Wednesday, March 31, 2010

Ellen Brown: Student Loans

In the Calendar section of today's LA Times a front page story features
tonight's Tavis Smiley special on MLK, Jr. The page 8 continuation is
titled "King at his most fearless," and says it all. It examins King's last
year of life and expanded views, is revealing, stunning and not to be
missed. It's on KCET here in LA and likely on PBS throught the country.

Student Loans: The Government Is Now Officially in the Banking Business
by: Ellen Brown,

t r u t h o u t: March 20, 2010

"We say in our platform that we believe that the right to coin money and
issue money is a function of government.... Those who are opposed to this
proposition tell us that the issue of paper money is a function of the bank
and that the government ought to go out of the banking business. I stand
with Jefferson ... and tell them, as he did, that the issue of money is a
function of the government and that the banks should go out of the governing

-William Jennings Bryan, Democratic Convention, 1896

William Jennings Bryan would have been pleased. The government is now
officially in the banking business. On March 30, 2010, President Obama
signed the reconciliation "fix" to the health care reform bill passed by
Congress last week, which includes student loan legislation called by the
President "one of the most significant investments in higher education since
the G.I. Bill." Under the Student Aid and Fiscal Responsibility Act (SAFRA),
the federal government will lend directly to students, ending billions of
dollars in wasteful subsidies to firms providing student loans. The bill
will save an estimated $68 billion over 11 years.

Money for the program will come from the US Treasury, which will lend it to
the Education Department at 2.8 percent interest. The money will then be
lent to students at 6.8 percent interest. Eliminating the middlemen allows
the Education Department to keep its 4 percent spread as profit, money that
will be used to help impoverished students. If the Department were to
actually set up its own bank, on the model of the Green Bank being proposed
in the Energy Bill, it could generate even more money for higher education.

A Failed Experiment in Corporate Socialism

The student loan bill may look like a sudden, radical plunge into
nationalization, but the government was actually funding over 80 percent of
student loans already. Complete government takeover of the program was just
the logical and predictable end of a failed 45-year experiment in government
subsidies for private banking, involving unnecessary giveaways to Sallie Mae
(SLM Corp., the nation's largest student loan provider), Citibank, and other
commercial banks exposed in blatantly exploiting the system.

Under the Federal Family Education Loan Program (FFELP), the US government
has been providing subsidies to private companies making student loans ever
since 1965. Every independent agency that has calculated the cost of the
FFELP, from the Congressional Budget Office to Clinton's Office of
Management and Budget to George W. Bush's Office of Management and Budget,
has found that direct lending could save the government billions of dollars
annually. But the mills of Congress grind slowly, and it has taken until now
for this reform to work its way through the system.

In the sixties, when competing with the Soviets was considered a matter of
national survival, providing the opportunity for higher education was
accepted as a necessary public good. But unlike Russia and many other
countries, the US was not prepared to provide that education for free. Loans
to students were necessary, but students were notoriously bad credit risks.
They were too young to have reliable credit histories, and they did not own
houses that could be posted as collateral. They had nothing but a very
uncertain hope of future gainful employment, and banks were not willing to
take them on as credit risks without government guarantees.

The result was the FFELP, which privatized the banks' profits while
socializing losses by imposing them on the taxpayers. The loans continued to
be "originated" by the banks, which meant the banks advanced credit created
as accounting entries on their books the way all banks do. Contrary to
popular belief, banks do not lend their own money or their depositors'
money. Commercial bank loans are new money, created in the act of lending
it. The alleged justification for allowing banks to charge interest although
they are not really lending their own money is that the interest is
compensation for taking risk. The banks have to balance their books, and if
the loans don't get paid back, the asset side of their balance sheets can
shrink, exposing them to bankruptcy. When the risk is underwritten by the
taxpayers, however, allowing the banks to keep the interest is simply a
giveaway to the banks, an unwarranted form of welfare to a privileged
financier class at the expense of struggling students.

Worse, underwriting these private middlemen with government guarantees has
allowed them to game the system. Under the FFELP, banks actually profit more
when students default than when they pay back their loans. Delinquent loans
are turned over to a guaranty agency in charge of keeping students in
repayment. Pre-default, guaranty agencies earn just 1 percent of the loan's
outstanding balance. But if the loan defaults and the agency rehabilitates
it, the guarantor earns as much as 38.5 percent of the loan's balance.
Collection efforts are also much more profitable than efforts to avert
default, giving guaranty agencies a major incentive to encourage
delinquencies. In 2008, 60.5 percent of federal payments to the FFELP came
from defaults. An Education Department report issued last year found that
only 4.8 percent of students who borrowed directly from the government had
defaulted on their loans in 2007, compared to 7.2 percent for the FFELP; and
the gap widened when longer periods were taken into account.

In 1993, students and schools were given the option of choosing between the
FFELP and the Direct Loan program, which allowed the government to offer
better terms to students. The Direct Loan program was the clear winner,
growing from just 7 percent of overall loan volume in 1994-1995 to over 80
percent today.

The demise of the FFELP was hastened in early 2007, when New York Attorney
General Andrew Cuomo began exposing the corrupt relations between firms
lending to students and the colleges they attended. Lenders that had been
buying off college loan officials were forced to refund millions of dollars
to borrowers.

Congress responded by cutting the private lenders' subsidies. But after the
2008 economic crash, the lenders claimed they could no longer afford to lend
to low-income (high-risk) borrowers without these subsidies. Congress
therefore acquiesced with a May 2008 law requiring the federal government to
give banks two-thirds of the funds lent to students. The bill also required
the Education and Treasury Departments to buy loans from lenders made
between May 2008 and July 2009 for the full value of the loans plus
interest. To comply with this bill, the Department of Education projects
that it will eventually have to buy $112 billion in FFELP loans.

