Beth Akers, Preston Cooper, and Joe Pitts write for the American Enterprise Institute about a way to improve today’s student loan picture.
Federal student loans dominate the market for education finance, with privately originated loans accounting for just 8 percent of outstanding student debt. But as the federal student loan program flounders amid high delinquency rates, administrative troubles, and enormous fiscal costs, many have suggested privatization as a potential solution. Privatization would involve scaling back or even eliminating the federal student loan program and allowing private lenders to fill the gap. Lenders would be able to set the terms of the loans they make and bear the financial losses if students fail to repay.
Turning over the responsibility for student lending to the private market has many potential benefits. Since private lenders would take financial losses if they lend to students who pursue forms of higher education with a low return on investment, they have an incentive to steer students toward institutions and programs whose graduates typically earn enough to repay their debts. This would help more students realize the economic promise of college. Moreover, privatizing the federal student loan program would save taxpayers hundreds of billions of dollars; part of the savings could be used to expand financial aid programs for low-income students.
Privatization does come with stumbling blocks that policymakers would need to contend with. First, private lenders may not adequately finance higher education with a low private but high social value, such as training for teachers. There are also practical barriers to market expansion—most notably the lack of obvious collateral for most private loans—that may lead private lenders to underinvest in higher education. Finally, a hostile regulatory environment may stop private lenders from adopting modern underwriting techniques based on students’ expected return on investment. This may cause private lenders to overlook some students who could benefit from higher education.
