Wrestling with the Consequences of Success
This spring, financial aid officials cringed as they read about the unsavory practices at colleges and universities across the country. Some instances are clearly troubling and inappropriate, such as those situations where lenders and financial aid officials have engaged in "payola" or in-stock dealings.
Other instances are more ambiguous and indicate more about the state of the loan sector itself than those involved in it. Many of the "improprieties" identified by New York attorney general Andrew Cuomo involve aggressive marketing practices that may strike us as distasteful but amount to nothing more than what is typically found in any business dependent on sales--relationship-building, aggressive marketing, and institutional rebates. Meanwhile, financial aid officials are attending to considerations of cost, institutional need, and provider quality in a changing marketplace. It's not surprising that we're unhappy with the results.
While Cuomo's recommendations will help clarify permissible practices, mere codes of conduct will neither address the root causes of today's controversies nor provide a satisfactory long-term solution. Unfortunately, it appears likely that legislators will opt for patchwork solutions and pass on a chance to reassess the student loan sector as a whole.
Fundamentally, the rationale for today's system of student lending rests on several assumptions that no longer hold.
In the 1960s and early 1970s, when the federal student loan system took shape, policymakers were most concerned that banks would be reluctant to provide funds to students who are mobile, small-dollar, and high-risk borrowers. Consequently, they provided resources and incentives to ensure an adequate pool of financing.
Today, amidst sea changes in American education, economic conditions, and credit markets, the challenges have changed. Private student loans have exploded to over $17 billion a year, amounting to about 25 percent of the federal loan volume, and that figure continues to grow. Thanks to the success of earlier reforms, there is an array of for profit banks and loan providers that are willing, even eager, to lend money to college-goers under conditions that students find acceptable.
Access vs. Choice
Today's discussions of student lending are complicated by the failure to distinguish between two goals: access, which is primarily important for low-income families, and educational choice, which is most relevant to middle-income students who are weighing in-state public institutions against more expensive alternatives. While the discussion of subsidies has been shaped by student complaints about debt and books with plaintive titles like Generation Debt, the reality is that less than sixty cents of every dollar in federal aid is provided on the basis of student need. It is not clear that taxpayers should subsidize middle class students so that they may attend the expensive private institutions of their choice.
The typical private school borrower graduated in 2003-2004 owing $19,400, and the typical public school borrower owed $15,500. As Harvard University's Susan Dynarski has pointed out, however, on a ten-year payment schedule this amounted to a monthly payment of $209 and $167 respectively. Given that college graduates in most fields now earn starting median salaries between $30,000 and $50,000 (approximately $2,500 to $4,000 per month) and that the lifetime premium on a college education is agreed to be $1 million or more, it is not necessarily an unreasonable burden. For comparison's sake, Dynarski has pointed out that the typical American car loan of about $23,000 requires a monthly note of more than $400.
Furthermore, students and families are hardly being asked to fend for themselves. In addition to the $90 billion in federal financial aid (including grants, loans, work-study, and tax benefits), states devote significant dollars to higher education. In 2005, states provided $65.3 billion for public higher education, or a subsidy of about $5,800 per fulltime student. The result was that the typical family paid only about 37 percent of the actual cost of tuition for students enrolled in public colleges and universities.
Actions to Consider
What does all this mean for the future of student lending?
Transparency: First, the push for increased transparency in the lending industry, clear codes of conduct, and a more level playing field is all to the good. However, transparency alone won't change the fact that today's student lending machinery is showing signs of wear--and reactionary policymaking could forfeit opportunities for improvement.
For instance, Cuomo has fretted that lenders are engaging in differential treatment of students depending upon the institution they attend. However, it's not clear that this is a problem--it might just as readily be an opportunity. If lenders are eager to serve students on the basis of good credit or in anticipation of future earnings, this may allow taxpayers to avoid bearing the cost of servicing at least some of those loans.
Better targets: Second, if the federal mission is to ensure access rather than choice, then this suggests efforts to better target the allocation of funds. Today, Washington seems to be leaning the other way. Earlier this year, the Democratic majority in Congress voted to cut interest rates on student loans in half, without any effort to direct this new benefit to low-income students. Such untargeted measures seem a poor use of taxpayer funds. Policymakers might focus on using guarantees and subsidies to ensure that loans are available to low-income students and poor credit risks and on establishing strong consumer protections for borrowers better served by the private loan industry.
Comparison shopping: Third, we should rethink measures that impede comparison shopping by students and may make loan originators less sensitive to the ability of students to repay loans. Widely recognized is the need to replace the FAFSA with a more user-friendly and predictable system for determining student aid. Another step would be pushing state-funded institutions to be more transparent about the manner in which they calculate need and distribute aid.
Due diligence: A less familiar proposal would be to address the risk that securitization, by potentially separating credit decisions from credit risk bearing, encourages loan originators to issue loans with little concern for a student's ability to repay. We have recently seen in the subprime mortgage industry how this can play out. Requiring lenders or schools to adopt a credit risk position in the loan or rethinking the utility of the due diligence requirements for loan repayment may be useful correctives.
New lending models: Another tack entails exploring ways to encourage the availability of income-contingent loans. A major concern with loan burdens is not necessarily the aggregate amount a student carries, but the fact that loans may limit career choices and do not account for the fact that students don't know how much they'll earn after graduation. Income-contingent loans, already in use by New Zealand and Australia, pool this uncertainty by allowing high earners to subsidize those who earn less. Policymakers would do well to give due consideration to how such lending models may be explored in the United States.
New role for financial aid offices: Finally, for four decades, financial aid officers have functioned as gatekeepers of a government-directed system, operated with government and institutional money. Now, private lenders and direct-to-consumer marketing are increasingly common. As colleges and universities become less central to the lending process, financial aid officials will inevitably face frustrations.
Among these will be safeguarding students from unscrupulous loan originators. Yet these developments also mark the emergence of more diverse borrowing options and promise the benefits of heightened competition. Financial aid officers will have the opportunity to negotiate more creatively and pioneer new informational, outreach, and monitoring strategies. It will require much more than a code of conduct to effectively redefine such a role in this new era.