In August 2009, a college friend posted on his Facebook status "My student loans are due…what should I do?" While we went to a public college with low in-state tuition, three years of out-of-state graduate education was expensive, and student loans were his only option to fund it. The bill came to about $40,000.
His status update elicited dozens of replies. A few of his friends suggested ways to take care of the problem, including loan consolidation, new government repayment options, paying them off with other credit lines or just ignoring them. More interestingly, most of his friends used the opportunity to bemoan their own student loan woes, with debts as much as $100,000.
Obviously, student loan problems are not limited to my friends. Around 18 million people were enrolled in two- and four-year degree and non-degree granting institutions in 2008. According to most estimates, around 60% of all students took out a student loan, averaging over $5,000 a year. Therefore, around 10 million people took out student loans last year, which is almost 3% of the American population. This does not include all the former students who were still paying off loans that are years old.
On March 30, 2010, with legislation that was included in the health care reform bill, President Barack Obama signed new legislation that overhauled the student loan industry in the United States.
Largely eliminating the older Federal Family Education Loan Program (FFEL) that offered private student loans with a federal government guarantee, the 2010 Student Loan Bill empowers the Federal Direct Loan Program (FDLP) to make almost all federally backed student loans directly to the student, or parent, borrower.
The FDLP plans to reduce some of the costs of student loans largely by cutting the private banking industry out. The Congressional Budget Office expects the government to save around $60 billion in 10 years. The Obama administration then plans to use those savings to expand access to Pell Grants, lower the cost of loans, and pay down the federal deficit.
This legislation has provoked plenty of discussion. The political right in the United States is unsupportive of a perceived expansion of federal power. They argue that government control will only perpetuate spiraling college costs.
Many on the left argue that making education more accessible to students is paramount. They point to the cost saving measures of the FDLP, especially when compared to the money funneled to private banks through FFEL, as evidence that school will be more affordable to all, at least in the short run.
As the costs of a university education have spiraled upwards over the last few decades, the task of making school affordable has become an ever more important social and economic policy goal for leaders in Washington.
Hard statistics for increased college costs are difficult to determine, but the cost of tuition (after inflation) has increased about 1.5 to 2% a year for the past 70 years. The cost of attending college since World War II, in real terms, has nearly tripled. The College Board reported that in 2009, the total cost of a year at a community college was $4,552, at a public in-state university was $17,336, and at a private university was $35,374.
Ensuring that all people can afford a college education is important. It offers a degree of social justice, ensures that talented individuals can excel despite their socioeconomic background, and allows the country to remain competitive in a global economy that increasingly requires trained and talented workers. During the 20th century, and especially during the Cold War, the U.S. focused on producing an educated population in its efforts to lead the world and out-perform the Soviet Union.
Despite the social and economic importance of a university education, the U.S. federal government—unlike many other parts of the developed world—has not attempted to make university affordable by stepping in to control costs. Instead, they have focused on offering assistance to pay whatever those costs might be.
Whatever the partisan political debates swirling around FDLP, one thing is certain. As long as it remains a social policy of the federal government to increase the number of citizens with a college education, and as long as the federal government will not dictate what schools can charge—those decisions are made mostly by state governments and trustee boards—then the federal government will remain active in the business of helping students finance their education.
Somewhere between the stories of individuals burdened by student loan debt, policymakers struggling with a massive credit system, and people upset with an increased government role in the economy is the story of how college educations—long seen as a great equalizer—became financed in part through credit. By understanding that story, we better understand the importance of the student loan industry and why many believe it needs to be changed.
Creating the Student Loan Market
Before World War II, college attendance was not nearly as widespread as it is today. The number of people over the age of the age of 25 with bachelor's degrees did not break the 5% mark until after 1950. Today, that figure stands at around 28%. The federal government played a major role in that expansion through the GI Bill, which funneled millions of federal dollars to wartime veterans for housing and education.
Iterations of the GI Bill encouraged around 2 million servicemen from World War II and the Korean War to go to college between 1945 and 1965, and a "Peacetime" GI Bill passed in 1966 helped almost 7 million Vietnam-era veterans go to college through the 1960s and 1970s.
Those veterans, of course, were overwhelmingly men. A little later, women started attending college in greater numbers. The proportion of 18-24 year old women in college doubled from 20% to 40% between 1970 and 2000. In fact, women made up a majority of college students by 1979.
