Bob Shireman, senior adviser to Secretary of Education Arne Duncan, recently spoke on a panel "The Future of Federal Student Loans" moderated by the New America Foundation. Here is my not so official transcript of his prepared remarks which represent the most comprehensive rationale for the Administration's plan to move to Direct Lending:
Last month President Obama laid out a bold goal for America to
restore our place in the world as the country with the largest proportion of
Americans with college degrees. I’ll say
that in developing this bold goal, probably the toughest thing was to figure
out a way to get a president to say proportion in a major speech before Congress. That had to do with the detail that we went
through to avoid things that might cause problems like graduation rate goals that
can cause schools to deny entry to students to keep their rates up. We approached this very carefully. We chose our words very carefully so that the
goal would incentive the right activities by colleges, by states and in our
federal programs.
The major part of that overall goal is making the Pell Grant
program an entitlement; so that not only our high school seniors but our
children and families in middle school know that there, especially if they are
low-income, that there is money there for college when they are ready to apply
and they will undertake the academic preparation in order to go to
college.
One of the pieces of our higher education plan is a reform
of student loan programs. I am going to
give some overall context for how the Administration views the student loan
programs and why we are going in the direction that we have proposed.
There are basically three functions in a student loan
program:
There
is getting the capital – the money for the loan;
There
is originating the loan –the giving the money to the individual borrower
and receiving back from that individual borrower a signed promissory note promising to repay that loan.
The
bulk of the actual work for the loan is servicing. Servicing is the answering the phone
calls about “Did I have a payment due?”, “Am I eligible for a deferment?”, sending out the bills, following up when
someone does not repay their loan;
letting people know about their full options for repayment. I am going to talk about each of
these. Let me start with servicing.
The goal on servicing federal student loans whether they are
direct or guaranteed. Two main goals we
want to achieve: one is preventing default
In the current FFEL program, if you look at the default rates by lenders
that have been posted online for years, the most recent ones for FY06 the default rates are
anywhere from 0.2% to 23.3%. Now there
may be good reasons for different lenders having different default rates but
the reality is that we do nothing in the FFEL program to encourage the use of
lenders or servicers that seem to do a good job of preventing defaults. And a major goal of whatever way we design
the loan program should be to prevent default.
We also have these entities called guarantee agencies: which one of my colleagues at the Department
of Education when I complained of the lack of any analogy to explain exactly
what they do, said it’s like a Grateful Dead concert, “There is nothing else
like it.” So I won’t try to explain what they are but in any case the concept
is that they are supposed to help as sort of a backstop on collection. So it is a good concept but the reality is
that the basic approach to the incentives that Congressional staff put into the
law create incentives that could be seen as too much of an incentive to
collect on loans and not enough of an incentive to prevent default on loans. In other words, when somebody can make a lot
of money collecting on a default, they may not have enough of an incentive to
prevent that default from happening in the first place. So again, there is not enough of a built-in
competitive incentive approach to preventing defaults.
The second area, other than preventing defaults, is customer
satisfaction; student borrowers getting the information that they need when
they need it, knowing about their options.
In the current Direct Loan program, a customer service survey, an
independent survey that was done, showed that the Direct Loan servicer, private
sector servicer, had done as good or better job as some of the lenders. Now, some lenders may have not been part of
the survey and some probably do better job and some probably do worse. But the point is the way that we are moving
in the Direct Loan program and the servicing for the FFEL loans purchased by
the Dept. of Education is to have multiple private sector servicers competing
based on best service and preventing defaults; so using competition among
private sector entities. If they do a
good job they get more business from the federal government collecting on those
federal student loans. If they can’t
compete, they are not doing a good job, then they get less business. To the extent there might be jobs issues
here, there need to be just as many people in the private sector servicing
student loans, whether it is FFEL traditional, FFEL purchased by the federal
government or the Direct Loan program the question is what are the incentives
that we build in so that we get that the best service that serves taxpayers
best and serves borrowers best. That is
the approach we taking, taking advantage of competition and using the private
sector on the servicing side.
