Sputnik spurred U.S. government sponsored student loans

Congress’ scramble to reconcile a messy student-loan rate increase raises the question: Why did the U.S. get into the college loan business in the first place? The short answer: Because the Russians launched Sputnik.

In October 1957, Americans were shocked when the first artificial satellite passed overhead. They were even more shocked to find out it was Soviet-made.

Beach-ball-sized Sputnik initiated a Cold War space-race between the U.S. and the Soviet Union and raised fears that American students might not be up to the challenge of their Soviet counterparts – and that, to the U.S. government, would have been unacceptable.

Soon after, President Dwight Eisenhower heeded calls to improve science and technical education by establishing a low-interest college-loan program through the National Defense Education Act of 1958 – with loan dollars coming straight from the government.

Fast forward to 1965, when President Lyndon Johnson launched his “war on poverty.” Under this banner, student loans got a major boost as part of the president’s Great Society initiatives.

The Higher Education Act expanded Eisenhower-era loans and grants to help poor students and also changed the way the federal-loan program was financed.

Instead of using government money directly, the loans would now be made by bankers. Still, the government guaranteed that if students defaulted, the U.S. government would pay the balance.

Lawmakers preferred this system because outstanding loans wouldn’t show up on the government’s budget as red ink.

In 1972, President Richard Nixon led the creation of the Student Loan Marketing Association, known as “Sallie Mae,” to help get more money to students.

Sallie Mae was a “government-sponsored enterprise” – it got help from the U.S. Treasury to buy up banks’ student loans thereby freeing the banks’ money and encouraging them to do more federally insured lending.

In 2004, Sallie Mae was fully privatized and is now a corporate giant of the private student loan and college savings businesses. Taxpayers took the risk; bankers got the rewards.

But using private companies to handle government-backed loans proved to be more complicated and expensive for taxpayers than direct federal loans.

Because of that President Bill Clinton tried to go back to a direct-loan system like that of the Cold War days – but many Republicans opposed direct loans as “government takeover.”

Private lenders also didn’t want the feds moving in on their lucrative market, so Congress compromised by phasing in some direct federal loans while keeping guarantees in place for the bank loans.

Colleges largely decided which loans to offer students and, for more than a decade, the banks seemed to be winning the battle against direct loans because of how aggressively marketed private loans were compared to the lesser-known government alternative.

In 2008, the financial crisis changed everything. With chaos on Wall Street and credit markets in a tailspin, private student loan money disappeared.

That’s when Congress stepped in and gave the Education Department power to step in and buy loans from cash-strapped lenders.

And with fewer banks offering student loans, the number of colleges turning to direct federal loans shop up.

Private lenders launched an intense lobbying campaign to hang onto the government-backed student loan market.

But in 2010, Congress approved President Barack Obama’s plan to give commercial banks the boot and the entire federal student loan program now belongs to Washington.

Banks and other private lenders can still loan money to students, of course without a federal guarantee, but some students needed outside help as college costs keep climbing.

Under today’s system, direct federal loans are considered a better deal for students as government loans typically have lower interest rates than bank loans. The government also offers flexible payment options for people who have trouble with bills after graduation.

Students who qualify for subsidized Stafford loans, based on financial need, don’t rack up interest charges while they’re in school.

Additionally, students who go into public service careers such as teaching can have their loans forgiven or discounted – graduates who work in exceptionally low-paying professions stand to have their loans completely forgiven after 25 years.

However, students with federal loans are still at the mercy of Congress and its in-fighting. A stalemate in Congress has temporarily doubled interest rates on new subsidized Stafford student loans this summer.

But if a bipartisan compromise is reached, it will get rid of the interest rate hike before students sign up for loans in the fall.

Al Jazeera and wire services