Obama Erases Banks From Student Loans

BOSTON (TheStreet) -- President Barack Obama, who wants to limit banks' investments and charge them fees to pay for future bailouts, took over student-loan programs in a bid to save $61 billion over 10 years.

As part of the Healthcare and Education Reconciliation, the final legislative piece of health-care reform, the federal government will now directly dispense loans and grants through the Department of Education rather than give banks the subsidies to do so via the Federal Family Educational Loan Program (FFELP).

The new law also:

1. Invests more than $40 billion in Pell Grants, more than doubling the funding available a year ago. By the 2020-2021 academic school year, more than 820,000 additional Pell Grants will be made. There are currently nearly 8 million.

2. Expands the existing income-based student-loan repayment program. New borrowers who assume loans after July 1, 2014, will be able to cap their student-loan repayments at 10% of their discretionary income and, if they keep up with their payments over time, will have the balance forgiven after 20 years. Public-service workers -- such as teachers, nurses and those in military service -- will see any remaining debt forgiven after just 10 years.

3. Includes $2 billion over four years for community colleges.

4. Provides $2.55 billion in mandatory funding for Minority Serving Institutions, such as historically black colleges.

Not everyone is pleased by the move, deemed by critics as a "government takeover" of the student-loan industry. America's Student Loan Providers, a coalition of entities in the student-loan industry that are critical of the new changes, has called the reform package "a loser for students."

The changing system will certainly mean job losses for a portion of the 35,000 workers employed by organizations that participate in FFELP.

Sallie Mae ( SLM), the nation's largest student lender, has announced plans to trim up to a third of its 8,500 workforce. The company manages $188 billion in education loans and serves 10 million students.

Thousands of other jobs could also be shed by financial institutions unable to obtain service contracts the government will award through competitive bidding. The banking industry stands to lose billions of dollars in federal subsidies, a fact driven home by the strong language deployed by the Obama upon signing the bill: "A great battle pitting the interests of the banks and financial institutions against the interests of students finally came to an end."

Critics point out that benefits to students, already scaled back from earlier versions of the bill, have been further eroded. Eliminating banking industry "middlemen" allows the government to put more money into Pell Grants, though a third of that increase will be used to defray shortfalls existing with the perpetually underfunded program. Savings will be applied to reducing the federal deficit ($19 billion) and defraying the cost of health-care reform ($9 billion).

The effect on consumers can be gleaned from Sallie Mae's 2009 "How America Pays for College" study, conducted by Gallup. It found that, among U.S. families, 51% received grants and scholarships, 25% of students borrowed federal loans, 12% of students took out private-education loans and 5% used credit cards to pay for college expenses. Fifty-eight percent of families paid for college without borrowing at all.

On an alarming note, 58% of families who borrowed didn't take the student's expected starting salary into consideration when deciding whether or how much to borrow. In addition, 23% of students couldn't answer when asked to estimate their future monthly student loan payment. The remaining 77% gave estimates that showed little correlation with the total amounts the students said they borrowed.

The study also found that nearly one in four families remains ineligible for federal grants or student loans because they fail to complete the Free Application for Federal Student Aid. Almost nine in 10 lower-income families submitted the application but the completion rate drops as income rises. The survey found that half didn't fill out the FAFSA because they were unaware of it (18%) or they didn't think their family would qualify (30%).

-- Reported by Joe Mont in Boston.

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