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Bailout for Private Student Loan Providers Creates Controversy

-by Thomas Hauck

With the cost of college soaring, more and more families are depending upon student loans to pay the cost of higher education. That can be a good thing, if the funds come from low-interest federal loans. If they are of the higher-interest private variety, they can be expensive. Most families will turn to private student loans only if federal loans are exhausted or unavailable.

Not a big problem, until the financial crash of 2008. With credit drying up, families are concerned about the cost and availability of funding for higher education. Recent announcements by the Federal Reserve have made the situation even more complicated for parents.

When U.S. Treasury Secretary Henry M. Paulson Jr. announced a change in how the federal government planned to spend the balance of its $700 billion financial rescue fund, many experts hoped the government was prepared to expand its efforts to ensure the flow of federal student loans. They also feared that it could offer federal aid to providers of costlier, riskier, and more controversial private student loans.

In response to Paulson’s plan, the National Association of Student Financial Aid Administrators (NASFAA) wrote to Paulson and to U.S. Secretary of Education Margaret Spellings to express its support and gratitude for the proposed shift of funds to assist banks and organizations that issue federal student loans.

However, the letter also expressed support for extending the financial backing to private loan providers as well. While private loans make up a relatively small part of all student loans, they are increasingly used to fill the shortfall between the cost of education and the total of state, federal, and institutional aid for some students. Private loans generally carry much higher interest rates and more restrictive terms for borrowers.

The Consumer Bankers Association, which represents many of the nation’s largest student loan companies, supported the Paulson plan. Special counsel to the CBA John Dean, stated that the announcement of the intervention was good news to anybody concerned about student’s education plans for the current academic year being disrupted.

The NASFAA Letter is Challenged

Higher education groups representing students, consumers, and some colleges took a much different viewpoint from NASFAA. In their own letter to Paulson, the groups discouraged the government from helping providers of private loans. The letter stated that private loans are risky and expensive, and lack the oversight, protections, and regulations of safer federal loans. In addition, providers of private student loans already receive taxpayer support. Given a choice, taxpayer dollars should not be spent enabling lenders to continue making high-risk private loans.

The groups signing the letter included the American Association of Collegiate Registrars and Admissions Officers, the American Association of State Colleges and Universities, Campus Progress, Consumers Union, the National Consumer Law Center, the Project on Student Debt, National Association for College Admission Counseling, U.S. Public Interest Research Groups, and the United States Students Association.

If anything, the government should use the opportunity to lower the interest rates and improve the terms of private loans, and strengthen the protections for borrowers who use them. The letter asserted that the college affordability crisis caused by the failing economy will not be solved by a bailout for the providers of high-interest private student loans. At least, the group said, the government should also provide better consumer protections.

Michelle Smith, a spokeswoman for the Federal Reserve, stated that the formulators of the program were only concerned with fixing the economy, and not with broader issues of the government’s approach to student loan policy.

Although Paulson has not yet issued any formal plan to help private student loans, the groups hope the government will use the opportunity to control some of the practices that in their opinion make private loans detrimental. The group wrote that private lenders that receive federal rescue funds should be required to offer income-contingent repayment options, more affordable fixed interest rates, and discharges in case of a borrower’s death or disability.

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