The average graduate of a four-year college now sets off in life burdened by almost $20,000 in student loans. Among those graduating from four-year private schools, it is not uncommon to owe $40,000 or more. Responding to this unprecedented burden on Americans seeking to improve themselves, the House recently passed a bill that, on average, would reduce the loan interest paid by college students by about $30 a month.
That's welcome relief. But by forcing banks to compete for the right to make government-guaranteed student loans, we can do much more to ensure that young Americans are not sunk by debt before they get a chance to start their careers and families.
How much could interest rates and government subsidies for student loans fall without causing banks to stop lending? Probably a lot, though no one can say for sure because there is no market mechanism for determining the price of student loan subsidies. Instead, the federal government guarantees banks that the student loans they issue will be repaid in full, and then, through the political process (i.e., after listening to bank lobbyists), promises banks a profit set in law by formula. Separately, Congress also sets the interest rates that borrowers pay.
Those terms leave the good folks who make student loans with little to complain about. Loan giant Sallie Mae makes a 43 percent return on its cost of capital while incurring virtually no risk. Such rich rewards suggest that guaranteed profits on guaranteed student loans could be cut substantially without reducing the number of Americans who can obtain such loans. But finding exactly the right subsidy price or market-clearing interest rate for student loans is not something Congress or anyone else can divine in the absence of a market.
Fortunately, there is an easy solution: Make lenders bid for the right to sell federally guaranteed student loans.
As the commercial says, when bankers compete, you win. The right to originate loans guaranteed against default by taxpayers is something of great value that the government currently gives away for free to the banking industry. Why shouldn't banks have to bid against one another to secure this sure source of profit, especially when it's the taxpayers who create this "business opportunity"? Banks could compete by offering the highest bid for the right to sell guaranteed student loans to designated schools or by agreeing to accept the lowest amount of subsidy.
How much revenue would such an auction raise? It's hard to say exactly in the absence of a market. But recently, one of the country's largest lenders, the Missouri Higher Education Loan Authority, sold off half its portfolio of student loans at a premium of 7.1 percent. This hints at the market value of government-guaranteed student loans and suggests that taxpayers could save $15 billion to $20 billion over the next five years if Washington relied on market mechanisms instead of backroom politics to establish subsidy rates.
We could use all that extra revenue to benefit needy college students directly through grants or by cutting interest rates on their loans. Or we could extend the No Child Left Behind Act into high schools, as the Bush administration wants. Really, we should do all three.
The idea of such an auction is hardly radical. The government auctions off its Treasury debt, as well as spectrum licenses and offshore drilling rights, among other things. These auctions are not without their flaws, but they are preferable to the government simply giving away public assets to the well-connected.
From the borrower's perspective, loan terms would not change. Banks with winning bids would be required to make the same government-guaranteed loans that are available today.
Yes, the auction system might reduce the number of lenders, but the difference wouldn't be much. According to the Education Department, 32 lenders control 90 percent of the market, and one, Sallie Mae, already owns more than half of all outstanding federal family education loans.
Besides, in the event of poor service, colleges that don't like the winning bidders would retain the option of shifting to the government's own Direct Loan program, which provides the same loans under the same terms and conditions as the subsidized bank alternative. And if borrowers are upset with the winning bidders' service, they could refinance with another lender, as millions who hold consolidated student loans already have.
The American system of financing higher education needs reform, and soon -- but we must do it by moving away from the current system of government price controls. Conservatives should approve of a system that lets a market mechanism determine the cost of student loans, while liberals should applaud the dismantling of one of the country's most egregious examples of corporate welfare.
Michael Dannenberg is director of education policy and Phillip Longman is a senior fellow at the New America Foundation, a nonpartisan public policy institute.