Sallie Mae: Subsidy Cuts Hurt, But Why So Bad?

Shares of student lender Sallie Mae (SLM) are down 42% this morning after the Obama Administration’s newly unveiled budget included a proposal to eliminate government subsidies paid to private banks who make student loans. The subsidies, which cost the government billions each year, would cut government spending by $47.5 billion over the next 10 years. Wall Street is outraged, claiming that getting rid of the subsidies will drown out private student lenders and increase the market for government loans (and therefore government involvement in our economy).

I’m confused. I thought we all want a free market capitalist system? If private student loans are unprofitable (and therefore require government subsidies in order for banks to offer them), wouldn’t the free market dictate that private student lending is not a worthy endeavor for private, profit-seeking banks? Maybe I’m missing the point, but I think reducing any government subsidy, and therefore the budget deficit, would be a good thing, especially for proponents of the free market.

As for the argument that this measure would virtually eliminate private student lending, I guess I’m not convinced. Given how creative and entrepreneurial our private industry is, do we really think they can’t come up with a student lending program that is both attractive to the borrower and also profitable for the lender? I have no doubt that the banks would love to keep getting these subsidies, but the notion that student lending in the private sector can’t be maintained without them seems a bit extreme, and even if that is the case, maybe private lending is a flawed model.

What do you think?

Disclosure: No position in Sallie Mae at the time of writing, but positions may change at any time

Comments

[Trade Radar...:]

Default rates on student loans are high and the government guaranties make it worthwhile for private lenders to offer these loans. Given that the government limits what interest rate can be charged to borrowers, the government has effectively caught lenders in a vise - they are unable to adjust credit cost according to creditworthiness if the lender wants to participate in the FFEL program.

Feb 26 03:11 PM

[Crocodilian:]

Interesting observation, and a thoughtful comment by Trade Radar.

My two cents' is that overly subsidized student loans have contributed to the rather dramatic increase in the cost of education, which somehow seems to get more expensive, even as inflation is nil.

Colleges and Universities are remarkably expensive for what they do, and subsidized student loan products are to that market as overly aggressive FNMA lending was to the mortgage market-- inducing people to assume excessive levels of debt while acquiring assets of dubious value.

We want a well-educated and well-trained work force, and national investment in human capital pays dividends; but subsidies should be looked at skeptically.

Feb 26 03:35 PM

[Consider_this:]

Their point is that withdrawing the subsidy while still having direct govt education loans (which are ultra low interest rate) will kill private market lending.

Not hard to see that the lenders, because they have to borrow from the Fed ultimately, can't make this equation work.

But I don't see why we have to FORCE private lending to work or even exist. Since the equation obviously doesn't work, then move on and let private lending to education end. Why subsidy?

Maintaining a facade or charade just so that it seems that there's a slew of "choice" on the marketplace, when the choice is a false choice, is silly. (i.e. Lend direct from govt; or lend from private, which gets subsidy, which behind the scenes really borrow from govt anyway)

That's not free market; that's silly market.

Feb 26 03:35 PM

[Gtarras:]

i want to study SLM now.. the government will not be able to service the loans, and most likely it will be left to private enterprises like Salie.. is it not it good for SLM then? no risk and plenty of servicing fees? what am I missing here? they can charge hand over fists, can they not... the govt will have no way but to play by their rules... it can not service the loans.. hmmm...

Feb 26 03:41 PM

[Gtarras:]

good points... i highly suspect servicing is the reason behind this charade... govt can not do it, so they play by private enterprise rules.. now they try to move the bowl away, which will result in higher servicing fees... either way, capitalist pigs win...


On Feb 26 03:35 PM Consider_this wrote:

> Their point is that withdrawing the subsidy while still having direct
> govt education loans (which are ultra low interest rate) will kill
> private market lending.
>
> Not hard to see that the lenders, because they have to borrow from
> the Fed ultimately, can't make this equation work.
>
> But I don't see why we have to FORCE private lending to work or even
> exist. Since the equation obviously doesn't work, then move on and
> let private lending to education end. Why subsidy?
>
> Maintaining a facade or charade just so that it seems that there's
> a slew of "choice" on the marketplace, when the choice is a false
> choice, is silly. (i.e. Lend direct from govt; or lend from private,
> which gets subsidy, which behind the scenes really borrow from govt
> anyway)
>
> That's not free market; that's silly market.

