WASHINGTON - In less than a year, the idea of radically revamping the college financial aid system has gone from a gleam in a congressman's eye to a live possibility.

When House Education and Labor Committee Chairman William Ford, D-Mich., proposed last fall to scrap the current system in favor of direct student loans, Washington insiders gave him little chance of succeeding.

In the end, he did not get the complete transformation he wanted. But recently he did get Congress and President Bush to agree to test the idea. If that test works, the current system of banks and student loan authorities would presumably be eliminated by the year 2000 in favor of allowing colleges to make and service their own student loans.

Proponents say the pilot will reveal the current system to be rife with problems, such as large numbers of defaults and an overwhelming complexity, that would be solved if only the middlemen were removed and colleges made the loans directly.

Critics of direct loans, meanwhile, say it will take more than four years to decide whether that approach would really work. They are watching anxiously, however, to see if the experience gained with the direct loan concept proves their point that the federal government cannot efficiently administer a program that makes $13 billion in student loans annually.

"People are expecting this to be a panacea," said Gary Rieman, director of the Illinois Student Assistance Commission's Illinois Designated Account Purchase Program, a state higher education authority. "The problem I see is that there's great hope for something to be the wave of the future before it's ever tested adequately and proves to be worthy of carrying the load."

Pilot to Plant Seeds

Under present law, the federal government guarantees loans made to students by commercial banks which in turn sell the loans to state higher education authorities. The authorities often finance those purchases with tax-exempt bonds, and some operate bond-financed loan guarantee programs of their own to supplement the federal system.

On July 23, President Bush signed into law a bill to create a four-year demonstration program beginning in 1994, with the federal government providing seed money to colleges to set up revolving loan funds for student aid. Banking and education lobbyists have warned that a permanent direct loan program would obviate the need for the state education authorities and, in turn, for issuance of tax-exempt student loan bonds.

The bill places no limit on the number of schools that may participate in the pilot program or on the amount of loans they can make.

But it contains an implicit cap, by directing the secretary of education to select a group of schools that represents $500 million in combined loans under the current system for the 1992-93 school year. That would translate into less than 300 schools, lobbyists said.

In October 1991, Rep. Ford's panel had approved his proposal for a permanent direct loan program, but the House leadership balked and scaled it back to a demonstration. Even so, the idea began to gain steam.

Although the Senate did not include a direct loan plan in its version of the guaranteed-loan reauthorization bill earlier this year, at least one top education lawmaker said he had become convinced such an approach was preferable to the current system. Senate conferees ultimately agreed to a pilot program.

Saying the plan should be taken seriously, Sen. Edward Kennedy, D-Mass., noted that when he first brought up the idea of direct loans in 1979 the idea was set aside.

But since then, "the growing problems and costs of [the guaranteed student loan] program have generated new interest in the direct loan approach," said Sen. Kennedy, chairman of the Senate Labor and Human Resources Committee, the panel with jurisdiction over education legislation. "Now it seems to be an idea whose time has come."

The Cost Debate

Rep. Ford and other critics of the current system say that eliminating profit-driven banks from the student loan system will cut the federal government's costs. In a study last year, the General Accounting Office estimated the annual cost to the federal government of the current system at $2.71 billion a year, compared with $1.55 billion under a direct loan program.

The savings would result from the elimination of the federal government's current practice of paying the student's servicing costs to the banks while the student is in school. In addition, the government could cut payments it now makes to the banks to lower the loan rate, the GAO said in its study.

But a study released by KPMG Peat Marwick last month faults the accounting office's approach and says that, rather than saving money, direct loans would cost the federal government an extra $257 million a year.

"The GAO has underestimated and failed to recognize significant costs associated with managing the proposed direct loan program," the firm said in a June 15 letter to the National Council of Higher Education Loan Programs and the Consumer Bankers Association, the two groups that commissioned the study.

The ignored or underestimated costs include expenses associated with phasing out the old program, administrative costs, and servicing fees, Peat Marwick said.

Although detractors of the direct loan approach have fought the idea of a pilot program, they acknowledge that it could end up helping them by proving their case.

"A lot of people feel the program will not work, and are ready to show the program will not work" said Marilyn McAdams, president of the McAdams Group, a Washington, D.C., consulting firm that deals primarily with education issues.

Laurie Quarles, deputy director of the National Council of Higher Education Loan Programs Inc., said, "They're going to find while it may work at some institutions ... it may not be the right program for every institution."

A university like Harvard already has a well-run, computerized, highly organized student loan office, and it should have little difficulty handling a direct loan program, Ms. Quarles said. That would not be true for large numbers of other smaller schools, she added.

Lobbyists Are Watchful

A critical period for the pilot will come during the next year, when the Department of Education draws up program regulations. To get a true reading of direct loans' effectiveness, the Education Department will need to "make sure the selection of institutions is done in a way that accounts for diversity of institutions participating in the current program," said Larry O'Toole, president of NEw England Education Loan Marketing Corp.

The department will also need to make sure rules governing the current and pilot programs are equivalent. If regulations are eased under the direct loan program, that could cause the program, results to show a misleading cost savings, Mr. O'Toole said.

"A good portion of the cost of administrating current loan programs is driven by the extreme detail of federal law and federal regulation," he added.

Banking and education lobbyists are also concerned about the amount of lending that would be done under the pilot. They want it tightly restricted so as not to draw too much business away from the current system.

The legislation's provision for choosing schools based on past loan volume may not effectively limit lending, they say, because the bill makes changes in loan qualification standards that will allow schools to make more and bigger loans than in the past.

There is a related danger to the current system, according to Mr. Rieman of the Illinois purchase program. If only the best schools are skimmed off the top and placed into the pilot, he warned, banks will be left with less than desirable institutions and may opt of the education business altogether.

"If there is some kind of creaming process that occurs, [then] my concern is that some of the existing players that have performed very well over the years will choose not to participate, at least as aggressively or at the same levels as in the past," Mr. Rieman said.

But despite their concerns about direct loans, state education officials acknowledge there are problems with the current system and realize a better way needs to be found.

"If [the direct loan concept] truly turns out to be something beneficial, I think you will even see those who are not optimistic about it be supportive," Mr. Rieman said.

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