The federal government started those frameworks in 1958 through the National Defense Education Act, part of which established what would become Perkins Loans, a need-based government loan system that pinned interest rates at 5% and gave former GIs and other eligible students affordable loans for college.
Cold War fears that American students were falling behind in science and engineering fostered increased federal interest in what congressional and educational leaders coined “postsecondary education,” to incorporate all types of education after high school.
In 1965, the Higher Education Act established a basis for the federal government to offer more student financial assistance through the Federal Family Education Loan Program (FFEL).
The federal government expanded Perkins Loans and introduced Stafford Loans, where the federal government guaranteed and encouraged student loans by paying the interest that accrued during a student’s time in college and paid the difference between a set low rate and the market rate once the student graduated
The government made a number of partnerships with private companies to service these loans, and this partnership was how private student loan creditors got into the market. Private lenders were more than willing to join in this partnership because of the government guarantee and the rising tide of individuals looking to fund increasingly expensive college educations. Over 60 million Americans have paid for college with these loans in the past 45 years.
In 1972, the federal government reauthorized the Higher Education Act from 1965 and created the ubiquitous student loan firm, Student Loan Marketing Association (Sallie Mae), a government sponsored enterprise (GSE). Sallie Mae served as the agent for government backed student loans, collecting payments and offering customer services as a GSE until 2004, when it privatized its operations, but continued to service government backed student loans.
In general, this partnership has proven profitable for the private companies involved. In 2008, for instance, Sallie Mae collected $2.75 billion in interest on private loans (ones not backed by federal guarantee) and another $2.16 billion in interest on Stafford and other government-backed loans.
In the late 1980s, the U.S. Congress and the U.S. Department of Education pushed for a system of direct loans, where the federal government would loan directly to students or universities, who would serve as intermediaries. After President George H. W. Bush’s vetoes, President Bill Clinton signed the Federal Direct Loan Program (FDLP) into law in 1993. It allowed the Department of Education to make loans directly and bypass the GSEs and other lenders who managed the loans.
However, through the 1990s, colleges and students did not go after FDLP financing since heavy lobbying of private student loan managers succeeded in continuing the old system of using GSE and private creditors to service government secured loans.
While most lenders servicing federal student loans were not in real danger of shutting down, they had a limited ability to weather the late 2000s recession because of relatively high rates of underpayment and low locked-in interest rates. Some of them suffered bad publicity through aggressive collection tactics and continuing to post profits during the recession.
When the credit market melted down recently, the decades-old attempt to change the student loan system to one that offered direct government loans received new life
The Obama administration assumes that by taking over student lending, the federal government will be less affected by future credit problems by saving the costs of paying middlemen to service the loans. For better or worse, the government wants colleges and students to trust it to absorb the risk associated with young adults borrowing tens of thousands of dollars to go to school.