Feb 26 03:48 PM

[captainccs:]

You have to look at this in context to make sense of it. The main reason student loans exists is because the government sets low rates and guarantees the loans and the only way to get private banking involved is to subsidize these low rate loans. Without the subsidy the rates are too low for a commercial bank to make a profit on the loans.

There is a smaller market for private loans which are not government backed and which carry higher rates. This market is currently dead because the banks can't securitize the loans.

The so called private student loans that are going to disappear were in fact a collaboration between government and private banking, not truly a private business.

Feb 26 04:45 PM

[Paulyyyyy:]

Wow... You do not know anything about free markets. You argue:
(I’m confused. I thought we all want a free market capitalist system? If private student loans are unprofitable (and therefore require government subsidies in order for banks to offer them), wouldn’t the free market dictate that private student lending is not a worthy endeavor for private, profit-seeking banks?)

What part of a free market competes with the government? Ding Ding give another one to the socialist morons.... That’s right it can not exist.

Student loans are not profitable without the subsidies because they are regulated by the government. Most people wouldn't qualify without the government because they have no way to protect against default. (Have a loan Mr./Ms 18 year old and buy a case of beer and drop out of school.)

Feb 26 05:54 PM

[Paulyyyyy:]

We are talking about federal loans... or loans that are guaranteed by the government through the private sector. Ultimately the subsidy by having private lenders disburse and service loans leads to a more efficient system than government can ever produce. The "Billions Saved” will end up as a net loss for the government and the taxpayer. The government will now have pay more on the tail end to service the loans that SLM will get a bulk of the duty. Maybe we should end government backed student loans all together and allow the banks to fill the void. (Then we can watch the upper education bubble burst.)


On Feb 26 03:48 PM Gtarras wrote:

> good points... i highly suspect servicing is the reason behind this
> charade... govt can not do it, so they play by private enterprise
> rules.. now they try to move the bowl away, which will result in
> higher servicing fees... either way, capitalist pigs win...

Feb 26 06:07 PM

[JohnL:]

"Maybe I’m missing the point, but I think reducing any government subsidy, and therefore the budget deficit, would be a good thing, especially for proponents of the free market."

You're not missing anything. The government should end this and all other subsidies. Of course they have to get rid of their market-distorting regulations which make unsubsidized ventures unprofitable at the same time. There will be some pain in the transition, but we'll all be much better off afterward.

Feb 26 11:09 PM

[atlasman:]

This is why you cannot nationalize just a couple of banks. Once government takes over one bank, they will use their competitive cost advantage with rates to slowly take over the market and puish the remaining banks aside. So which is it, socialize the entire banking system or let capitolism reign. It really is one or the other. You cannot thread the needle and have the best of both worlds.

Feb 27 07:51 AM

[James Wilson:]

IF THE USA IS GOING TO COMPETE WE CAN'T CRIPPLE OUR STUDENT WITH DEBT !!!!!

Feb 27 08:52 AM

[James Wilson:]

Free Markets ????????

What are you talking about ??

Barrier to Enrty Laws !

Grandfather Laws !

There is no Free Market !

Government Price Supports !

Feb 27 08:54 AM

[35 Yr Gov't...:]

I can tell you this: The government is the most inefficient model to get anything done. Employees that have no duties year after year. Hire companies that must hire people that can not perform the job, like janitorial services. Buy supplies from the blind and other special interest groups at very inflated prices. The list is long and value is short.

I didn't vote for obama but I think things are so bad in this country that no president can even begin to fix this mess.....................

Feb 27 08:57 AM

[James Wilson:]

Servicing = Fannie and Freddie


On Feb 26 03:48 PM Gtarras wrote:

> good points... i highly suspect servicing is the reason behind this
> charade... govt can not do it, so they play by private enterprise
> rules.. now they try to move the bowl away, which will result in
> higher servicing fees... either way, capitalist pigs win...

Feb 27 08:59 AM