Introduction

The federal government provides student loans for college and graduate school in two ways: by guaranteeing bank loans and by lending directly to students. Approximately three-quarters of federal student loans are guaranteed and one-quarter are direct. In the guaranteed loan program, a 40-year-old system, banks lend students money and profit from the interest payments while the government guarantees the loans against default and makes subsidy payments to the banks. In the direct loan system, the alternative President William J. Clinton enacted in 1993, middlemen are cut out of the process. The government provides low-interest loans directly to students, using borrower interest payments to help cover the costs of the program.

The difference between the two systems, in budgetary terms, is substantial. In the decade since the beginning of Clinton's initiative, there have been numerous audits and investigations of both the direct and guaranteed student loan programs, and in every case the auditors have agreed: Direct lending is the more cost-effective approach. In fact, it is much more cost effective.

The General Accounting Office (GAO), the Congressional Budget Office (CBO), and the Office of Management and Budget (OMB) have all found that switching completely to direct lending would save billions of dollars a year. Following their lead, President George W. Bush's latest budget tells Congress that the guaranteed student loan program is structurally flawed, with "unnecessary subsidies" and "inefficiencies." The president's budget concludes: "Significantly lower Direct Loan subsidy rates call into question the cost effectiveness of the [guaranteed student loan] program structure, including the appropriate level of lender subsidies."

As analysts from across the political spectrum have pointed out, the money that would be saved by reforming the student loan program could be used to help more students. During the past few years, the money wasted on guaranteed loans would have been enough to fully fund the No Child Left Behind Act, or give every low-income college student an extra $4,000 in grant aid. In fact, each day, more than $15 million is wasted that could help a deserving student pay for college.

Congress should take action now, before more money is wasted. Lawmakers should insist that the student loan industry offer up a system that is as cost-effective as direct lending. If the industry cannot deliver, Congress should completely replace the guarantee system with direct lending and capture those savings for the benefit of American families who are struggling to afford higher education.