to student borrowers, the government began buying the loans from private originators last year. But this larger federal role was intended to be temporary, with an expiration date next summer. The news from Washington now is that rather than scaling back federal involvement, the pols want the U.S. Department of Education to be the exclusive banker to America's college students. Again according to the Journal editorial, the problem of having the government become the direct lender is that student default rates go up drastically - even though under current law, student loans are not, for example, generally dischargeable in bankruptcy. There are other questions not addressed in the WSJ editorial - how does the federal government plan to repackage those loans, and do what with them? If the credit quality deteriorates, is the federal government on hook not just for the unpaid student loans but for any losses on downstream securities based on them? The government has been claiming lower default rates than private lenders, but most government loans have been to students at four-year colleges. The private lenders have serviced a higher percentage of students at community and two-year colleges, where defaults are more common regardless of lender. If the feds are now making and owning all such loans, expect default rates to soar. When the government hires contractors to collect on its loans, it pays them for simply calling the borrower, regardless of the result. Private lenders, on the other hand, make money from a performing loan and have a greater incentive to do careful underwriting and aggressive collection. The government will nonetheless start spending these illusory "savings" immediately, and this spending is certain to top official estimates. This has been a topic of discreet discussion at universities among senior administrators, I think we can safely assume. How could how students pay for school not be? Mostly staunch Obama supporters, in my experience, these administrators and university leaders nevertheless have a strong suspicion that the federal government direct supplying university tuition funds will be followed by interventions in university management. Starting with price controls on tuition - it is not exactly a secret that subsidies aimed to aid student tuition bills largely wind up in school hands as tuition increases. Discussion among university administrators I know has centered on how to diversify revenue streams on the assumption that the federal government will try to control costs at the universities, in part to make up for losses by defaulting ex-students (or by defaulting ex-students at other institutions, such as two year colleges or technical schools where default rates are far higher; some of the issues here are akin to the insurance pool issues of health care reform, such as pooling of otherwise sharply different risk pools). (cont. below fold) (show) The commonest dream - promoted, in part, by the fact that the next couple of years are the top of the baby boomlet, and then a long fall-off in students - is to find students abroad. Asian students, wealthy enough and eager enough to want to get a US university credential - that is one much discussed. The university as tourist industry, or export industry-at-home, however you want to see it. My law school has been fantastically successful at it, long before other schools understood the model of foreign LLMs. For that matter, my law school is almost certainly the only school in the world - heck, in the United Federation of Planets - that manages, through its summer program, to make money on human rights. (Yes, you heard that right. Don't look so shocked - or get any bright ideas - my dean reports that it is a lot, lot harder than it looks, even when you are in DC.) Then there are other questions as to whether, over time, a federal government directly paying the bills for student education might start intervening not just in cost questions - price controls - but forms of "educational industrial policy." After all, it happens anyway in lots of different areas, directly and indirectly through federal funding for medical schools, or research grants for various areas of science and technology, and has been a chief characteristic of the large research university post-WWII. Why not start doing a little social engineering at the undergraduate level in the social sciences and humanities? Make some decisions based on the rational criteria of what jobs are going to be needed - nurses, e.g. - and steer undergrads that direction not just subsidizing nursing school, but further by, say, starving the classics or philosophy department? Imagine the Congressional debate over what to do with the economics department - or athletics? If one believes, in other words, that he who pays the piper, etc., then one way or another, such a radical shift in funding over the next decade is likely to have far reaching consequences for university education. Not all of them necessarily bad, I suppose (and I admit, as a tenured professor, autonomy of the university is second in my priorities only to its ability to raise tuition and give me a cut) - but far reaching in any case. (hide)