Guaranteed vs. Direct Lending: The Case of Student Loans

The existence of two competing government student loan programs provides a unique opportunity to compare the cost to the government of direct federal lending versus loan guarantees. The cost of capital in the private student loan program is used to infer the market price of risk for federally-backed loans. We find that budget costs for both programs are well below their market value. It appears that the guaranteed program is fundamentally more expensive than the direct program, primarily because guaranteed lenders are paid more than is required to induce them to lend at statutory terms.