SAFRA claimed to be saving grace, falls short of salvation

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February 26, 2010

12:23 AM

“Working Americans pay while bankers get rich. Sallie Mae executives have paid themselves hundreds of millions of dollars in the last decade, while teachers, nurses, and scientists — the backbone of the new economy — face crushing debt because of runaway college tuition costs.”

This was the language U.S. Secretary of Education Arne Duncan used recently to urge the passage of the Student Aid and Fiscal Responsibility Act, currently deadlocked in the U.S. Senate, that would end guaranteed student loans in favor of direct government-issued loans. The supporters of the bill paint it as a fight between students and soulless financial institutions, and view its implementation as a major educational reform greatly benefiting students and taxpayers. In reality, the bill is little more than a sensible cost-saving maneuver with modest benefits.

What SAFRA accomplishes is simple. Currently there are two ways to finance student loans. A student may borrow directly from the federal government, or through an intermediary, usually a bank or financial institution. These choices are not made by the student, but rather by the college or university, which chooses to accept either direct loans or guaranteed loans from an intermediary. This makes little difference to students, since both lenders offer identical loans. Student loans are offered at low interest rates with flexible repayment schedules. This is possible because the government guarantees them, effectively assuming all the risk of default. Government subsidies to banks really benefit students to whom banks would not otherwise lend. These subsidies are not a pipeline of free money created by Wall Street lobbyists.

SAFRA will do away with the option of guaranteed loans and effectively set up the government as the sole financer of student borrowing. This move will streamline the process and, according to the Congressional Budget Office, save up to $87 billion over 10 years. However, the government — which would now be the sole lender — would incur significantly higher administrative costs, and actual saving could be much lower; $47 billion was the CBO’s lowball estimate. However, private lenders are generally better at keeping track of borrowers and securing repayment. If private lenders are removed from the market, the repayment rate on loans will likely fall further, reducing predicted savings.

Also, not all, or perhaps not even most, of these savings would be at the expense of the banks. Instead, much of the savings would come from a reduction in services to student borrowers. Financial institutions compete for student borrowers, and because their product is identical, they must do so by offering high- quality customer service, or by giving incentives to schools and students. As SAFRA would eliminate competition in the student loans market, there would be no need for such devices. There would be savings, but much of it would come at the expense of colleges and students themselves in the form of poor customer service and no incentives.

The overall effect on students is ambiguous. Congress proposes to use some of the savings for a modest increase in Pell Grant caps and investment in community colleges. These are worthy causes, but when you consider that the savings on the bill over a decade might be around as much as the 2011 budget proposes to spend on highway maintenance in one year, some skepticism is in order. Furthermore, the bill will have virtually no effect on actual loan rates or on college tuition, and thus no effect on overall student debt.
In Lucy James’s Feb. 9 column in The Flat Hat, “Lobbying firestorm should not be the last word on student loan reform,” she wrote, “the inescapable reality is that something must be done,” demonstrating how overblown this debate has become. In the Tea Party age, it is once again fashionable to rail against big business, but that doesn’t change the fact that this legislation isn’t nearly as earth shaking as it is being made out to be.

Such hyperbole emanating from SAFRA supporters is unwarranted. Overall, the current system is not that favorable to bankers and will do little, if anything to benefit students. However, as a minor cost- saving proposal, the bill might be worthwhile.

E-mail Ed Innace at [email protected]

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