Don't just tweak student loans

As it looks for a fix, Congress should consider whether the feds should even subsidize lenders.

Two-thirds of students borrow for college. They have no small interest in the cozy relationship between lenders and colleges investigated by Andrew Cuomo, New York's attorney general. This week he takes his new lending code of conduct to Congress for consideration. But why stop with that?

The US Department of Education could also use scrutiny. It recently placed an official on leave because he owned stock in a student-loan company while he oversaw the student-loan industry. Last week, the department shut down a database on students after it was reported that the loan industry gained improper access to it for marketing. This has prompted calls for better oversight at the department. But again, why stop with that?

It's true that Mr. Cuomo has done the nation a service by uncovering the revenue, free trips, cost-free personnel, and other incentives that loan companies give colleges and universities to become a school's "preferred lender" recommended to students. Congress should pass legislation that mirrors Cuomo's conduct code, that would prevent lenders from giving colleges anything of value in exchange for favorable treatment.

But the $86 billion student-loan business is ripe for much more fundamental reform. The key issue is whether the federal government should still be subsidizing banks and other lenders which provide student loans.

To make college more affordable for students and less risky for lenders, Uncle Sam started subsidizing lenders in the 1960s. The government insured them against student default by agreeing to repay bad loans. It also subsidized lenders to make up for interest-rate caps set by Congress, which are lower than the market rate.

But much has changed over the decades. First, the number of college students has ballooned, so the market is much bigger. And just as with home financing, credit is more widely available under a much greater variety of terms.

A proposed $25 billion takeover of student-loan giant Sallie Mae gives an indication of just how profitable this business has become. With soaring tuitions and enrollment, and with the loan guarantees and subsidies of the US Treasury behind it, Sallie Mae has delivered a 435 percent total return since 1997. (This compares to a 126 percent return for Standard & Poor's 500-stock index.)

Students themselves have become less of a risk because bankruptcy laws make it difficult to choose that option. Indeed, at 5.1 percent, the default rate is near a historic low. Students are also captive clients, in a sense, because they are allowed to refinance their debt only once after they graduate.

Business is so good, that 20 percent of the student-loan market is now serviced by private lenders that receive no help from the federal government.

All this suggests that Congress should consider significantly reducing federal subsidies, especially since loans made directly by the federal government cost taxpayers only about a third of the cost of subsidized loans.

Indeed, it's encouraging that the administration and Congress are moving in this direction. The billions saved could help fund more federal direct loans, and more education grants for the poor, for whom loans are a disincentive.