National Direct Student Loan Conference
Monday, May 17, 2004

"Direct Lending: A President's Perspective"

Good morning and thank you, Sue, for that wonderful introduction. I was delighted to be invited to speak at this conference, and I immediately asked who the speakers had been during the event's previous years. Was it traditional, I wondered, to have a university president as a speaker?

The answer from WMU's financial aid guru Sue O'Flaherty was cautious.

" Judi," she said rather hesitantly, "I don't know that I would say it's all that traditional. We've never actually had a 10th anniversary celebration before. You would be the first."

As the first university president to address this inaugural gathering, I am honored to be here today. I was asked to give you a president's perspective on the topic of direct lending this morning, and I feel particularly qualified to do so. I'd like to use my time with you to voice some concerns about public policy issues that are shared by many of my colleagues who lead this nation's colleges and universities. Our concerns center on the strengths, vulnerabilities, and tremendous potential of the federal program we celebrate today.

Ten years ago, this nation took a giant step forward when it overhauled a seriously flawed lending system. Student loans were very important then, of course. Today, they have literally become our student's salvation—the pass that keeps many on the path to a degree. But what was accomplished when direct lending was adopted is just part of the puzzle. Today, we must think about the whole picture if we are to face the most important challenge in higher education today—student access.

First, the successes
So here I am, and my first order of business is to wish a happy anniversary to all of you, who, like me, represent direct-lending institutions. Collectively, we're finishing our 10th year in the program, and like those in a solid marriage, we're contented—maybe even a bit complacent—and we've grown very comfortable with the routine. Direct lending is clearly the best thing that could have happened to us. More important, it's the best thing that could have happened for our students.

To those of you in the audience who are policy makers and the creators of, or the successors to those who created direct lending, thank you. You are responsible for a match made in heaven. You invented that rarity in government programs—an initiative that stoked the competitive fires of the marketplace, saved billions of dollars for taxpayers and put smiles on the faces of citizens from literally every walk of American society—not a bad day's work in anyone's book.

Now before any of you gather up your papers and head for the door thinking you've just heard the shortest address ever given, settle back in your chairs, because there's much more to my message to you this morning.

There's a lot more, in fact. Let me begin by giving you the Cliff Notes version. Here are the three things everyone here needs to realize. They are the three messages that together make up our mantra on direct student loans.

• First, direct lending has proven a powerful tool that is good for students, good for colleges and universities, and good for taxpayers. It is a tool that simply makes sense. It is good public policy.
• Second, direct lending is threatened today by forces that have little to do with higher education and everything to do with corporate finances and now, the dire budget problems in states across the nation and in the public institutions that rely on those states.
• Third, and most significant, direct lending holds the promise of providing the funding that will keep our universities accessible to low-income students—the ones we are now turning away in ever increasing numbers.

When Congress considers reauthorizing the Higher Education Act, it will make decisions that will affect the viability of direct lending. Congress should also consider ways to encourage more U.S. colleges and universities to move to direct lending. The public good that would come from such a move should not be underestimated.

First let me tell you why so many of us who lead America's universities are enamored of direct lending. I've already told you it is a powerful tool that is good for students, good for colleges and universities, good for taxpayers, and it is good public policy.

Let me use the university I lead as an example. I could easily pick someone out of the audience and they could tell you the same story about the university they represent, but for convenience sake, let me share the information I know best.

Since direct lending was launched ten years ago, Western Michigan University has successfully dispersed $661 million in direct loans to students. I say "successfully" because we do so with a management error rate of less than .01 percent. What does this mean? It means that because of reconciliation—a word somewhat dreaded in financial aid offices—the right amount of debt is being charged to the right student. I also say successfully, because the default rate of our students has dropped from around 7 percent to 3.3 percent, and it continues to decrease.

We are justifiably proud of that negligible error rate and a 3.3 percent default rate, but they are figures that are no longer that unusual. They reflect the trends found in direct lending institutions around the nation. It is, ladies and gentlemen, what happens when we get it right—when a program leaves so little room for error that it actually serves the population it is designed to serve.

