American colleges accept a variety of financial
incentives from some large student-loan companies, like Sallie Mae, to
steer students to borrow from them, New York State Atty. Gen. Andrew
Cuomo charged on March 15. Goodies include substantial cash payments,
free trips to resort destinations for campus financial-aid officers, and
company-manned call centers to answer students' financial-aid questions.
Mr. Cuomo's complaint will no doubt energize politicians eager to take
credit for clipping the wings of private lenders who earn profits from
federally guaranteed student loans. The alternative they favor would
increase direct lending by the government.
But such a shift could increase the taxpayers' burden and drive up the
overall costs of college.
As many taxpayers may not be aware, the U.S. Department of Education
operates two competing loan programs, and the taxpayers bear the risk
burdens of both. Under the William D. Ford Direct Loan Program, the
department makes and administers loans directly to borrowers. Under the
Federal Family Education Loan (FFEL) program, private companies provide
the capital and administer the loans, but these loans are largely
subsidized and insured by the federal government.
Some believe that one way to rein in costs would be to scale back the
FFEL program and expand the Ford Direct Loan program, thereby cutting
out the middleman and potentially reducing costs.
But the devil is in the details - or, in this case, the defaults. The
default rates under the Ford Direct Loan Program are higher than under
the FFEL program, and the gap is widening. When a college grad defaults
on a federally insured student loan, the taxpayer is on the hook for
most of the balance.
According to the Office of Management and Budget, the 2007 projected
weighted average default rate under the FFEL program is 11.7 percent;
under the Ford program, it is a whopping 16.65 percent. Already more
than 3.1 million Direct Loans are expected, and taxpayers can expect an
increased burden should the program be expanded.
What accounts for the difference in the default rates? Private companies
have both the incentive and the ability to be innovative in keeping
track of borrowers, enabling them to prevent and recover bad debts.
Students are a poor credit risk. They typically have limited credit
histories, no secure jobs and an immature sense of responsibility.
That's one of the main reasons why the federal government insures
student loans.
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