Alice Morgan, Photo Illustration by Investopedia
TAKEAWAYS KEY
- President Donald Trump signed an Executive Order recently that closed the Department of Education. He also hinted at privatizing student loan.
- Federal student loans have been privately held and backed by the government up until 2010. Some conservative politicians believe privatization would reduce federal expenditures and encourage debtors to pay off their debt.
- The transition to private student loans could be expensive and difficult.
Recent moves suggest that Donald Trump may try to privatize the federal loan system for students, but experts warn he might have trouble getting lawmakers and lenders on board.
Trump recently signed an Executive Order initiating closure of the Department of Education. In the order, the administration said the Department of Eductions handles more than $1.6 trillion in student debt, equating it to the size of one of the U.S.'s biggest banks, Wells Fargo. The Office of Federal Student Aid has fewer than 1500 employees, compared with more than 200,000 at Wells Fargo.
In the executive order, Trump stated that “the Department of Education isn’t a bank and it must return banking functions to an entity capable of serving America’s students.”
Trump also announced, one day after signing the order, that the Small Business Administration would manage federal student loan programs. The SBA guarantees small business loans issued by private banks or other financial institutions.
Mark Kantrowitz a student loan specialist told Investopedia by email that these actions could signal a move to privatize student debt. The White House and Department of Education have not responded to requests for comment. However, there is precedent for a federal private student loan system.
What would privatizing students look like?
Federal student loans have been made privately under the Federal Family Education Loan program (FFEL), until 2010.
When the FFEL program was still providing new loans, the Department of Education partnered with private lenders to provide student loans with federal guarantees. Some borrowers still have FFELs, but they are often ineligible to receive federal student loan relief.
If student loans are privatized, the problem would be much more widespread. Kantrowitz wrote an article for The College Investor that borrowers would lose federal forgiveness programs and discharge programs in addition to flexible payment options.
Some conservative politicians criticize student loan programs for spending too much money on forgiveness programs and failing to incentivize borrowers to repay their debt. According to a Government Accountability Office report, federal student loan costs the federal government $197 Billion as of fiscal year 2020.
"Since private lenders would take financial losses if they lend to students…they have an incentive to steer students toward institutions and programs whose graduates typically earn enough to repay their debts,” said fellows from think tank American Enterprise Institute in a report. The federal student loans program could save taxpayers hundreds billions of dollars by privatizing it.
Will Trump be able To Privatize Student Loans
Experts say that student loans may return to a private system. However, this would require Congressional approval and private servicers are not likely to be willing to accept the large student loan portfolio.
To privatize student loans, the federal governments would need to sell their existing portfolios to private lenders. Kantrowitz stated that private loan servicers will not be able fund more than one trillion dollars in capital markets or bond issues.
Kantrowitz said that they did not have the money to discount the portfolio by half. “If they try to sell it for that, how can Congress fund such an enormous write-down?”
The federal government may need to provide subsidies or guarantees to make private lenders more interested in lending. Kantrowitz wrote that private lenders might not have the administrative capability to manage all student loan servicing and would still likely work with existing loan servicers.
