Introduction
The federal government currently ensures that students have access to loans for college and graduate schoolin two ways: by guaranteeing bank loans, and by lending directly to students.The Federal FamilyEducation Loan Program (FFELP) takes the government-guaranteed approach. In this program, the government provides financial incentives to banks and student loancompanies that provide student loans. The lenders keep the profit fromstudents’ interest payments as well as subsidies they get from the government. The government also guarantees the loans against default, using taxpayer dollars to protect lenders from financial risk. Congress sets the fees, interest subsidies, and guarantee rates that the government pays banks, loan companies, and other vendors and intermediaries that participate in this system.The other program takes a different approach. Through the the government provideslow-interest loans directly to studentFederal Direct Student Loan Progam (FDSLP) ts, then uses their interest payments to help cover the program’s costs. The direct lending program uses market competition to determine the appropriate price to pay for loan capital and for private sector services to administer theloans. Instead of fixed fees and rates of return, it can pay the lowest price that the market will bear.In both programs, taxpayers are responsible for virtually all default costs, as well as much of the interest rate risk. However, the returns are distributed differently. In the guaranteed program, lenders get to keep student interest payments along with taxpayer-financed fees and subsidies. In the direct loan program the government uses the income earned by the loansto minimize taxpayer costs.
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