As you have probably heard by now, the “credit crunch” has been making the student loan market less lucrative for many lenders, and has caused a bit of a controversy in the world of higher education.

To recap – lenders are trying to argue that problems in the credit markets will lead to a crisis for students who need loans to attend school, while most others think that the affects for most students will be small. Congress and the Education Department have created new policies to make sure that, no matter what happens, students will be able to access financial aid, but lenders, who already receive government subsidies to make loans to students, keep pushing to get a sweeter deal for their bottom line (as opposed to sweeter deals for students or taxpayers).

I thought this new article in the Chronicle of Higher Education might help point to the difference between planning for the worst (good), and unnecessarily wasting taxpayer money (not so good):

Late last week the department issued an update on its talks with industry representatives over the second plan, a backup system known as "lender of last resort." That plan would let students who have trouble finding a willing loan company obtain federal loans through guarantee agencies—a collection of 35 nonprofit entities whose role in the government's loan system is usually only to hand out federal money to participating lenders when borrowers default.

The department has proposed that it retain ownership of such loans rather than let the guarantee agencies keep them. But Brett E. Lief, president of the National Council of Higher Education Loan Programs [NCHELP], said that was "not a borrower-friendly approach" because the government would hire its own contractor to service the loan, increasing the likelihood that the student has a lender and a guarantor different from the lender and guarantor that the student used previously.

The objections of the NCHELP (a lobbying organization for lenders, guarantee agencies, and others that would benefit from retaining ownership of the loans) are pretty silly on their face, since, as the article later notes, lenders tend to “sell student loans to other companies an average of four times per loan.”

Their real objection is that they want the public to provide cheap financing to make the loan, and then they want to be able to keep the loans so they can receive both subsidies and monthly payments from borrowers, even though it would provide few if any benefits to students and be more expensive for taxpayers.

That sounds like a great idea right?

In fact, this whole “lender of last resort” (LLR) thing may not be a great idea anyway. The system has never been tried, and many think that there are few reasons not to use the existing and proven direct loan system as the ultimate fail safe instead. Higher Ed Watch gives at least two pretty convincing reasons:

·         Requiring Additional Federal Payments: With the regular Direct Loan program, the government's initial expenditure is equal to the principal of the loan. But under LLR, the Department would provide a fee to a guaranty agency for "originating and servicing LLR loans made with advances." The government would thus provide money to make the loan and then give the guaranty agency MORE money to agree to originate a loan with ZERO default risk.

·         Designating the Debt as FFEL Loans: As we noted earlier, borrowers have nearly the same terms under the two federal student loan programs, with at least one notable difference: Direct Loans can be partially forgiven for public service. Under the Department's LLR plans, however, the guaranty agency must assign to the Secretary any loans made with federal advances that she requests. These assigned assets will still be considered FFEL loans, meaning a borrower could end up with a loan owned by the government with inferior terms to other Department-held loans.