Toward Better Student Lending

The New York Times' Editorial Board outlines the future of student loans as they ought to be, the political forces working against the reform, and the realistic middle ground that can be achieved.

President Bush showed good sense on Wednesday when he signed legislation to ensure an uninterrupted flow of federal student loans during the credit crunch. Now comes the test of leadership.

The new law will help lenders who have found themselves unable to raise money for new loans on acceptable terms — if at all. The difficulty has nothing to do with the quality of the loans. The government guarantees all federal student loans against default and guarantees lenders an interest rate set in law. But as capital has become costly and scarce, student lending has become less profitable, leading several dozen lenders to stop lending.

There was no real danger of students being left high and dry because plenty of lenders remain in the market and the government also offers loans directly. To keep the situation from deteriorating, the new law allows the Education Department to buy some outstanding loans, thus providing money to make new loans.

At the same time, however, the student loan crunch has shown that the private lending program is costlier and less reliable than it should be. Fixing it will mean standing up to lenders that have long reaped immense profits from the status quo and would no doubt prefer to revert to the old ways as soon as credit conditions permit. It is up to lawmakers and Mr. Bush to prevent that.

The major reform is to push for more direct government lending. Currently, direct lending accounts for about 22 percent of student loan volume, down from 33 percent in the mid-1990s. It has suffered as free market enthusiasts insisted that it is better for the government to subsidize lenders rather than make loans directly.

Various government reports, including President Bush’s own budget estimates, have shown that direct lending is a much better deal for taxpayers, and just as good for students. But ideology, reinforced by huge campaign donations from lenders, has created deep support for subsidized lending. Lenders have burrowed into the financial aid system, providing software and other support to colleges and universities and — as we learned last year — kickbacks to aid officers.

Then, when trouble loomed, some of the lenders who profited so well for so long headed for the exit. Direct lending won’t dry up when credit gets tighter.

Ideally, all student lending could be handled directly. But politically, that may be a long way off. In the meantime, subsidized lenders should be made to adhere to new rules. The ability to profit from government subsidies during good times should come with a reciprocal obligation, currently lacking, to hang tough in bad times.

And rather than simply provide generous subsides for lenders to make federally guaranteed student loans, lenders should have to bid for that profitable opportunity. Auctions would potentially raise tens of billion of dollars in revenue that could be used to improve grants and loan terms for college students. Free marketeers should cheer the development, because auctions would bring market forces to bear on a system that is currently nothing more than an expensive government giveaway.

Student lending always has been a government program designed to make college more attainable. The new law could be a first step toward that core goal — if political leaders will take the next necessary steps.