Effort To Cut College Loan Rates Has Dems Taking Aim At Banks

The student loan program works brilliantly for the banks but not for the students," Sen. Edward Kennedy, D-Mass., said last month.
Simply cutting college loan interest rates in half, by itself, wouldn't negatively impact student lenders. Firms that participate in the Federal Family Education Loan Program are guaranteed a return that is 2.34 percentage points over the market rate on commercial paper.
In recent months, that guaranteed rate has been about 7.8%, or a full point over student loans. So a move to halve student loan rates to 3.4% could make that guarantee seem generous. And because Democrats have pledged not to boost the deficit, the profits of student lenders are a likely target.

"Expect the Democrats to start off with hearings that will try to put the lending companies in a bad light and question why executives are making so much money on the backs of poor working students," said Keefe, Bruyette & Woods analyst Brian Gardner.
Shares of industry players like Sallie Mae have been under pressure as the specter of a Democratic takeover has turned into reality.

Gardner said there are reasonable policy arguments on both sides.
"Any time the government is guaranteeing you a rate and guaranteeing you against risk, yes, you do have a good deal," Gardner said. "But the credit-sharing is there for a reason. Student loans are some of the more risky loans that the industry makes."
When borrowers default, the government reimburses lenders for up to 98% of the principal and accrued interest. And that's after the guarantee was pared earlier this year.

Outlook Unclear
While the House likely will eventually pass student-loan legislation, the Senate outcome, the final shape of any bill reaching President Bush's desk, and what he would do with it are "a little tough to handicap right now," Gardner said.
But it's pretty clear that Democrats would only seek to cut the interest rates on new student loans, not existing ones. The five-year cost of rate relief for new loans is an estimated $18 billion.
Lenders also may face stiffer competition from the government, Gardner said.
New federal student loan originations totaled $69 billion in the 2005-06 school year, with about three-fourths by private lenders and the rest via the government's direct loan program set up in 1993.

But Sen. Kennedy and Rep. George Miller, D-Calif., who will run their respective education committees, have drafted legislation giving colleges an extra incentive to deal directly with the government.
Because the Congressional Budget Office has found that direct loans cost the government far less -- a finding disputed by lenders -- Kennedy and Miller would send the savings to colleges to be used for need-based financial aid.
The push to cut student loan rates is part of Democrats' broader aim to ease what they see as a middle-class squeeze. Miller says someone with $17,500 in student loan debt would save $5,600 under his plan.

But conservatives argue the Democratic approach is misguided.
"They are going to try to tackle the problem of college affordability by simply increasing government subsidies for higher education," said Dan Lips, a policy analyst at the Heritage Foundation. "That would do little to tackle the real problem, which is the growing cost of higher education."

Subsidizing Tuition Hikes
Fast-growing education subsidies have arguably helped fuel tuition hikes, which have outpaced even health care inflation, Lips said.
There's also the question of priorities.
"Students who go to college are going to have higher lifetime earnings," Lips said. "Is it right to be benefiting those who could find other means to attend college?"