And such service must be the crux of any discussion we have on direct lending. Indeed, service should be at the heart of any discussion we have on financial aid as an entire package. Financial aid was designed to make higher education available to students. It is all about students, and every decision made about financial aid must focus squarely on what is good for those students.

Direct lending is good for students. It was designed to make life easier for students who need federal loans to realize their dreams of higher education. The design of the program was nothing short of transformational. The student direct loan program launched 10 years ago literally turned the student loan world upside down.

There's a Biblical proverb that says: "The borrower is servant to the lender." (Bible, Proverbs, 22:7) That's a wonderful description of the dynamics of the traditional borrower/lender relationship. But Congress, in its wisdom, realized that borrowing money for higher education is a proposition quite unlike the business loan transactions of the working world. Borrowing for higher education is borrowing to promote a public good—that of creating an educated and informed citizenry. A student loan, far from being a simple business transaction, is an investment—an investment made by individual students, certainly, but even more important, it is a collective investment in our nation's future well-being.

With loans fast becoming the only way many students could achieve their goals and fulfill our nation's collective desire, Congress made the wise decision to turn tradition on its head and make the lender servant to the borrower. The result is the direct student loan program, which is not focused on the needs or demands of the lender but rather on the needs and potential of the borrower—our students.

Before direct lending, the terms "service" and "student loans" were almost mutually exclusive. Try as they might, the staff at a large public university was often hard-pressed to help students navigate the loan process. At my own institution, the financial aid staff worked with some 1,000 private lenders, and each had their own demands and individual paperwork requirements. They also dealt with as many as 30 state guarantee agencies – those state entities charged with overseeing all of the players in the student loan process.

For students, the results of that old system included:

• Confusing and chaotic application procedures that led to late or lost checks and the cancellation of class registration for non-payment of tuition,
• Endless hours of standing in line at financial aid offices to check on aid status or get help from an aid counselor,
• Destructive emotional roller-coaster rides and frantic attempts to find emergency short-term loans to bridge the gap and cover living expenses when loan checks failed to arrive,
• Hours spent trying to track down information on loan status or even determine the name of the lending institution that held a loan that had been sold by the original lender, and finally,
• Decades of loan repayments that left graduates with few options and often found them and their alma maters scrambling to determine who actually held their loans.

The private lenders who ran the student loan business until the early 1990s really had little to recommend them. They were inflexible and resistant to any changes that would make life easier for our students. They truly saw the borrower as their servant—not a customer to be served. It was a system in disrepair, and it needed to be fixed.

It's now 10 years after Congress intervened in that sad state of affairs and created the William D. Ford Federal Direct Loan program. For colleges and universities across the nation, direct lending has become a way of life. It is a way of life that is less stressful for our students and staff. It gives students the ability to focus on their studies, rather than their loans. It offers students the flexibility they need now and the simplicity and transparency they need in the future as they repay their loans. And it pays real dividends when it comes to often-difficult institutional issues like cash flow and efficient use of resources.
This is what direct lending has meant to our students.

• Our students now have one application, one process to negotiate and one point of contact for handling their loans.
• They come to school each fall knowing their loans are ready and their tuition bills paid.
• They have near instant access to information about their loans, and that information is accurate.
• Students know who holds their notes.
• They can consolidate their loans at a fixed low rate before graduation.
• They have a variety of payment options, including those that make repayment amounts and timing contingent on income levels.
• Students can now spend their student years studying rather than standing in line or on the phone trying to correct errors.
Such service to students is, in itself, reason enough to celebrate and protect direct lending. But, there's more.
Because of direct lending, institutions that use the program can:
• ensure tuition bills are paid on time;
• save valuable staff hours spent in tracking down the loan status for current and former students;
• ease cash flow problems through the timely transfer of loan funds; and
• avoid the constant necessity of arranging emergency loans for students experiencing problems with a lender.

But there's still more to recommend this marvelous addition to higher education. Because of direct lending, the nation's taxpayers save nearly $10 in costs for every $100 loaned. The processing cost of $100 loaned to a student through direct lending is $.69. The same amount loaned through the Federal Family Education Loan program, using private lenders, costs taxpayers $10.51.That's a huge disparity. It bears repeating.

