Financial Risk Of For College Aid From The Department Of Education

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Student loans are unique. This same analysis would not apply to, say, home loans. With houses, private lenders play a critical role in determining who is a credit-worthy borrower, and what the appropriate loan amount is for the asset that is being purchased with the loan proceeds. The financial risk of being wrong causes lenders to take seriously the job of allocating loan capital efficiently. But in the federal student loan program, there is a single process for determining eligibility for college aid from the Department of Education and other federal agencies. When private lenders are involved in the student loan program, they get paid but add no economic value to the process beyond the provision of capital—a role the federal government…show more content…
Every loan program now has an estimated “subsidy cost”—put simply, the amount of money that needs to be set aside when the loan is made in order to cover the loan’s costs to the government over the life of the loan. The GAO explains that the old approach “distorted costs and did not recognize the economic reality of the transactions,” while the new approach “provides transparency regarding the government’s total estimated subsidy costs rather than recognizing these costs sporadically on a cash basis over several years as payments are made and receipts are collected.” This more rational approach changed the nature of policy discussions on Capitol Hill. Student loans were among the first programs to be affected. Federal student loans had originally been direct loans, following a recommendation of the economist Milton Friedman in the 1950s. But when Congress in 1965 wanted to expand on that start, the irrational budget rules of the time got in the way: A guaranteed loan appeared to cost nothing, and a direct loan showed up in the budget as a total loss in the year it was made, even though most of it would be paid back with interest. But now, after the 1990 budget reforms, the equation changed. Congress, prompted by a memo leaked from the Bush administration that indicated direct loans would be less costly and
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