WASHINGTON -- The federal government's new college lending program will probably be inadequate to cover students' financing needs, forcing many state agencies to create their own bond-financed loan programs to pick up the slack, education lobbyists and state officials say.

Signed into law in August, the program requires the federal government to give colleges seed money to set up revolving loan funds. After a five-year trial period, Congress is expected to fully implement direct lending and kill off the old system of federally guaranteed bank loans to students.

But lobbyists and state officials are predicting that the new program will be so costly for the federal government that it will have to be scaled back, leaving states to make sure that all students who need loans get them.

"There's no program in this country that the federal government has ever enacted that provides the level of services today that it intended," said Donald Vickers, executive director of the Vermont Student Assistance Corp.

"Anybody who thinks this program called direct lending is going to do whatever it claims to do is just crazy, because the [cost] will not allow it," Vickers said.

For about 30 years, under the old Guaranteed Student Loan program, the federal government has been guaranteeing loans made to students by banks, which in turn sell the loans to state education authorities. The authorities often finance their purchases with tax-exempt bonds.

Next July, the federal government will begin phasing in the direct-loan program, under which colleges will make the loans themselves, replacing private lenders. The Department of Education will own the loans and oversee the schools.

The legislation enacted in August permits the amount of direct lending to grow to 60% of all student loan volume. In 1998, Congress will be required to evaluate the two systems and decide which one to keep. Most industry sources said they believe that a switch to direct lending at that time is a foregone conclusion.

When direct lending was first proposed, education lobbyists warned that it could put the state agencies out of business: With no role for banks in the new system, there would be no need to create a secondary market, and thus no bond-financed purchases of student loans.

But state officials and lobbyists said they are now coming to realize there will be a role for state agencies, because the federal government probably will not be able to afford to fully cover every student.

"It is my absolute belief that the federal government is not prepared to finance the full freight" of a direct loan program, said a bond lawyer who has worked on student loan financings for more than 10 years. "There's going to be a perception that its cost has got to be contained in some way or another."

For example, the federal government could lower the maximum amount a student may borrow for each year of schooling. When the program starts next year, the maximum will range between about $2,500 and $10,000, depending on how far along a student is in his college career.

If the federal government does scale back direct lending, "we're going to pick up the slack," said Preston Woodruff, the chairman of the Education Finance Council, a coalition of 20 state authorities that issue student loan bonds. Woodruff is also president of the Arkansas Student Loan Authority.

Lobbyists and state officials said the main way in which states could aid students not covered in the federal program would be to create supplemental programs in which the state agency would guarantee the loans and purchase them from private lenders.

A handful of states already operate such programs to supplement the Guaranteed Student Loan program, but more states are likely to need those programs if direct lending is fully implemented, the lobbyists and officials said.

Aside from cost issues, the bond-financed supplemental programs may also be needed because many small schools may not be equipped to participate in direct lending, Woodruff said.

If direct lending becomes the only federal program available in five years, students in small schools would have no way of getting loans unless the state stepped in.

"Our mission here in Arkansas is to be sure kids have access. We think, going forward, [many of them] really aren't going to have access, and we will give them that," Woodruff said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.