Direct educational loan student

Low- and middle-income college students could get a break on their student loans next year -- if Congress can defy the wishes of private lenders.

A little-known provision in a 1993 law may lower student-loan interest rates by a full percentage point beginning next July. The change involves what benchmark lenders use to determine interest rates. But banks and other financial institutions stand to lose about $9 billion if the measure takes effect, student leaders say. Most of these savings would pass through to borrowers.

"This change is something we're trying very hard to protect," said Erica Adelsheimer, legislative director for the United States Student Association (USSA). "In our view, banks have made a lot of money off student loans."

Representatives of the guaranteed loan system say the new rules could drive them out of the program, however, causing a disruption in loans to students.

"Under the change, you can expect to see a shrinking market for student loans," said Mark Cannon, executive director of the Coalition for Student Loan Reform, which represents those who administer the guaranteed loan system, called Federal Family Educational Loans, in which banks provide loan capital.

Cannon characterized the 1993 law as a way to undermine private lenders and create more business for the government-backed direct-loan program favored by the Clinton administration.

"Some will say the 1993 change was a diabolical scheme and a ticking time bomb under the guaranteed student loan program to favor direct lending," he said.

At issue is what economic measure lenders use to calculate student loan interest rates. The current system relies on ninety-one-day U.S. Treasury bills, while the new system will focus on ten-year U.S. Treasury notes.

Administrators of guaranteed loans agree the change will produce short-term gains for students. But lenders rarely use ten-year notes to make financial decisions because they are much more volatile than ninety-one-day Treasury bills.

"There is not a pool of investors for ten-year notes," Cannon said.

Such a system would give preferential treatment to direct lending, he added, since the government can absorb such volatility more easily than private lenders.

Although the provision would not take effect until next July, supporters of bank-financed loans want Congress to repeal the rule before lawmakers adjourn this year. The reason: most students apply for aid in the spring, said Cannon, and lenders begin making loan decisions at that time as well.

One possible compromise is to give students another cost break in exchange for repealing next July's change. One such scenario is a cut in origination fees students pay when they take out loans.

"We need to look at reducing costs for students in some other way," Cannon said. Cutting origination fees "would be a real, tangible benefit they could bank on, rather than rely on an interest-rate system that is historically volatile."

Private lenders are raising issues at a time when they enjoy strong support in Washington, D.C., because of failures in the government's direct loan system. The Clinton administration had to shut down one part of that program this summer because its contractor could not deal with an applications backlog.

Both Republicans and Democrats in Congress are looking to the bank-financed system to fill the void.

Adelsheimer acknowledged there is "frustration" among students and education groups about the direct lending system. But USSA also believes students deserve the lower loan costs promised four years ago.

"We need policies that focus on students as important customers," she said.