Each $100 distributed through direct lending costs U.S. taxpayers $.69. But taxpayers pay $10.51 for each $100 distributed by private lenders but backed by the federal government. That's a difference of $9.82 on every $100 of the $50 billion loaned annually.

This means the one-third of federal loans that come to students through direct lending each year saves taxpayers about $2 billion. If every institution of higher education participated in direct lending, the savings could amount to $6 billion. Conversely, when just one large public university abandoned direct lending for the private sector last year, it meant the federal government — taxpayers — now pay an additional $22 million in loan administration costs.

Direct lending, however, is vulnerable
Those loan administration dollars—the ones paid by the government to process the two-thirds of student loans made outside the direct lending program—are now the source of threats that could end direct loans as we know them.

The bottom line is simply that there is an enormous amount of money involved in the student loan business. At the same time federal direct lending was implemented, loan eligibility requirements were revamped. Student loan applications have skyrocketed in the past 10 years—the same 10 years that saw the increased convenience and savings of direct lending.

When direct lending was implemented, a third of public colleges and universities signed on, virtually driving private lenders out of business on those campuses. With their history of poor service and unwillingness to change, those private lenders and state guarantee agencies were easy marks for a program that took the hassle and cost out of student loans.

But no industry appreciates losing that kind of business, especially when the business shows every sign of growing. For private lenders, student loans are a lucrative business. You'll remember I told you the cost of private Federal Family Education Loans is $9.82 higher than the cost the government pays to loan the same amount directly to a student.

That extra $9.82 includes administrative costs of processing loans and federal interest payments on subsidized loans as well as deferment and default costs and a series of special allowance payments to the lender. It's a terrific business—high in profit and low in risk.

Private lenders certainly showed they wouldn't take their loss lying down. Over the past 10 years, those lenders have proven true one of our nation's basic tenets: There's nothing like competition to force improvements in service and some creative thinking. The competition from direct lending has forced private lenders to improve service, lower some rates and loan origination fees, offer new repayment options and find creative ways to keep the schools they still have and try to lure others back to the fold. These are things that would never have happened without competition.

It's been a healthy development and a boon to the students who are on the receiving end of some of those incentives. What was once a broken student loan system is now a student loan system that offers the public two distinct options, and both options are increasingly based on service to the borrower.

These two options do not happily coexist. In fact, competition between the two is intense and will only increase as the size of the student loan portfolio grows. That's why it is critically important for Congress to ensure the competition takes place on a level playing field. I'm sure private lenders once felt threatened by direct lending. It is now those of us committed to direct lending who feel like we're charter members of a "Threat of the Week Club."

Today, with the amount of money in the system at an all-time high and public university budgets practically on life support, the financial incentives being offered to institutions to leave direct lending are difficult to turn down. No loophole has been left untouched, no creative alternative untried in the quest to retain the student loan business.

Competition spurs creativity, and the direct lending program needs to be as creative and competitive as private-sector programs. The direct loan product is wonderful, so if the playing field is level, we'll be able to compete just fine. But if the field tilts in favor of private lending, the viability of a program that is good for students and good for taxpayers will be in jeopardy.

Private lenders, some of giant proportion, are among those stoking the competition and trying to lead institutions away from direct lending. It's a trend that has been gathering steam and even the attention of the popular press. In an October cover story, U.S. News & World Report looked at the whole range of student loan issues—from direct lending to the courtship of universities by private lending giants like Sallie Mae. The magazine dubbed the entire package of stories BMOC—"Big Money on Campus."

Here are some of the recent signs of trouble we can attribute to the arrival of the new BMOC.

Last year, it was reported that attempts were made to lure some institutions away from direct lending by the promise of a share of the loan management funds in return for their agreement to abandon direct lending completely. If true, such actions truly push the envelope on the rules governing incentives.
Then there's the "schools-as-lender” move by some universities with sizeable graduate and professional programs who work in partnership with private lending entities. Schools involved in such agreements actually hold the notes on the students they enroll. In return, the school and the private lender share the revenue and the special allowances that comes from the government. That extra $9.82 cost to taxpayers is more than enough to share.

