Federal Irony Alert!

From Cato

Posted by Neal McCluskey

The nation’s biggest subprime student lender–your federal government!—has just called out private “subprime” lenders.

This morning the Consumer Financial Protection Bureau and U.S. Department of Educationreleased a report examining private student loans. It concludes that private lenders were out of control, just like all of Wall Street, before the “Great Recession” hit, a fact largely evidenced by high default rates. It was, the report argues, a part of the overall subprime lending debacle and it hurt innocent students.

“Subprime-style lending went to college and now students are paying the price,” said U.S. Education Secretary Arne Duncan in a release accompanying the report.

What’s the report’s solution to the problem? Push people into federal loans to the maximum extent possible. After all, those loans have low, taxpayer-backed interest rates; generous repayment terms, including speedy forgiveness for anyone going into “public service”; and essentially no requirement that borrowers offer evidence of creditworthiness.

Wait—essentially no evidence of creditworthiness? Isn’t that subprime lending in its very purest form? Indeed it is, which is perhaps why the report offers no comparison of default rates on private and federal loans.

Basically, the report is pushing for even greater subprime lending, only with taxpayers on the hook rather than voluntary investors.

The report tries to further portray the fate of private lending as part of an exclusively Wall Street-driven recession by arguing  that a big drop in private lending between the 2007-08 and 2008-09 academic years was  entirely the result of private lenders suffering from the collapse of credit markets. No doubt that had a significant role, but the report somehow manages to not discuss numerous changes to federal law in the 2007-2010 time frame that pushed private lenders out of the way, including:

• The College Cost Reduction and Access Act (2007), which set federal subsidized-loan interest rates on their halving path from 6.8 percent to the current 3.4 percent.
• The Ensuring Continued Access to Student Loans Act (2008), which increased unsubsidized loan maximums, reduced eligiblity criteria for PLUS loans (the only loans requiring some demonstration of creditworthiness), and offered federal money when guaranteed lending participants couldn’t get it through capital markets.
• The reauthorized Higher Education Act (2008), which increased Pell Grant maximums, authorized forgiveness of up to $10,000 in debt for anyone working in an area of “national need,” and added new regulations for private lending.
• The Student Aid and Fiscal Responsibility Act (2010), which ended federal guaranteed lending in favor of federal lending directly from the U.S. Treasury

Fully private lending probably was reined in thanks to the recession, which is a good thing, with private lenders taking less risk when it didn’t pay off. But it is no doubt also important that Washington enacted many laws that made it much harder for private lenders to compete. The fact is the Feds can subprime-lend without any major concern about losing big bucks. It’s only taxpayer money, after all, and there’s always more of that! Plus the political dividends are sizable, enabling politicians to heartily and repeatedly congratulate themselves for “making sure everyone can go to college!”

That gets us to the next critical point: In addition to reinforcing the utterly discredited notionthat the recession was all the fault of “greedy Wall Street fat cats,” a report focusing on private lending is just a distraction from the 800-pound gorilla in higher education: the federal government. At their peak in 2007-08, private loan originations were less than one-third the size of federal loans, and about one-fifth the size of all federal aid. Today they are slightly more than one-20th the size of federal loans, and about one-30th the size of all federal aid.

In other words, private loans are but bit players in a student-aid show dominated by Washington. It is super-abundant federal aid, not private lending, that signficantly fuels tuition inflation, enables dreadful college completion rates, and fosters a glut of degree holders. Yet it’s those same federal lenders who dare scold private companies and warn us about their subprime failures.

Oh, the irony!