Who Should Lend?

by Andrew Gillen

Justin Fox frames the recent student loan debate in an insightful way:

Over the past two decades, student lending became a textbook case of a privately run, government-subsidized program that delivered a worse, more-expensive result than a government-run program probably would have... So now it looks like we'll put the government completely in charge of student lending. Our entire financial system currently amounts to a privately run, government-subsidized program. I don't think that means we should put the government in charge of all lending. I'm just sayin' ...

As the work showing that Direct loans (government) costs less than FFEL loans (private) has come to light, I keep hearing that the government should do all the lending. But just because FFEL is badly designed and expensive doesn't mean that there is no use for private lenders in the student loan market, and that private loans are by nature more expensive. I've been struck by the lack of what seems an obvious solution - quit subsidizing the FFEL loans.

Why are they subsidized in the first place? Right now, the government tries to set the quantity of loans (who qualifies), the price (interest rate) on loans, and the profits of the private lenders. Needless to say, the sages in Washington haven't realized that you generally can't control price and quantity at the same time, and are not too good at anticipating the trade-offs in micromanaging all of these. Last years "reforms" are a perfect case in point. As noted in Bailout of the Year in the WSJ:

Usually, the law of unintended consequences takes so long to reveal itself that no one remembers the culprits. But the speed at which Congress's student lending changes have gone south is raising political danger... But the pols can hardly repeal their autumn blunder mere moments after taking credit for it...

The result is that the same man who authored last year's bill to cut lenders' returns has crafted a new bill to subsidize those same lenders...

To summarize: Congress mandated a return on student loans that is too low to attract private capital in the current market. So Congress will now use your money to create artificial investor demand. Taxpayers will bear more risk so that Congress can fashion a new business model to replace the one it just destroyed.

Since I'm not a big fan of using taxpayer money wastefully, I won't shed any tears at the death of the current FFEL program. But acknowledging that the current system is flawed (that taxpayers are essentially guaranteeing the profits of lenders), and concluding that private lenders under any system should have no role in lending are two different things. It would be a mistake to not replace FFELP with a new and improved version. First on the list of things to go would be subsidies to lenders.