A Short History of Student Loans

In 1971, I was working for a US Senator from Vermont(Winston Prouty - first picture), who was the ranking member on the subcommittee that would rewrite the Higher Education Act. Federal higher education policy had gone through two previous revisions in recent years. In the mid-1950s Congress had adopted the National Defense Education Act that was designed to encourage more people to go compete against the commies by being better educated. Then less than a decade later, as a part of LBJs Great Society, Congress adopted the Higher Education Act which created some new forms of student assistance and other programs for aiding college students. In the early 1970s the Congress began a process, now familiar, called reauthorization. The Act, eventually adopted in 1972 (called the Education Amendments of 1972) began with a philosophical debate between Edith Green (second picture) and Claiborne Pell(third picture).


Green, who chaired the higher education subcommittee in the House thought any new programs should go through institutions. Pell, on the other hand, thought aid should go through students. The republicans who were in the minority in both houses, decided to side with the Pell view of the world. In those days it was possible to do some bipartisan work and in part because Pell was from Rhode Island and Prouty from Vermont (and the third major player in those discussions - Jacob Javits from New York) they figured out how to get along. Ultimately the 1972 Act took Pell's notion not Green's.


Prouty had a major role on the bill on student loans. A problem facing student loans at that time was liquidity. The assets were hard to move. Sure they were guaranteed by the federal government. But many banks did not like them as an asset class because they were illiquid and because each loan was pretty small compared to mortgages. So Congress created, with my boss' leadership, a secondary market mechanism to allow banks to make the loan and then sell it off. That mechanism was called the Student Loan Marketing Association or Sallie Mae. Sallie Mae was one of those public-private partnerships. It soon became apparent that like others of its ilk, the balance did not work. Sallie Mae was a lot more entrepreneurial than its founders had thought it would be. It was not all that surprising. Very soon into its future, Sallie Mae was reconstituted as a private entity.

Loans soon became a big business. That happened for a lot of reasons. First, the original premise of the 1972 Higher Education Act was altered - and the value of grant assistance in relation to loans began to change. Second, higher education's prices continued to rise - so the real cost to students grew. Beginning in the 1990s banks began to be very interested in student loans. Unlike the conditions which spawned Sallie Mae, they were now guaranteed assets that could be sold off very easily. When the banks held them they had a guaranteed return. How about an asset class that had a guaranteed return and could be sold off easily? Competition for loans began to heat up. That accelerated when a new class of loans began to appear.

The original maximum limit for loans did not expand quickly enough and so a new class of loans was created that were called Alternative or Private Loans. Banks were pretty creative in the way these loans were structured. They had all sorts of rates and repayment terms. And some began pretty aggressive sales programs with institutions. Beginning a few years ago student aid officer conventions began to have some pretty lavish perks. That induced some ambitious politicians to begin to nose around a bit. The NY AG began a series of highly publicized intrusions into institutions and rooted out some financial aid officers who had some serious conflicts of interest - but like most politicians he also tarred some very good people who had simply been doing their job.

There was one other thread here. Congress had two factions on student loans. One thought the private markets should operate - albeit with federal guarantees and subsidies. The other thought the federal government should run loans (because they would take the profit out of the program). One of the major initiatives of the Clinton administration was the creation of a competitor to the traditional federal student loan called the Direct Loan Program. It was really a return to the original structure of the student loan program. Rather than having banks issue loans which were guaranteed by the federal government, the DLP had institutions issue the loan using federal funds. The original program had been called the Federally Insured Student Loan Program(the acronym was an apt one). In the 1972 and 1978 reauthorizations the private sector was given a larger role because the feds had proved incompetent at collecting loans - defaults were sky-high. The two programs (DLP and FFEL) ran as competing models for a couple of years.

But the supporters of the DLP and budget hawks thought the FFEL (the Family Federal Education Loan) would be an easy target for budget savings. Last year margins for the FFEL loans were reduced substantially and then in a pretty quick turnaround they were partially restored because the banks began dropping out of the program in huge numbers.

That is a pretty confusing story - and a long one. On the one hand you have a group who believe that the private sector will be more efficient than the government. On the other you have a group that believes that these kinds of things are best done as government enterprises because there is greater surety that the public nature of the programs will be protected. These arguments have been replicated in many areas of government activity. But there are two conclusions I take from all the history. First, the tradeoff of increased government support has been a lot more regulation. The recent reauthorization of the Higher Education Act contained precious little new authorizations for spending and tons of new regulations - reporting requirements and other new rules that simply increase costs for colleges. The balance of benefits to costs has clearly been destroyed. Second, the ingenuity of the market seems to be reasserting itself. Version 1.0 of alternative loans were opaque and confusing for borrowers (some lenders refused to disclose the terms of the loan until it had been executed). This year I have spent a lot of time looking at alternatives to the current programs - and there are some interesting variations that will offer borrowers some real refinements and options with a significant increase in transparency.

There is one other conclusion here. In the 1972 process democrats and republicans were able to work together to think about competing visions of how federal policy should work. That is simply no longer true. Prouty, Javits and Pell had significant philosophical differences about a lot of things - but they found a way to work with each other. The 1972 Act (which also included some huge contributions from House members) was unique for accomplishing a fundamental discussion about policy. The whole process took about two years to accomplish. In this iteration, it took almost a decade and the result was unsatisfying for both members of congress and colleges.