Skyrocketing student debt has prompted important discussions about ways to improve funding for higher education in the United States, including proposals for debt cancellation and other reforms. A key to understanding the complex dynamics at play is to break down the role of the federal government as a direct lender; how this role has evolved over time; and its effect on student aid, government costs, the borrower experience, and the nation’s finances.

Student debt is steadily increasing

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For more than 60 years, the federal government has played a major and growing role in helping students finance their higher education by expanding access to credit through loans and loan guarantee programs. Over time, federal policy changes have expanded the role of government, allowing for greater administrative flexibility and better access to more advantageous loan programs at potentially lower cost to the borrower. However, these improvements have also led to a rapid increase in student debt, which can have costly implications for the federal budget and impose serious economic burdens on borrowers.

The Evolution of Federal Student Loan Programs

The first federal student loans were issued directly to borrowers under the National Defense Education Act of 1958 to help ensure the availability of highly skilled Americans in scientific and technical fields. Since then, federal student loan programs have been significantly restructured twice.

First, in 1965, the federal government began to subsidize and guarantee student loans issued by private lenders through the Federal Family Student Loans (FFEL) program. Through the FFEL, lenders received federal grants to provide low-interest loans, with the government agreeing to cover most of the losses if the student failed to repay the loan. Then, in 1972, legislators established the government-sponsored Student Loan Marketing Association (Sallie Mae) to facilitate liquidity in the loan market. Sallie Mae originated federally guaranteed student loans under the FFEL and worked as a federal student loan manager and collector.

Research on the cost of federal loans suggested that issuing loans directly to borrowers would be more cost effective than loan guarantees, prompting lawmakers to pilot a direct student loan program in 1992 as part of a deficit reduction plan. Implementing a direct student loan program would eliminate the “middleman” of FFEL lenders and the associated subsidies. The guaranteed and direct student loan programs operated in parallel until 2010 when the FFEL program was phased out for new loans. At that time, all things being equal, the Congressional Budget Office (CBO) estimated that switching to direct lending would save $62 billion over the next 10 years.

Another impetus for the move to direct lending by the federal government was concern that students would have limited borrowing opportunities due to tight credit markets at the time of the Great Recession. For example, the number of FFEL lenders decreased by 65% ​​between 2008 and 2009 because they cite insufficient capital to issue loans. Many analysts and policymakers have argued that moving entirely to direct lending by the government would ensure that the credit supply for student loans would not be threatened in future recessions due to the program’s use of federal funds. .

Direct loans account for 85% of outstanding federal student debt

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What has been the result of the federal government’s implementation of direct lending?

The federal government’s shift to direct lending has had various impacts on the demand for federal student aid, government costs, borrower experience, and administrative flexibility.

Increase in demand for student financial aid

The increase in demand for student financial aid was likely not the result of better access to credit resulting from the move to direct lending. According to the Bipartisan Policy Center (BPC), there is no evidence that borrowers did not have access to FFEL lenders during the Great Recession despite the reduction in the number of participating institutions because the Ministry of Education purchased loans for allow private lenders to continue providing credit. However, the shift to direct lending created access to more favorable terms for borrowers and expanded loan cancellation and repayment programs, which may have encouraged individuals to borrow, or borrow more, than they would not have done otherwise.

Higher costs for the federal government

The shift to direct lending was expected to produce fiscal savings, but lower repayment rates due to the cancellation of student loans and income-tested repayment programs contributed to higher-than-expected costs for the government. For example, credit re-estimates in the first decade after the move to direct lending (2010-2019) show that student loans generated higher costs than originally predicted by the CBO. The Administration produces re-estimates annually to reflect changes in assumptions regarding interest rates, repayments and other factors as well as actual experience with loan cohorts.

Re-estimates reflect changes to original assumptions regarding fiscal effects of student loans


Under direct lending, the CBO originally projected that the new loans would produce 9 cents in savings for every dollar lent during the first decade of the program. Instead, re-estimates show that these loans cost the government 8 cents for every dollar on average, according to BPC. That said, it is unclear whether the direct loans were more or less expensive than the FFEL loans would have been.

Simplified process

Direct loans have improved the borrower experience by streamlining the application process. For example, the change eliminated the need to interact with a private lender after the government approved a borrower, easing the burden on students seeking education funding. Although the experience of borrowers has improved, some argue that the loan advice provided by the Ministry of Education has been less effective than the advice provided by private lenders and may cause some borrowers to misunderstand the financial obligation they assume.

Relief Options

Direct lending has given the government greater flexibility to provide relief to borrowers and has contributed to lower default rates, although these rates remain high. As an example of relief efforts, during the pandemic, the government suspended interest and payments on federal student loans until August 2022; however, most FFEL loans are not eligible for such relief.

Default rates are falling but remain high

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Look forward

Direct loans gave the government the flexibility to expand access to student loans and relief initiatives. However, evidence shows that the change did not produce the savings originally anticipated. At the same time, student debt continues to grow and weighs on millions of Americans. As policymakers consider ideas to reform the student loan program, proposals should effectively target relief and take into account increased burdens on the federal budget and taxpayers.


Related: How Do Federal Student Loans Affect the National Debt?


Image credit: Mario Tama/Getty Images

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