Sallie Mae, the largest private lender of student loans, recently announced that it will split into two entities. The first company will manage nearly all of Sallie Mae’s assets–$118.1 billion worth of federal loans and $31.6 billion worth of private loans–and the second will continue to lend to students. This development underscores a disquieting truth: Americans have a healthy attitude toward higher education but an unhealthy relationship with student debt. While household debt comes in many forms, only student debt grew during the Great Recession. Federal policy has encouraged this habit. In the two years following the financial crisis, spending on student loans grew 19 percent and 18 percent, respectively.
Though students and families are borrowing more to cope with the ever-growing cost of college, the loans that they are taking out may actually be a cause, as well as a result, of the problem. Many studies suggest that colleges are capturing part of this increase in federal loan funds and using it to pay for high-cost expenditures–such as research labs, student amenities, and administrators–that are then passed on to students in the form of higher tuition and fees. Since colleges are guaranteed funding for students who demonstrate need, they are insulated from the consequences of raising prices.
Therefore, student loan reform needs to introduce competitive pressure into the student loan system. De-linking the cost of specific colleges from decisions on loan awards is one way of achieving this goal. Instead, colleges could offer every eligible student four possible loan awards based on financial need and the median cost of college. This reform would force colleges to compete for students’ loan money by demonstrating the actual value that their education provides. And since colleges would no longer be shielded from market pressures, they would be forced to become more cost-conscious.