Despite all this government help, lenders have continued to turn their backs
on riskier borrowers, driving students to the government's direct lending
program. With the banks enjoying heavy subsidies while failing in their
mission, Obama campaigned in 2008 on a promise of eliminating the middleman
lenders; and with the new SAFRA, he appears to have fulfilled that goal.

Thus, ends a 45-year experiment in subsidized student lending. In the
laboratory of the market, direct lending from the government has proven to
be a superior alternative for both taxpayers and borrowers.

The US is not the only country exploring government-sponsored student loan
programs. New Zealand now offers zero percent interest loans to New Zealand
students, with repayment to be made from their income after they graduate.
And for the past 20 years, the Australian government has successfully funded
students by giving out what are in effect interest-free loans. They are
"contingent loans," which are repaid if and when the borrower's income
reaches a certain level.

Where Will the Money Come From? The Green Bank Model

Eliminating the middlemen can reduce the costs of federal lending, but there
is still the problem of finding the money for the loans. Won't funding the
entire federal student loan business take a serious bite out of the federal

The answer is no - not if the program is set up properly. In fact, it could
be a significant source of income for the government.

The SAFRA doesn't mention setting up a government-owned bank, but the Energy
Bill that is now pending before the Senate does. Funding for the energy
program is to be through a Green Bank, which can multiply its funds by
leveraging its capital base into loans, as all banks are permitted to do.
According to an article in American Progress:

Funding for the Green Bank should be on the order of an initial $10
billion, with additional capital provided of up to $50 billion over five
years. This capital could be leveraged at a conservative 10-to-1 ratio to
provide loans, guarantees, and credit enhancement to support up to $500
billion in private-sector investment in clean-energy and energy-efficiency
projects. [Emphasis added.]

Banks can create all the credit they can find creditworthy borrowers for,
limited only by the capital requirement. But when the loan money leaves the
bank as cash or checks, banking rules require the bank's reserves to be
replenished either with deposits coming in or with interbank loans. The
proposed Green Bank, however, is apparently not going to be a deposit-taking
institution. Presumably then, it will be relying on interbank loans to
provide the reserves to clear its checks.

The federal funds rate - the rate at which banks borrow from each other -
has been maintained by the Federal Reserve at between zero and .25 percent
ever since December 2008, when the credit crisis threatened to collapse the
economy. An Education Bank qualified to borrow at the interbank lending rate
should thus be able to borrow at zero to .25 percent as well, generating
more than 6.5 percent gross profit annually on student loans.

The Treasury, by contrast, paid an average interest rate for marketable
securities in February 2010 of 2.55 percent, which explains the 2.8 percent
interest at which the Education Department must now borrow from the
Treasury. The interbank rate is obviously a better deal, but it could go up.
The cheapest and most reliable alternative would be for the Treasury itself
to become the "lender of last resort," as William Jennings Bryan urged in

The Treasury Department and the Education Department are arms of the same
federal government. If the government were to set up a government-owned bank
that simply lent "national credit" directly, without borrowing the money
first, it could afford to lend to students at much lower rates than 6.8
percent. In fact, it could afford to fund a program of free higher education
for all. That such a program could be not only self-sustaining, but a
significant source of profit for the government, was demonstrated by the
G.I. Bill, which was considered one of the government's most successful
programs. Under the Servicemen's Readjustment Act of 1944, the government
sent seven million Americans to school for free after World War II. A 1988

Congressional committee found that for every dollar invested in the program,
$6.90 came back to the US economy. Better-educated young people got
better-paying jobs, resulting in substantially higher tax payments year
after year for the next 40-plus years.

Taking Back the Credit Power

Winston Churchill once wryly remarked, "America will always do the right
thing, but only after exhausting all other options." More than a century has
passed since William Jennings Bryan insisted that issuing and lending the
credit of the nation should be the business of the government rather than of
private bankers, but it has taken that long to exhaust all the other
options. With student loans, at least, government officials have finally
come around to agreeing that underwriting private lenders with public funds
doesn't work.

We are increasingly seeing that underwriting banks considered "too big to
fail" doesn't work either. Banks are borrowing at near-zero interest rates
and speculating with the money, knowing they can't lose because the
government will pick up the losses on any bad bets. This is called "moral
hazard," and it is destroying the economy.

Issuing the national credit directly, through a federally-owned central
bank, may be the only real solution to this dilemma. Today, the government
borrows the national currency from the privately-owned Federal Reserve,
which issues Federal Reserve Notes and lends them to the government and to
other banks. These notes, however, are backed by nothing but "the full faith
and credit of the United States." Lending the credit of the United States
should be the business of the United States, as William Jennings Bryan
maintained. The dollar is credit (or debt), in the same way that a bond is.
Both a dollar bond and a dollar bill represent a claim on a dollar's worth
of goods and services. As Thomas Edison said in the 1920s:

If the Nation can issue a dollar bond it can issue a dollar bill. The
element that makes the bond good makes the bill good also. The difference
between the bond and the bill is that the bond lets the money broker collect
twice the amount of the bond and an additional 20 percent. Whereas the
currency, the honest sort provided by the Constitution pays nobody but those
who contribute in some useful way. It is absurd to say our Country can issue
bonds and cannot issue currency. Both are promises to pay, but one fattens
the usurer and the other helps the People.

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