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Shares of student lender Sallie Mae (NASDAQ: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

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