This year, the threat comes from cash-strapped states that see those loan management funds as a new revenue stream that will help address daunting budget shortfalls.

California and New York have been in the forefront of attempting to overcome state budget shortfalls by trying to capture a portion of administrative dollars from the ever-growing student loan market. Those states and others have discovered there's a gold mine of subsidy and administrative costs that's there to be had when private lenders process federally guaranteed loans.

New York proposed withholding some state funds from state universities not using private lenders and not doing business with New York's student loan guarantee agency. The legality of that move is being challenged. Just last week in California, the state backed away from its proposal to protect state schools from further deep budget cuts if they withdraw from direct lending and agree to funnel their students' loan dollars to that state's guarantee agency.

These moves by states and universities are understandable. The sheer size of the loan market is enormous. From a purely business perspective, what savvy leader could ignore such potential, especially in this time of tight budgets?

But think about the message being sent for a moment. College students and taxpayers, who already are faced with paying higher and higher tuition as states reduce support for state universities, are now being asked to take on the additional burdens and costs when schools return to private lending—not because it's good for students academically, but because it's good for the bottom line of cash-starved states and universities.

While competition forced private lenders to offer competitive rates and better service to some borrowers, the problems inherent in having multiple lenders and notes still remain for too many students. At the precise time when being a student is toughest, states are considering moves that will make students' lives even more filled with stress.

And there are other, perhaps unintended, costs to be considered by those who move outside their core mission and become embroiled in the purely business side of the student loan market. When colleges and universities become lenders, or state governments stake out their cut in the revenue stream, do they open themselves up to charges of conflict of interest? Will students and their parents think that because their university is making money from student loans, it has a vested interest in raising tuition to ensure that students borrow more? Will a state that is relying on revenue from loans turn its back on its responsibility to keep tuition low by providing needed funding? Those are questions that must be addressed.

As a public university president, one of the toughest things I do is explain to parents why tuition keeps rising. In the best of times, it's a complex issue and the public already approaches that complexity with a certain level of mistrust. Add a question of conflict of interest to the mix, and even the best explanation of costs will likely fall on deaf ears.

When Sallie Mae comes calling, I've decided to pass. I don't need to add a credibility gap to the task of explaining costs to families who are already struggling to help their children earn degrees.

I've just outlined some trends and initiatives that are aimed at decreasing the number of schools that participate in the direct lending program. If the trend continues, direct lending's numbers may dwindle to the point where the program becomes just a memory.

The consequences of such a loss cannot be fully understood. A few moments ago, I told you what life was like—the day-in, day-out reality—before the advent of direct lending. I literally walked you through what now seems like just a bad dream.

Since 1992, the volume of student loans has more than doubled. Loans have literally become the tool that allows some 60 percent of our undergraduate students to complete their degrees. For graduate and professional students, the figure is even higher—72 percent.

Life in financial-aid circles before 1992 may now seem like a bad dream. The return, now, to life without direct lending in this new student loan environment could become a scary nightmare.

While competition has forced private lenders to change and make service to students a priority, will the lesson learned stick if the competition of direct lending disappears? Will those special loan incentives and repayment rates become available across the board or will they remain options for small numbers of low-risk students?

Those are the problems we face. We want Congress to address those problems when the Higher Education Act is reauthorized. Reasonable profits for private lenders offering FFEL loans and a level playing field to ensure healthy competition are important, so that schools can be sure direct lending will be healthy 10 years from now on its 20th anniversary. Honest competition is healthy. It has given us two strong lending programs. Given the benefits of direct lending to students, schools and taxpayers, I am confident that in a fair and competitive environment, direct lending will continue to grow and prosper.


The potential of direct lending
If Congress sets the stage to allow direct lending to prosper, the nation could realize one more benefit—an incredibly important one. The money saved through direct lending could be used to increase both the amount and number of Pell Grants awarded each year to our neediest students. Such a move would address the access crisis in higher education that grows more serious with each passing year.

