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Student Loans 101: Why Uncle Sam is your banker

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WASHINGTON - 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:

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Americans got a shock from the sky in October 1957.

The first artificial satellite was passing overhead. And it wasn't just man-made, it was Soviet-made.

Beach ball-sized Sputnik touched off a space race and stoked big fears that American students might not be up to the challenges of the Cold War.

Calls to improve science and technical education led to creation of a low-interest college loan program in the National Defense Education Act of 1958. The loan dollars came directly from the government.

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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.

Lawmakers liked that approach because outstanding loans wouldn't show up on the government's books as red ink.

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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.

Sallie Mae was fully privatized in 2004 and is now a corporate giant of the private student loan and college savings businesses.

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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.

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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.

Meanwhile, with fewer banks offering loans to students, the number of colleges turning to direct federal loans shot up.

The shine was off private lenders.

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In 2010, Uncle Sam took over.

Private lenders waged an intense lobbying campaign to hang onto the government-backed student loan market. But in the end, Congress approved President Barack Obama's plan to give commercial banks the boot.

Now, the entire federal student loan program belongs to Washington.

Banks and other private lenders still loan money to students on their own, without a federal guarantee. Some students need the outside help to fill in the gaps as college costs keep climbing.

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.

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Under today's system, direct federal loans are considered the best deal for students.

The government loans generally have lower interest rates than bank loans. And the feds offer flexible payment options for people who have trouble with their bills after graduation.

Also, students who qualify for subsidized Stafford loans, based on financial need, don't rack up interest charges while they're in school. Students who go into public service careers such as teaching can have their loans forgiven or discounted. And graduates who work in exceptionally low-paying professions stand to have their loans completely forgiven after 25 years.

Students with federal loans are at the mercy of Congress and its bickering, however.

A messy standoff has temporarily doubled interest rates on new subsidized Stafford student loans this summer. But a bipartisan compromise promises to head off that rate hike before students sign up for loans in the fall.

Copyright Copyright 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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