Student Loans 101: Why Uncle Sam is Your Banker

Created: 07/19/2013 6:09 AM By: Jennie Olson

Photo: MGN Online
Photo: MGN Online

As Congress scrambles to pull back a messy student loan increase, it raises the question: Why did Uncle Sam get into the college loan business, anyway?
The short answer: Because the Russians launched Sputnik.
A look at the 55-year history of federal student loans:
Americans got a shock from the sky in October 1957.
Then came Lyndon Johnson's "war on poverty."
Student loans got a boost in 1965 as part of the president's "Great Society" initiatives. The Higher Education Act expanded loans as well as grants to help needy students. It also changed the way the federal loan program was financed. Instead of using government money, the loans would be made by bankers. But the government guaranteed that if students defaulted, the U.S. would cover the tab.
And that led to the birth of Sallie Mae.
In 1972, President Richard Nixon spearheaded creation of the Student Loan Marketing Association - known by the nickname Sallie Mae - to help get more money to college students.
Sallie Mae was a government-sponsored entity that used Treasury funds to buy up banks' student loans, freeing up the private lenders' money and encouraging them to make more loans.
Taxpayers took the risk; bankers got the rewards.
Using private companies to handle government-backed loans proved to be more complicated and expensive for taxpayers than direct federal loans. So President Bill Clinton sought a switch back to a direct loan system more like the Sputnik days.
But many Republicans opposed direct loans as a government takeover. And private lenders didn't want the feds moving in on their lucrative market. Congress compromised by phasing in some direct federal loans while keeping guarantees in place for the bank loans.
For more than a decade, the banks appeared to be winning the battle with direct loans. Colleges largely decided which kinds of loans to offer their students, and the aggressively marketed private loans were more popular than the lesser-known government alternative.
The 2008 financial crisis changed everything.
With chaos on Wall Street and credit markets in a tailspin, private student loan money started drying up. To keep money flowing to college students, Congress gave the Education Department power to step in and buy private loans from lenders.
The shine was off private lenders.
In 2010, Uncle Sam took over.
Now, the entire federal student loan program belongs to Washington.
And many people are still paying off student loans they got through private lenders under the old Federal Family Education Loan program before it ended on July 1, 2010.
Under today's system, direct federal loans are considered the best deal for students.
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