Modification of Federal Student Loan Program, Essay Example

Problem Statement

Participation in higher education in the United States has been increasing significantly in the past decades. According to the National Center for Education Statistics, enrollment to degree programs increased by 11 percent between 1991 and 2001[1]. However, according to the 2014 statistics[2], average tuition fees have been increasing significantly in the past 12 years. Consequently, the demand for affordable loans for education is increasing significantly. The current system of two different loan types (Federal Family Education Loan and the William D. Ford Federal Direct Loan Program) seems to be ineffective for the government and students, while it is not profitable for financial organizations.

Significance

When assessing invaluable systems in the United States, based on their effectiveness,  results, and costs, it is important to review different estimates and opinions. The below review of the present and the potentially better future or student loans in America will provide a comprehensive analysis of all aspects of change; effectiveness, service level, costs, and benefits for stakeholders. The increasing demand for higher education loans is clearly creating a challenge for the Federal Government and the Department of Education. The main challenges are to make the delivery of these loans more effective, less costly, while ensuring that fair allocation is maintained. The below Aide to Education Secretary Arne Duncan will provide both background information and potential solutions.could have more control over student loans and financial agreements.

Recommendation

The current system of two different loan types (Federal Family Education Loan and the William D. Ford Federal Direct Loan Program) seems to be ineffective for the government and students, while it is not profitable for financial organizations. Managing the FFEL costs the government a significant amount of money, and direct landing seems to be an option that provides clear management options and lower costs associated with student loans. The author of the current memorandum argues that replacing the FFEL program would result in several benefits for students, higher educators, and the government. The cost associated with administering the loans would be reduced, students would have clear choices and simple solutions, while colleges and universities could have more control over student loans and financial agreements.

Background Information

According to the Congressional Budget Office[3], the two different types of student loans (Federal Family Education Loan and the William D. Ford Federal Direct Loan Program) creates double administration burden for the Federal Government. The William D. Ford Federal Direct Loan Program (FDLP) is administered by the Department of Education, and the financial background is provided by the Treasury. In contrast, the Federal Family Education Loan (FFEL) is administered by the lenders, and finance is provided by subsidiaries. Still, the government incurs increased risk related costs by selecting, managing, and compensating these lenders. In recent years, the share of guaranteed loan programs (FFEL) fell, due to market volatility and lenders’ financial difficulties. This calls for a revision of the two systems as of 2010: should the government stick with the two lending methods, or should it take responsibility for the administration of both FFEL and FDLP.

Key Issues Identified

According to the U.S. Department of Education[4] , there are several challenges that both students and lenders face. Reviewing the 2009 statistics published by Woo & Soldner[5] the number of students who are repaying their loans one year after graduation fell between 1994 and 2009. In 2009, only 60 percent of students were repaying their loans, while this figure in 2001 was 65 percent. The ratio of monthly repayment to income also increased between 2001 and 2009 respectively by two percent on the average. This means that there is a high risk of lending to students, and by providing guarantees to private financial institutions, the government incurs a high cost. This adds to the already high cost of administering outsourced loans. See the graphical illustration of trends below[6].

In a 1997 review, Miles & Zimmerman[7] found that the risk adjusted return of student loans over life-time for lenders in year 1996-1997 was only 1.25 percent[8].

Elmendorf[9] states that “replacing new guarantees of student loans with direct lending would yield gross savings of about $40 billion in mandatory spending over the 2010–2020 period”.

Another set of interesting data revealed by Dynarski’s research[10]. The author states that private lenders participating in student finance programs are more vulnerable to market changes than governments’ budgetary offices. This means that the allocation and management of student loans can be more effective and reliable when it is in the hands of the government. Secondly, the author also mentions that some lenders have been previously accused of bribing school officials in order to get students to take credit out through their company. Finally, while the rates of student loans were regulated, some lenders currently have financial products labeled as “student loans”, while they are not provided through federal loan programs, and often have an interest rate of up to 10 percent annually. During the last long-lasting recession, when students fell behind their payments, according to the annual report of the Consumer Financial Bureau[11], private lenders were unresponsive and did not offer adequate rescheduling or deferment solutions. The direct lending program, however, provides students with more flexibility and income-based repayment options, therefore, expanding it would benefit not only the federal government, but students as well.

Policy Options

Discontinuing the FFEL Program

One of the potential solutions is to discontinue FFEL programs, and only provide new loans on the direct lending basis, from the budget of the treasury. As Elmendorf[12] states, this would save the Federal Government over $40 billion over the next ten years. However, the government would still need to provide guarantees for lenders who administer current student loans provided through subsidiary lending. At the same time, the Federal Government would face increased risk of non-payment directly, which would affect the budget.

Efficiency:

Long term savings can be realized, however, managing the existing FFEL programs would be inefficient, and costly.

Social Equity:

Keeping existing FFEL programs in place would create confusion and inequality between groups who have old loans and those with direct lending agreements.

Feasibility:

It would take decades until the last FEEL loans expire and are paid off, and the government would need to have an allocated budget for their administration for this time.

