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Guaranteed Versus Direct Lending: The Case of Student Loans

The federal government makes low-cost financing for higher education widely available through its fast-growing student loan programs. The existence of two competing government programs -- the Federal Family Educational Loan Program (guaranteed program) and the Federal Direct Loan Program (direct program) -- provides a unique opportunity to compare the cost to the government of direct federal lending versus loan guarantees. We propose and implement a methodology to provide a comprehensive cost estimate for the two programs in market value terms, and analyze the sources of the differential. We find that even after adjusting for the market cost of capital, asymmetric treatment of administrative costs, and other inconsistencies in how the programs are budgeted for, the guaranteed program appears to be fundamentally more expensive than the direct program. The differential can be attributed primarily to the fact that guaranteed lenders are paid more than is required to induce them to lend at statutory terms. The excess payments appear to be partially absorbed in competition for borrowers, which occurs through various discounts, marketing activities, and higher service levels and subsidies to educational institutions.

Deborah Lucas, Massachusetts Institute of Technology
Damien Moore, Congressional Budget Office
Publication Date: 
February, 2010
HCEO Working Groups: 
Publication Type: 
Place of Publication: 
University of Chicago Press
Deborah Lucas
Document Number: 
Book Title: 
Measuring and Managing Federal Financial Risk