June 18, 2004

Republicans in Congress will soon have an opportunity to show that they value efficiency over ideology: they can increase student aid without adding to government spending. When they vote to renew the federal Higher Education Act, which expires this year, lawmakers should use the opportunity to strengthen the direct student loan program.

For years Republicans have supported the government's other loan program, the expensive guaranteed student loan program, because it uses banks as middlemen, and too many of my colleagues believe private enterprise is always better than a government program. But the direct loan program, which lends directly to students from the United States Treasury, has proved to be far less costly. Greater use of this program would free up resources that could be used to provide students with more money.

I recognize the efficiency with which market forces and for- profit businesses operate. So when I entered Congress in 1979, I was inclined to believe that a student loan program that encourages private banks to lend is a better deal for taxpayers than the government lending directly. But then I learned how our guaranteed student loan program works. No fiscal conservative or free-market supporter could justify embracing it.

Consider an analogy. A friend asks you to lend him some money. You want to help him, but instead of lending him the money yourself, you ask a bank to do it. You'll guarantee the bank is paid back (plus interest) and even kick in extra money to ensure the bank makes a nice profit. Seeing a deal, the bank agrees, and your friend gets his loan. Over the next year the bank collects its principal and interest, along with the extra money you agreed to contribute.

This is how the federal government provides loans to college students under the guaranteed program. For banks, it's a guaranteed return - and profit - with almost no risk.

This is hardly a market-oriented approach; it's more like a government-assistance program for lenders. Tax dollars even go toward special payments that ensure banks don't lose money when interest rates rise. What's more, interest paid on the loans is set in law, above lenders' costs. And if a borrower defaults on a loan, banks have a government guarantee that they will get their money back. Because of that guarantee, banks have no incentive to spend resources trying to collect from difficult borrowers - and taxpayers end up subsidizing private agencies to recover bad loans.

Most of these rules, by the way, are set by Congress; no market forces are involved. Moreover, no competitive bidding takes place to determine who can provide the loans at the lowest cost to taxpayers. All banks are entitled to the same subsidies.

There is a simpler and less costly way to help students get loans. The government provides about a third of current federal college loans by raising capital through the sale of Treasury bonds - a remarkably efficient process - and then lending it directly to students. There's no need to subsidize banks or private guarantee agencies. And all major functions under direct lending are run by private companies through competitively bid contracts, minimizing the costs to taxpayers.

As one would imagine, the savings under the direct loan program are immense, actually earning money for the Treasury in some years. Over and over, government budget analysts - both in Congress and at the White House - have concluded that direct loans cost the government far less (including the costs of contracting with the private sector for loan collection) than guaranteed loans.

My fiscally conservative colleagues must learn to cast aside their prejudices and support this low-cost alternative to guaranteed loans. Saving taxpayers money should not be a partisan issue.

This column by Rep. Petri first appeared in the June 14 New York Times