Tightening Requirements

The next option is to continue providing the FFEL loans to students, but tighten requirements and policies regarding maximum interest rates. It has been noted by Miles & Zimmerman that the net profit (interest in the product) of lenders is relatively low. Taking into consideration the lower rate of repayment one year after graduation, highlighted by Woo and Soldner[13], today’s net profits would be even lower.

Efficiency:

The introduction of tighter requirements would reduce the number of eligible students securing finance for their education.

Social Equity:

Social equity would suffer in the society, as some groups from disadvantaged backgrounds would be excluded from th2 program.

Feasibility:

It is likely that stricter requirements would trigger resistance and opposition from political parties and student organizations. This would make policy making costly and lengthy as well.

Conversion of FFEL Loans to Direct Loans

The final option would be to not only discontinue FFEL loans, but to convert them into new, direct student loans. While the policy development and research cost of this option would be initially high, it would create an easier to manage and more homogenous system. Budgets for financing, servicing, and administering student loans would be easier to create. Policy development and paying off existing subsidiaries would impose a high burden on the already overstretched educational budget. It is estimated that the initial cost of purchasing would be $120 billion. Policy creation and modification would cost around $150,000. However, – as Klobuchar[14] states: “Allowing distressed borrowers to convert their private or FFEL loans to Federal Direct loans would permit them to participate in the IBR and ICR programs, which would reduce their monthly payments to a more manageable level, minimizing their risk of default”, therefore, it would benefit graduates who are burdened with debt.

Efficiency:

Managing loans and modifying existing agreements, as well as financing education would be more efficient and straightforward.

Social Equity:

The “one student loan” system would increase social equity: universal conditions would apply to all students.

Feasibility:

Provided that the conversion of loans is carried out gradually, it would not strain the budget of the Federal Government, and make the system more efficient. No development of new policies is needed, apart from the ones related to converting FFEL loans to direct ones.

Conclusion

Recommendation

Based on the budgetary analysis and effectiveness of the two different programs running simultaneously as of 2010 in the United States, offering student loans, it is recommended that – in order to reduce the cost of administration and policy-making – the government ceases the FFEL program. While buying all existing student loans from subsidiaries would impose a huge burden on the Treasury, offering students an option to convert their financial agreements would benefit both the Department of Education and graduates. Taking into consideration the interest of all stakeholders: the public, graduates with loans, and the Treasury, this solution seems to provide the most advantage and cause the least damage for all.

Trade Offs

The main beneficiary of the above option would be the government, making substantial savings long term. The secondary beneficiary will be the group of students, who will be provided equal opportunities and terms. However, it is likely that the government would lose the trust of private lenders, who would lose their business. Further, developing a system for conversion and policies for buying back loans from private financial companies would have financial implications on next year’s budget. Finally, the government would be buying a significant amount of “bad debt”, and will need to deal with rescheduling agreements for those whose loans are due but are not in repayment yet. However, the author of the current study believes that the government would be more efficient in dealing with this issue if they had direct control over agreements.

Bibliography

Consumer Financial Protection Bureau “Annual Report of the CFPB Student Loan Ombudsman” http://files.consumerfinance.gov/f/201310_cfpb_student-loan-ombudsman-annual-report.pdf

Congressional Budget Office “Costs and Policy Options for Federal Student Loan Programs” Pub. No. 4101. 2010.

Dynarski, S. “An Economist’s Perspective on Student Loans in the United States”. Economic Studies. ES Working Paper Series, September 2014.

Elmendorf, Douglas “Memo” Congressional Budget Office. 2010. Institute of Education Sciences. “Fast Facts.” National Center for Education Statistics.  United States Department of Education. http://nces.ed.gov/fastfacts/display.asp?id=98.

Klobuchar, Amy “The Causes and Consequences of Increasing Student Debt” Joint Economic Committee Democratic Staff Report. 2013.

Miles, Barbara, and Zimmerman, Dennis “Reducing Costs and Improving Efficiency in the Student Loan System” National Tax Journal. Vol 50. No. . pp. 541-556. 1997.

Woo, Jennie, and Soldner, Matthew “Degrees of Debt: Student Borrowing and Loan Repayment of Bachelor’s Degree Recipients 1 Year After Graduating: 1994, 2001, and 2009” Institute of Education Sciences. NCES 2014-011 2013.

[1] National Center for Educational Statistics, 2012.

[2] Ibid, Student Loan Volume and Default Rates (Last Updated: May 2014)

[3] Congressional Budget Office “Costs and Policy Options for Federal Student Loan Programs” 2010.

[4] Woo and Soldner, “Degrees of Debt” 2014

[5] Ibid

[6] Ibid, p. 12.

[7] Miles and Zimmerman, “Reducing Costs and Improving Efficiency in the Student Loan System”1997.

[8] Ibid, 543.

[9] Elmendorf, “Memo” 2010, 4

[10] Dynarski, S. An Economist’s Perspective on Student Loans in the United States. Economic Studies. 2014, 11

[11] Annual Report of the CFPB Student Loan Ombudsman

[12] Ibid,  4.

[13] Woo and Soldner, “Degrees of Debt” 2014, 12

[14] Klobuchar, The Causes and Consequences of Increasing Student Debt” 2013.