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Student-Loan Plan Creates Controversy

Parties dispute whether direct-lending saves money,time

LIKE half of the students entering college this fall, Kimberly Amaya is spending part of her summer shopping for loans. She has been admitted to several colleges, but because she hasn't heard about her eligibility for financial aid, she's asked those schools to extend their acceptance deadlines.

"[The time constraints] kind of put you up against the wall," says Ms. Amaya, who went to high school in Kensington, Md.

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But if the Clinton administration gets its way by expanding the government's direct-lending program, the tedious and confusing student-loan process may become simpler for many students in September.

Under direct lending, a student applies for a loan from the college of his or her choice. The school then issues the loan, and the government reimburses the school within three days.

The idea is to eliminate "middleman" financial institutions, making the system easier to manage. Loans and potential defaults could be better tracked, and colleges would have less paperwork.

With so many players in the present system, the Federal Family Education Loan Program, the "net effect [has been] hardship for students and schools," says Leo Kornfeld, senior adviser for direct lending to Education Secretary Richard Riley. Subsidies to middlemen "amount to corporate welfare."

During the 1994-95 academic year - the first year the program was in effect - 5 percent of student loans were administered through the program. By September, it is slated to cover 40 percent. The latest proposal would move all schools to direct lending within two years.

The program's main selling point is that the government could save anywhere from $4 billion to $12 billion over five years, according to administration officials.

But critics question whether the Department of Education is suited to manage the gargantuan job of dispensing and collecting student loans - and whether this will actually save the government money.

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Middlemen claim the Clinton plan would leave student-loan customers with fewer products to choose from and poor customer service.

The nonpartisan Congressional Research Service (CRS) stated in a recent report: "There may be a logical rationale for direct lending, but lower cost is not it."

And with collection of new loans still years away, some people say direct lending is too young to be expanded - and may not be an improvement.

The program is also threatened by GOP proposals to abolish the Education Department and to transfer lending functions to the Department of Health and Human Services. Opponents say that by moving quickly to implement direct lending, the Education Department is trying to make itself indispensable.

"I'm concerned with the stability of the student-loan system," says Jamie Merisotis, president of the Institute for Higher Education Policy in Washington. "It has all been framed as a budgetary matter."

But some universities contend that the program has helped simplify the student-loan process. "We're very happy [with direct lending," says Carolyn Sabatino, financial-aid director at Ohio University in Athens. "It's a much simpler process."

The Clinton program is supposed to save money in at least two ways. First, the government could eliminate interest payments on loans it now makes to banks while students are in school, and the government is able to obtain money for lending at a lower cost than banks.

The new system also boasts expanded repayment options, which banks had previously balked at, including forgiving debt if a loan is not repaid after 25 years.

According to the Department of Education, the first year was a success: A public accounting firm gave the program a "clean audit" that indicated increased accountability, less paperwork, and better management. In addition, officials cite a trade-publication survey finding that 92 percent of 104 participating schools rated the program as "exceptional."

But Dan Cheever, chairman of the Coalition for Student Loan Reform, representing guarantors and secondary markets, discounts the audit's results: "The real test isn't making the loan - anybody can do that," he says. The real test is "high-quality customer service" and collecting on loans, which the government has not yet had to do.

And the CRS report concluded that direct lending will not necessarily reduce default rates, nor is the government expected to provide cheaper service.

Others have criticized the Education Department for not moving quickly enough to expel high-default schools from direct lending. Interest rates for students will not change and, with students having the option to stretch payments over many years, it could actually cost them more in the long run. In addition, some say, forgiving debt after 25 years will be a disincentive to pay.

Several schools have dropped out of the direct-lending program, including the University of Maryland at College Park, which developed a loan system with the Student Loan Marketing Association (Sallie Mae) that would have many of the same advantages. "We are concerned that direct lending may not develop as it was envisioned," notes William Leith, the school's director of student financial aid.

One bill supported by Republicans and Democrats would cap the program at 40 percent participation. "The president has been misinformed about this program," says Rep. Bart Gordon (D) of Tennessee, sponsor of the bill with Rep. Bill Goodling (R) of Pennsylvania.

"For students and schools now, there's choice - you can do direct lending or FFEL," Mr. Cheever says. "Under direct lending, there [will be] no choice."

If the direct-lending program fails, "there won't be loan money," he adds.

Rep. Ernest Istook (R) of Oklahoma introduced a bill eliminating direct lending. "Out of one side of his mouth, the president says he is for reducing government, and [he] talks about cutting spending programs," he says. "But out of the other side, he is saying, 'Let's make the government bigger and bigger.' " He notes that more than 400 federal employees would be added to run direct lending.

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