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President Obama Uses Executive Order to Make an Important Fix to Direct Lending

Published:  October 27, 2011

President Obama announced on Wednesday that the U.S. Department of Education will encourage millions of student loan borrowers to convert loans they borrowed through the Federal Family Education Loan (FFEL) program into direct lending. At Higher Ed Watch, we are pleased that the administration is moving ahead with this plan, which aims to help borrowers who are stuck with student loans under both the FFEL and Direct Loan programs.

The initiative, which will get underway in January, will provide some savings to borrowers who take advantage of it by providing them with up to a 0.5 percent interest rate reduction on their federal loans. But the administration's primary purpose is to simplify the repayment process for borrowers who currently have to make payments on their federal student loans to multiple loan servicers each month.

As readers of Higher Ed Watch know, the Democratically-controlled Congress last year eliminated the FFEL program and shifted to 100 percent direct lending. While the transition has gone remarkably smoothly, nearly six million borrowers have found themselves with loans in both programs, creating an administrative burden for these individuals, as well as for colleges and the federal government.

Such borrowers must make at least two separate payments each month -- one to the Education Department, which runs the Direct Loan program, and another to the company or companies that hold their FFEL loans, increasing the likelihood of confusion and error. “The repayment process for these borrowers involves complicated record-keeping and making payments to multiple student loan holders, putting these students at greater risk for default due solely to the administrative complexity of the repayment process,” the Obama administrated noted earlier this year.

Financial aid administrators say that the confusion this split servicing is causing borrowers is putting a substantial burden on their institutions as well. “We’re finding an increasing number of borrowers with loans mixed between the two programs coming back to us to help them track down loan records,”  Mark Bandré, the vice president for enrollment management and student affairs at Baker University, told lawmakers at a House hearing on Tuesday on direct lending. Helping these students often requires “call[ing] multiple agencies to try and track down important loan information,” he said.

For its part, the Education Department must continue making subsidy payments to lenders for FFEL loans it could just as well service itself.

To remedy those problems, President Obama introduced a “debt conversion” proposal as part of his 2012 fiscal year budget request. Under the original plan, borrowers who switched their FFEL loans into direct lending would have received a two percent reduction in their loan balance.  Meanwhile, the president proposed using the savings generated from converting these loans to help shore up the Pell Grant program for the coming year. [The Congressional Budget Office estimated that the plan would save $1.8 billion under the current credit reform rules or $1.25 billion under the Republican-favored “fair value” accounting method by eliminating subsidies that the government would have paid to lenders holding these FFEL loans.]

While the proposal seemed like a no-brainer to us, it landed with a thud on Capitol Hill. House Republican leaders, who have a long-time allegiance to the student loan industry, refused to consider it. Senate Democrats, who believed the plan was dead in the water, didn’t even bother to include it as a way to help pay for Pell Grants in the fiscal year 2012 Labor-HHS-Education appropriations bill they introduced last month.

Recognizing this reality, President Obama decided to move forward with a modified version of the proposal on his own. Using his executive authority, the president directed the Education Department to engage in an aggressive outreach effort to encourage borrowers with loans in both federal programs to convert their FFEL loans into direct lending.  According to the White House, borrowers who do so will receive a 0.25 percent interest rate reduction on their former FFEL loans, and an additional 0.25 percent interest rate reduction on the overall balance of their combined former FFEL and Direct Loans.

This is a limited time opportunity. Borrowers who wish to take advantage or it must do so between January 1 and June 30, 2012. Under the debt ceiling bill that Congress approved this summer, the Education Department will lose the authority to provide repayment incentives for student loan borrowers beginning with loans issued as of July 2012.

Meanwhile, the administration plans to use savings generated by this plan to finance the administration’s new “Pay as You Earn” program, which aims to provide more generous repayment relief to borrowers with low earnings and unmanageable levels of debt than is currently available through existing programs.

The question now is how will House Republican leaders respond to the president’s action. They railed at the president this week for ramming through changes to the federal student loan program that Congress has not approved. But will they dare to try to block the Education Department from carrying out the president’s order?

At Tuesday’s hearing, Rep. Virginia Foxx, the North Carolina Republican who chairs the House subcommittee in charge of setting higher education policy, said her panel would hold the Education Department responsible for ensuring that “the Direct Loan program is meeting the needs of higher education institutions, students, and taxpayers.” If she and her colleagues on the education committee really believe that, then they should be applauding the administration for moving forward with its debt conversion plan.

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