Why is Student Loan Reform Holding Up Health Care?

Health care reform has hit a new snag. It's not the excise tax, or the individual mandate. It's student loan reform.

Huh? What does student loan reform have to do with extending health care coverage or bending the cost curve? Nothing at all! But Democrats are hoping to pass a measure that would eliminate private student lenders in the same reconciliation "side car" where health care reform could pass through the House and Senate. Seven Senate Democrats -- Sens. Carper, Lincoln, Pryor, Nelson(s), Bayh, and Kaufman -- have said they don't support the student loan barnacle that's attached itself to health care, and Marc Ambinder says they're worried about lost jobs and lost donations from the private lender industry. But enough about the politics: why are we trying to reform the student loan industry?

It's best to start at the beginning. Lending to students is risky. Think about it: who wants to make a low-rate loan to a 18-year old kid with no earnings, no credit history, and zero collateral when he won't start paying interest in four years, at the earliest? A reasonable bank might seek out significant guaranteed backing to make a loan like that.

So the government backs the private student lenders. Since 1965 the feds have offered a guaranteed rate of return for banks who put up capital for student loans. Congress sets the interest rate -- based on input from lobbyists, of course  -- and covers up to 97 percent of the losses if the student can't pay back the loan. Heads, students pay the bank. Tails, taxpayers pay the bank.

If that system appears wasteful or inefficient to you, it's only because you're paying attention. In fact, if the government cut out the middleman and originated all of the loans itself -- with paperwork assistance from private banks -- we would save between $65 and $85 billion in ten years, according to the Congressional Budget Office. That's billions of dollars a year that we can send back to students and colleges and states in the form of richer grants for low-income students, early childhood programs, money for community colleges and school construction.

It would be bad enough if taxpayers were subsidizing federally backed, rock solid assets with jacked up interest rates. But the story gets worse.* Student lenders aren't just in it for the guaranteed returns; they're also in it for the guaranteed young student market. Banks who deal with students directly through the financial aid office  can cross-sell kids additional loans. As New America Foundation's Jason Delisle puts it, "under the pretext of competition and choice and the private sector is a smokescreen for banks who want to highjack this federal student loan program and sell kids credit card like loans when they're least likely to know what they're getting into. Really, these are the jobs we want to protect?"

The key thing to know, Delisle emphasizes, is that student loan reform would provide the same loans to students: "there's nothing changing." Students would still fill out familiar loan forms. Student loan companies would still administer the loans. The government would still guarantee the money. But the paid interest would go to student programs rather than private companies. Public policy can be difficult. But this is a no-brainer.
*And if you're interested in a deeper wonkier look at how it gets worse, Jason Delisle from New America Foundation has a story for you:

"Another huge inefficiency that nobody talks about is that lenders have to borrow in the private market to make the loans. Even though they're guaranteed against default with a guaranteed interest rates, the private sector doesn't see them as fully government backed because there's some risk the lender could screw something up. If there's a paper work error or fraud, the loan no longer qualifies for the government guarantees. The private market actually charges a premium for that.

"So even though the loan has all these government guarantees, the complexity of this system we've set up actually creates a separate risk for private market that has a cost for tax payers because that's built into the subsidy we pay the lenders. So the government has said: Make this complex. Charge us a premium. And well pay it.  As a conservative, I think this is just a terrible way to run this thing."