Minority students also entered college in growing numbers, from just under 2 million in 1980 to over 4 million in 2000. This growth was led by Hispanic and Asian-American students, who saw their numbers on college campuses triple during those two decades. (Very recent studies on the college attendance of ethnic minorities, however, show some setbacks to these gains.)
This explosion in college attendance—along with periods of postwar inflation, increased staffing costs, state-level taxation policies, and several other factors—has contributed to increasing tuition and other costs of enrollment. The supply of seats in traditional, non-profit universities has grown, but not at the same rate as demand. This has increased tuition at those institutions and fostered the creation of new types of for-profit colleges and universities that hold courses online to help keep costs down.
As larger numbers of people enrolled in colleges, the consumer credit market also grew and more people became comfortable using credit. However, without much precedent for lending to young adults with no collateral, most private lenders in the credit market were slow to enter the student loan market. They did so only after the federal government set up frameworks and guarantees to protect them. In this way, credit became a principal way students paid for college.
The federal government started those frameworks in 1958 through the National Defense Education Act, part of which established what would become Perkins Loans, a need-based government loan system that pinned interest rates at 5% and gave former GIs and other eligible students affordable loans for college.
Cold War fears that American students were falling behind in science and engineering fostered increased federal interest in what congressional and educational leaders coined "postsecondary education," to incorporate all types of education after high school. These fears led many otherwise fiscal conservatives to support a large-scale federal government intervention into student loans.
In 1965, the Higher Education Act established a basis for the federal government to offer more student financial assistance through the Federal Family Education Loan Program (FFEL). The federal government expanded Perkins Loans and introduced Stafford Loans, where the federal government guaranteed and encouraged student loans by paying the interest that accrued during a student's time in college and paid the difference between a set low rate and the market rate once the student graduated.
The government made a number of partnerships with private companies to service these loans, and this partnership was how private student loan creditors got into the market. Private lenders were more than willing to join in this partnership because of the government guarantee and the rising tide of individuals looking to fund increasingly expensive college educations. Over 60 million Americans have paid for college with these loans in the past 45 years.
In 1972, the federal government reauthorized the Higher Education Act from 1965 and created the ubiquitous student loan firm, Student Loan Marketing Association (Sallie Mae), a government sponsored enterprise (GSE). Sallie Mae served as the agent for government backed student loans, collecting payments and offering customer services as a GSE until 2004, when it privatized its operations, but continued to service government backed student loans.
In general, this partnership has proven profitable for the private companies involved. In 2008, for instance, Sallie Mae collected $2.75 billion in interest on private loans (ones not backed by federal guarantee) and another $2.16 billion in interest on Stafford and other government-backed loans.
In the late 1980s, the U.S. Congress and the U.S. Department of Education pushed for a system of direct loans, where the federal government would loan directly to students or universities, who would serve as intermediaries. After President George H. W. Bush's vetoes, President Bill Clinton signed the Federal Direct Loan Program (FDLP) into law in 1993. It allowed the Department of Education to make loans directly and bypass the GSEs and other lenders who managed the loans.
However, through the 1990s, colleges and students did not go after FDLP financing since heavy lobbying of private student loan managers succeeded in continuing the old system of using GSE and private creditors to service government secured loans.
When the credit market melted down recently, the decades-old attempt to change the student loan system to one that offered direct government loans received new life. While most lenders servicing federal student loans were not in real danger of shutting down, they had a limited ability to weather the late 2000s recession because of relatively high rates of underpayment and low locked-in interest rates. Some of them suffered bad publicity through aggressive collection tactics and continuing to post profits during the recession.
The Obama administration assumes that by taking over student lending, the federal government will be less affected by future credit problems by saving the costs of paying middlemen to service the loans. For better or worse, the government wants colleges and students to trust it to absorb the risk associated with young adults borrowing tens of thousands of dollars to go to school.
Paying for a College Education
No one ever questions the economic benefits of securing a college education. For the past decade, college administrators and test preparation companies have claimed that, over a lifetime, a college education is worth $1,000,000 in wages (compared to those with just a high school education). A major benefit, even if a student takes out thousands in loans to realize it. A student would have to invest around $100,000 at the age of 18 to make up that difference.
Not all students who go to college do so with thousands of dollars of debt. In some cases, parents step in to pay for college—incurring a different kind of social debt to the student—directly or by using private or public—529 Plans—college financial plans, the use of which has increased in the past two decades.