In terms of origination, we already have an approach for
originating Pell Grants at virtually every school in the country. We currently contract with Accenture which
runs a system called Common Origination and Disbursement (COD) system where
schools draw down money from the federal government and then provide data back
to the federal government to say here are the students who received Pell Grants. The concept of adding on an element to that
where they draw down money for student loans and send back data that says here
are the students receiving federal student loans is an easy add-on to a system
already used for delivering Pell Grants.
The major difference is that with a student loan there is a promissory
note that needs to be signed; there is also in FFEL a promissory note that the school needs to make
sure gets signed. The processes are
certainly are different involve schools in FFEL moving to the Direct Loan
program they have to learn something different but it is not something that is
enormously complicated.
It is also important to point out here that lenders are not
making the usual decisions that lenders make.
Usually, in a loan program a
lender is deciding that this is a borrower who I want to lend money to because
I consider this student to be worthy of an education at this college or this is
an amount that I am willing to borrow because this school is worth it. That is what you would do for someone looking
to buy a car, buy a home, look at the asset, look at the borrower. You would make a decision about whether this
a risk you are willing to take as a lender.
Lenders do not do that in the federal student loan program. All those decisions
are made by formulas in the federal student loan program or in the federal
financial aid program overall with the administration of all of that undertaken
by financial aid administrators at colleges.
This brings me to the issue of the capital that is
provided. Lenders are not making the
decisions about risk. In fact, we as the
federal government are protecting them against the default risk and essentially
when lenders are raising money from private investors they go out to private
investors and say “Instead of buying a treasury bond why don’t you buy this
bond that is backed up by the federal government.” So the federal government on its balance
sheet shows this risk as a contingent liability; in other words, if there is a
default on these loans or interest rates don’t turn out the way as we had anticipated
this is on us, it is on the taxpayer.
But all of the payments for students, all of the extra interest on top
of the overall payments go back to the private sector lenders even though they
are not taking the risk on those loans. We promise these interest subsidies that we
have come up with in Congress, commercial paper plus some kind of an increment. What that means with that kind of a fixed rate
not based on any competition, it means that if there is enough of a subsidy or
too much, the lenders get to keep it. If
is not enough, they don’t make the loans and come running back to us and asking
for more. In the situation where they had 9.5% returns, it was way too much,
they took advantage and brought in more money.
It was not anticipated, they got to all of that extra money. In the last year, when subsidies haven’t
been high enough, they didn’t make loans.
We had to go to an entirely new system of providing the money up front
and paying different kind of fees. It is
not a competitive system; not a system that assures that the loans actually
will get made.
In the Direct Loan approach that we are proposing, since we
are taking the risk, we provide the funds, borrow the funds from the same people
who would lend the money for the bonds that would have gone to lenders and secondary
markets in the student loan program. You
can think of it over time, as we borrow the money, students repay the loans, and
in a sense it creates a revolving fund, where only the subsidy needs to come
from either taxpayers or from borrowing from the capital markets. Because we are receiving the student
repayments that helps to overall cover our cost; and all of this together, the
reforms, not only reduce the deficit but lowers the federal debt over time
because it costs us less to subsidize the overall system.
We use those savings to plow into the Pell Grant program, to
make the Pell Grant program an entitlement so not only do we avoid the potential
drop in Pell Grants in a couple of years by $1,000 to $1,200 but we propose an
actual increase in Pell Grants that would keep pace with Consumer Price Index
plus 1%. We also include $500 million
per year to go to states because there is an important argument that comes up
around FFEL and that is that some of the entities that that are involved in the
guaranteed student loan program use a portion of their proceeds to do important
things with schools and colleges; helping schools and colleges with outreach
and information. We think that this is a
valuable and important activity that happens in some states that they are lucky
to have money-making agencies but other states don’t have it. We want to make sure that all states have it
which is why we have created this fund that can be used for that purpose as well as to promote improvements in
college completion; improving the number of student who actually complete and
improve graduation rates.
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