Cramer: All Student Loans Could Lead to D.C.


Let’s take some time to revisit the student loan market, especially since President Obama came out with a plan recently to cut out the middleman and make Uncle Sam the direct lender of choice for college-bound Americans for the foreseeable future.

I’ve already written about getting and managing student loans in a recession (see the manifesto on student loans I wrote in late January).

But the new Obama plan deserves some close scrutiny. As part of his 2010 budget, which he rolled out on Feb. 26, the president announced that the federal government would elbow private student loan lenders, like Sallie Mae (Stock Quote: SLM), out of the way and have families come to the U.S. Treasury directly for student loans.

Now, there are some elements of President Obama’s overall higher education program that I support. For example, making permanent the $2,500 tax credit for family’s college spending needs (for stuff like books, computers, and necessary items like that) is a good idea. I also like the $2.5 billion that gives grants to states to help lower-income families pay for their kids’ college education (although that, too, might have waited until we were out of this economic mess).

But the direct lending program has its pros and cons. The call to reform student loans to a more government-centric approach is both bold and disconcerting. Bold because of its aggressive approach to real reform in the student loan market, especially at a time when so many American families are hurting, and when credit has become so tight. It’s disconcerting, however, because it keeps the private sector at arms length, which could reduce competition and make matters worse in the student loan sector.

Here’s how it would work: The U.S. government would cut out the bank- and lender-based (“private sector”) loans and originate all loans with the U.S. Treasury Department. The government, controlling all the levers here, would allow private lenders to compete for the servicing portion of the loan, for things like collecting on the loans and managing the paperwork.

The Obama administration’s fiscal argument is a reasonable one, although—typical for the White House so far—the numbers don’t really add up.

Government budget analysts say that the switch to a direct lending program would save $24 billion over five years, mostly by ending the practice of the federal government reimbursing private lenders for issuing and guaranteeing student loans. A lot of that money, however, would seemingly have to go to support annual funding for government-held Pell Grants, which would act as the de facto loan disbursement engine for the revamped student loan program. I noticed that in the proposal spin from the White House, the word “permanent” was used to describe the new flow of money into Pell Grants.  In Washington, “permanent” is code for “use the taxpayer as an ATM for as long as we want.”

So I’m not sure how much actual savings we’re going to see. Plus, we’ve already seen a lot of money pouring out of the government-run student loan programs in the past few years, so Obama and Congress will likely have to refill those coffers with money that hasn’t been identified yet. That’s also likely to eat into the $24 billion savings that the administration is touting.

But that’s the Washington angle. What’s the MainStreet angle? It’s early, and this thing hasn’t passed Congress yet, but if it does, it means pretty significant change in the way we look at student loans.

Right now, the largest private student loan issuer is Sallie Mae, which currently manages, approximately speaking, $170 billion in student loans, serving more than 10 million borrowers. That’s a pretty big stake in the student loan race.

The way the system has worked over the years was that private lenders like Sallie Mae would offer loans with low interest rates to families, with the U.S. government subsidizing the loans. It’s those subsidies where the White House says we’ll see most of the savings from moving to a direct based lending program. Expect Sallie Mae to howl over the proposal—it stands to lose 75% of its loan origination business to Uncle Sam if this thing goes through. Plus private banks, without those government subsidies, will effectively lose the ability to offer low-interest loans to college students—and that, as I noted above, could curb competition, and reduce the choices that American families have when shopping for a student loan.

The good news for borrowers? For starters, there should be more money—a lot more money—in the direct borrowing system. Already, the amount of cash allotted to direct lending programs from Uncle Sam is up about 50% over the past year. With tight credit in the private sector, that’s a pool of cash that will be hard to match for banks and other lenders.

Plus, I have a theory about private student loans, specifically when banks say how “low” their interest rates are for consumers. Being a Wall Street guy, I know how banks work. Those low interest rates sound great on the surface, but don’t forget to tack on 1% or even 2% on loan origination fees, and probably as much again if you decide to consolidate your loan. You never see the fee the banks get, because it’s rolled right into your loan payments. So cutting out the middleman may have some merit here.

And what about Sallie Mae? I think that things could be so bad right now in the U.S. that the government will use the direct loan program like it is using Fannie Mae (Stock Quote: FNM) and Freddie Mac (Stock Quote: FRE) to make sure as many people a possible could get a loan. Funny thing, though. They have everything in place with Sallie Mae. Now, if the new changes go through, Sallie Mae could be a cross between Citigroup (Stock Quote: C) and AIG (Stock Quote: AIG) after this. Except at least we won't have to own it. We'll be lending money ourselves through the new "direct" program!

This is a big change—if it passes Congress. So right now, it’s too early to say how this is all going to shake out, especially as Congress begins debating the issue this month.

But now that I’ve laid down the groundwork, I’ll keep you posted on how the direct loan proposal is shaking out in Washington—and how it will shake out, once it’s finalized, on Main Street, too.

One last piece of advice. To get a head start on the government’s new direct student lending plan, whatever form it takes, figure out what you’ll need to get your child into college with our college savings calculator.

—Brian O’Connell contributed to this article.

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