Currently, direct lending saves taxpayers $2 billion annually. If Congress can ensure a level playing field, and if we can fend off the attempts by states to use federal loans as a revenue source, we can expect direct lending to increase. As direct loans increase, so too will the savings. Doubling the amount of loans distributed through direct lending would result in a $4 billion savings to taxpayers. If every school and university used direct lending, the savings to taxpayers would be $6 billion annually.
Applied to the Pell Grant program, such savings could:

• overcome the habitual shortfalls in grant funding, now pegged at up to $3 billion annually, and
• allow Congress to actually raise the minimum Pell Grant level and make grants available to greater numbers of needy students.

Think of the possibilities—up to $6 billion in new Pell Grant money could be found to cover the unmet needs of the Pell Grant program without draining the funds from other worthy programs or raising taxes. While Congress works to contain the deficit, new money could flow into the program simply by using existing tax dollars efficiently and leveraging the direct lending savings to accomplish a nationwide imperative—producing more college graduates.

Adding more Pell Grant funding could literally breathe new life into an initiative that is a critical tool in ensuring access to qualified students without the financial resources to earn a degree. And that program, the cornerstone of the nation's student financial aid assistance programs, desperately needs new life breathed into it.

Despite the urgent and growing need for such assistance, both the maximum awards and the real purchasing power of Pell Grants started declining nearly 30 years ago and never stopped. The maximum Pell Grant, in inflation-adjusted dollars, was at its highest level of just over $4,500 in 1975. Today, the maximum grant is just over $4,000. I don't need to tell you what has happened to college costs in that same 30-year period.

According to a 2001 report of the Advisory Committee on Student Financial Assistance, to just reach the 1975-76 buying power Pell Grants enjoyed at four-year public institutions, the grant maximum needs to increase to more than $7,000.

How can we even start to accomplish that goal? The Department of Education estimates that to increase the maximum award by just $100, it will take an additional $300 million in funding. There's little doubt the $6 billion in potential savings from direct lending could be put to good use in the effort.

A quarter century ago, Pell Grants covered more than 80 percent of the cost of attending college for the poorest students. Today, for those who do get them, the Pell Grant covers only 40 percent of college costs. And because of the shortfall in funding, a student who once was a likely recipient of a Pell Grant may now become one of the estimated 4.4 million qualified Americans who will be turned away from four-year colleges during the current decade. These are students for whom no current combination of scholarships, loans and those increasingly scarce Pell Grants offer even the possibility of attending a four-year college.

The social and economic costs to our nation of keeping those students from the college classroom are already enormous and will continue to escalate with the number or qualified students who are turned away. And that number will grow. In the next decade, the largest growth in the college-age population will occur among low-income, minority individuals from families with no higher education history.

What I propose is that, instead of having more and more college-age students turned away, this redirection of student loan funding would bring them to college, help them prepare for the knowledge-based economy and narrow the gap between Americans at the highest and lowest income levels. Achieving that goal—narrowing that gap—according to the Advisory Committee on Student Financial Assistance, would add nearly $250 million to our gross domestic product and $80 billion in taxes. That's just the financial balance sheet. The social and cultural gains would be incalculable.

Closing
We've gathered here this week to celebrate the success of the Ford Federal Student Direct Loan program and to look into the future at what is possible if we can keep the focus of federal student financial aid where it rightly belongs—on students.

Our nation's fight for better schools, better teaching and better academic preparation will be undone if we do not put the puzzle of student financial assistance together correctly. Consider the disappointment of students who do everything right and prepare themselves for college only to find the gates of the academy closed to them because we, as educational and political leaders, have not done our part to assemble those pieces correctly. I considered asking you to imagine their disappointment, but I know that's not necessary. Many of you see and live it everyday on the job.

Direct lending is an amazing success story, but the work is not yet done. Let's all agree to meet here ten years from now to celebrate another success story. Perhaps we can look back on groundbreaking decisions that in 2004 paved the way for a Pell Grant renaissance. If we keep our eyes locked on those bright young faces at the doors of our classrooms, we might just pull it off.

Thank you for the opportunity to speak here today. And thank you for your dedication to the students who will build our nation's future.