Direct student loans: A better way to invest in education

Under current law, taxpayers provide as much as $9 billion each year to subsidize guaranteed student loans issued by banks. The banks earn profits on the interest; if students default, taxpayers take the loss, not the banks. In other words, working Americans pay while bankers get rich.

Meanwhile, educators, engineers and computer scientists -- the backbone of the new economy -- face crushing debt from six-figure college tuitions. A study of national postsecondary student aid found that in 2008, two-thirds of college seniors graduated with debt averaging more than $23,000. That number will rise as public and private college tuition costs escalate.

The banks have had plenty of help with government bailouts and other subsidies while working families and students are increasingly squeezed. President Obama wants to eliminate the subsidy for banks and use that money to help poor and middle-class students and adults attend college.

The president also wants to strengthen community colleges, give grants to states that improve college completion rates and boost early-learning programs. He wants to lower maximum monthly payments for student loans from the current 15 percent of income to 10 percent to make college debt more manageable.

Not surprisingly, the banks are working hard to block our common-sense proposal. Sallie Mae, the largest player in the student lending business, has spent millions of dollars to lobby Congress and run ads in several states, claiming that our proposal will cost jobs and inhibit service. These claims must be challenged.

The president's plan actually creates jobs and draws on free-market principles by selecting private companies through a competitive process to service student loans issued directly by the Education Department. These private companies, including Sallie Mae, compete for our business and are evaluated on the quality of their customer service and their default rates.

Loan servicing is a growing industry as more and more Americans pursue college degrees. Under our contract, the high-performing companies will get more business over time while poor-performing companies will get less. The market will play, and students and taxpayers will win.

It's no wonder that the banking industry is pushing back hard to protect its taxpayer subsidy. Over the years, this giveaway has generated billions in profits for banks and hundreds of millions of dollars in compensation for bank executives.

The banking industry's claims that it wants to protect American jobs are also suspect. The fact is, Sallie Mae sent thousands of American loan servicing jobs overseas in 2007 to further increase profits, and it agreed to bring them back last year only to compete for our loan-servicing business.

The Education Department has issued more than $187 billion in student loans since the Direct Loan Program was created in 1993. The number of universities participating in the program has more than doubled, to 2,300, in just the past three years. There is no justification to continue wasteful subsidies to banks. It is time to complete the shift to direct lending.

The president's proposal, which has passed the House and awaits Senate consideration, represents the ideal hybrid of public investment and market-based management. Through direct lending, we get a bigger bang for taxpayer bucks while using competition and private-sector expertise to improve customer service.

The writer is the U.S. secretary of education.