Tuesday, August 21, 2007

Rent-Seekers

By James Surowiecki
The New Yorker

Monday 13 August 2007

When Americans think of college these days, the first word tha often comes to mind is "debt." And from "debt" it's just a short hop to other unpleasant words, like "payola," "kickback," and "bribery. At least, that's how it's been since this spring, when news broke that student-loan companies had been using unsavory and possibly illegal tactics to get preferential treatment from university financial-aid officers. At some universities, officers were given stock options in companies whose loans they recommended to incoming students, while at others lenders offered millions of dollars in perks to schools that would stop doing business with competitors. In response, the Senate passed a bill toughening rules against "inducements" from lenders to administrators. All well and good, but it leaves untouched a more fundamental scandal - the huge profits that lenders make from student loans are being earned off the government's dime
For decades, student-loan companies have had one of the cushiest businesses in America. We want college students to be able to finance their education at reasonable rates. But banks are understandably leery of lending to people with no collateral and uncertain future earnings. So we provide incentives to lend. The federal government, for instance, guarantees the so-called Stafford loans that college students get: if a student defaults, the government will pay off almost the entire loan. On top of that, the government hands out billions of dollars in subsidies to lenders every year, all but insuring them a steady profit. In effect, lenders get a guaranteed return with very little risk.

This convoluted process is good at making student-loan companies rich - Sallie Mae, the biggest issuer of student loans, earned $1.3 billion last year, with a return on equity that dwarfs most other companies'. But it's not very good at getting government money to students cheaply and efficiently. President Bush's 2007 budget shows, for instance, that it's four times as expensive for the government to subsidize and guarantee private loans as for it to issue those loans itself. In other words, the current system is not just corrupt. It's also inefficient. So why are we stuck with it?

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