Higher "Ed" Could be Next Bubble to Burst
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Flunking banks out of college
Source: CNN
WASHINGTON (CNNMoney.com) -- President Obama is closer to winning a big fight with banks over who gets to dole out cheap student loans backed by the federal government.
In the next several weeks, legislation could pass forcing all government-backed student loans to come solely from the federal government. The move would cut out bank middlemen who now collect a subsidy to make federal student loans, such as Stafford loans, which offer the lowest interest rates because the federal government assumes the default risk.
Last week, the Congressional Budget Office said the Obama plan would save taxpayers $67 billion over 10 years. The savings would come from ending bank subsidies and allowing the government to keep income earned on the spread between making and issuing the loans that banks now pocket.
"For too long, bankers have gotten a free ride," wrote Education Secretary Arne Duncan in a Washington Post op-ed piece, saying the existing student loan system subsidizes banks, so that "working Americans pay while bankers get rich."
The impact
If the legislation passes, Democrats want to use the billions in savings to fund more need-based Pell grants for low-income students.
Consumer advocates say most students won't notice a difference in getting loans, since financial aid offices would continue to work as the intermediary and many offices already administer direct federal government loans.
But banks and some Republican lawmakers predict the legislation will cause delays and disruptions in processing student loans, saying the federal government doesn't have the manpower to take over the high volume of loans now originated by the private sector.
The banks also predict that thousands of jobs will be lost in the private student banking industry, including 2,500 at Sallie Mae (SLM, Fortune 500), said company spokesman Conwey Casillas.
The stakes are high, because federally backed student loans are the single most common way students finance higher education. It's a core product for student loan giant Sallie Mae, which also sells students its own private loans at higher interest rates.
The alternative
Banks would like to keep a piece of the action, when it comes to creating and delivering loans, for a fee of $55 per loan. The current version of their plan costs about $4 billion more than the Obama plan.
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The chief financial officer of Sallie Mae, Jack Remondi, believes the Obama plan would turn the Department of Education into "one of the world's largest banks."
The bill to cut banks out of the process entirely has already passed the House, but has languished in the Senate, thanks to intense lobbying. Sallie Mae spent $3.5 million last year, according to the Center for Responsive Politics. And a smaller student loan lender, Nelnet (NNI), spent $580,000 on lobbying.
Private banks issued far more federally backed loans, some $67 billion, in the 2009-2010 school year, compared to $30 billion issued in direct student loans by the federal government during that same period, according to the Department of Education.
The politics
The fate of who makes these student loans is poised to be decided in coming weeks.
The House bill cutting banks out of federally-backed student loans hasn't moved in the Senate, where bills need 60 votes to avoid a filibuster. So, Democratic lawmakers have been planning to stick student loans and health care together in a procedural move called "reconciliation," which avoids filibusters with a simple 51-vote majority.
Sallie Mae has some powerful friends in the Senate, including Sen. Evan Bayh, D-Ind., who said in a letter to the Senate education panel that the Obama plan threatened jobs in his state. He won't support a bill that doesn't "strike the right balance," he wrote.
But many Congressional watchers expect President Obama to win this round.
"The government has been funding these banking middlemen entirely. That's why a lot of members are OK with doing away with the program, because it basically doesn't work anymore," said Teddy Downey, a policy analyst for Concept Capital Washington Research Group.
The House version of the legislation would take effect July 1.
In the meantime, hundreds of universities each month are transferring their financial aid offices from the private-sector programs to the federal government's direct loan program.
The Department of Education says 46% of schools are ready for direct loans and 39% of schools are "in transition," preparing to make the switch to the federal direct loan program.
"Our experience has been and continues to be absolutely phenomenal," said Walter O'Neill, assistant vice president for financial aid at Roosevelt University in Chicago, which took three months to make the switch to the government's direct loan program last spring.
But that leaves 15% of schools that aren't ready. Some worry that students at these schools won't get loans if the schools, including several community colleges and historically black colleges, don't have the resources to switch their computer systems in time.
"There could be several institutions that can't make the switch and obviously there's some concern about what happens at those institutions," said Haley Chitty, spokesman for the National Association of Student Financial Aid Administrators.