DEMOCRATIC Senator Ted Kennedy (D-Mass.) reaffirmed his party's complete lack of economic sense last week with a proposal requiring banks to bid for government-backed student loans. What Kennedy and the Democratic Party fail to understand is that no one is requiring these banks to become involved in the first place, and that increased competition will remove incentives and drive smaller banks away. More importantly for students, this plan would mean decreased services, higher costs and having to deal with constantly changing lenders. While this proposal has yet to be officially submitted, already the possibilities inherent in a Democrat-controlled Congress should make banks and students tremble.
Kennedy's proposed change is a simple one, seemingly based on logic that would resonate with conservatives who dislike government control: let the market dictate who gets student loan payments. By forcing banks to compete in this way, the bank willing to make the lowest profit will get the federally-backed loan, and the government will save money -- according to Bloomberg news "as much as $7 billion a year."
Yet behind this façade is a factor Adam Smith never considered when writing about the invisible hand's effects on the market. The problem is that government is involved regardless, and thus has already violated the rules of free competition to which Kennedy and his supporters ascribe. These student loans are backed by the federal government, payments to lenders are made by the government, and a large part of the reason why banks are willing to accept loans from students with no assets to speak of is because the government minimizes the risk involved. Though less government involvement is desirable, forcing competition only increases it.
There are several reasons why this proposal is bad, and why according to John Dean of the Consumer Bankers Association an "auction concept was considered and rejected in a previous Congress." The first is that by forcing banks to compete directly over these loans, smaller banks will be disadvantaged and forced away because the risks involved will no longer be covered by potential government payments. In addition, these smaller banks will not be able to take on as many loans and will suffer compared to larger banks, which can make profits through high volume of loans.
During his failed 2004 Presidential bid, John Kerry introduced a similar student loan proposal, according to Inside Higher Education (IHE). In response to Kerry's plan, the Consumer Bankers Association (CBA) argued that "an auction mechanism would inject uncertainty into business planning by banks that would lead many to withdraw from the student loan market" and "would also most likely result in further concentration of lending among a few large institutions." The result of forcing more competition, then, would be to create a less competitive industry.
The second key reason this is an awful plan is that it will hurt the students who rely on these loans to get through college. Forcing banks to compete may save the government money, but lowering bank profits to the bare minimum means that banks "might have to cut services for students and investments in technology," as IHE notes. In addition, banks would no longer be able to afford much of the monitoring and other efforts which prevent students from defaulting on their loans -- under the current system the CBA notes that there "has been a steady decrease in borrower delinquency and default rates." This proposal would hurt students trying to get by, as well as cost the government even more money by having to ensure the payments.
Finally, students will also suffer greatly because of the nature of their loans, which are often taken out in successive years to cover the costs of their education. IHE points out the result of this is that students "could find themselves having to change the lenders they do business with every year," or worse yet have multiple loans with different lenders. This added complexity means students would have to deal with numerous competing financial institutions, each with its own policies and procedures -- a situation that would, in all likelihood, contribute to further defaulting on payments and more difficulty in obtaining financial solvency.
All in all, Kennedy's plan is an abomination that may save the government money but will hurt the students who rely on these loans and the banks who offer them. Competition is to be encouraged, but not by a method that increases government oversight and hurts everyone else involved. The bottom line is that this proposal only highlights Kennedy's and the Democratic Party's economic incompetence.
Allan Cruickshanks' column appears Wednesdays in The Cavalier Daily. He can be reached at acruickshanks@cavalierdaily.com.
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