Students of Reform: A Paradigm Shift In Lending
A consensus on the causes of the financial crisis will probably never be reached. However, most observers agree on one thing, at least: that risk and reward, the ying and yang that keep the financial sector in balance, grew wildly out of whack. Perhaps unsurprisingly, congressional efforts to strengthen regulation of the sector are at a standstill and even President Obama was unable to reignite reform efforts with a speech to the Wall Street faithful earlier this week.
In one area, however, Congress has made incremental progress towards realigning risk and reward over the last several years. Now, it is at the brink of a fundamental shift towards greater accountability in lending. The Student Aid and Fiscal Responsibility Act, which the House passed yesterday, is an important rebuke of the "Heads I Win, Tails You Lose" quagmire that has plagued government throughout the financial crisis. For years, the federal government has allowed private student lenders to reap government subsidies while assuming the tiniest (at times only 1%) risk when their loans went bad. The Act changes this by making the government the direct lender for all federally backed student loans.
The Student Aid and Fiscal Responsibility Act terminates the Federal Family Education Loan program, which provides subsidies and guarantees to private lenders that make student loans. Instead, the federal government would issue student loans directly to borrowers. Ending the subsidization program would save the government $87 billion over ten years.
The Act plows the savings into ensuring that interest rates on student loans remain affordable and increasing the maximum Pell Grant, a need-based grant designed for lower-income students, from $5,350 in 2009 to $5,550 in 2010 and $6,900 in 2019. Approximately $40 billion would be applied to increasing the maximum Pell Grant, the most widely used college assistance program. In recent years, the program has failed to keep pace with the rising cost of college: thirty years ago the maximum Pell Grant covered 77 percent of the cost of attending the average four-year public school, but today it covers only 35 percent. Increasing the maximum award would restore some of this lost purchasing power, providing more students from lower-income families with an opportunity to attend college. The bill's provision for automatic Pell Grant increases helps ensure that the Pell Grant permanently maintains its value.
The bill's caps on interest rates and a reworked fixed interest-rate program will not only make college more affordable for all students, but will make obtaining and keeping a middle-class standard of living easier by reducing the growth of student loan debt, which now averages almost $23,000 for bachelor's degree recipients, and reducing student loan defaults, which have recently increased. Funds for a variety of initiatives to increase access to early-childhood education and graduation rates, to modernize schools, and to improve community colleges will expand the opportunity for students to succeed at all levels of education.
The private student loan industry, predictably, has argued that private lenders are more efficient and should be permitted to originate at least a portion of student loans. The nonpartisan Congressional Budget Office estimates exposed this as a straw-man argument, finding that continued private lender participation in origination would cost the federal government an additional $13 billion with no apparent benefit to students.
The Student Aid and Fiscal Responsibility Act achieves what comprehensive financial sector reform has not been able to: the realignment of risk and reward. By cutting unnecessary middlemen out of student lending, the Act demonstrates that the federal government can make important investments even as it confronts large budget deficits.