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History and Background: Financial Aid

Photo credit: Christian Horz/Adobe Stock

Back to Financial Aid

Student aid has been around almost as long as colleges have. In the early days of the republic, churches, benefactors and even communities would pay for promising, but poor, young adults to attend college, sometimes stipulating that they return to the community to work after graduation.

The federal role in financing college is more recent, dating to the passage of the GI Bill in the 1940s. The first federal student loan program and the first loan forgiveness program followed in the late 1950s.

But the watershed moment for federal aid came in 1965, when Congress passed The Higher Education Act, creating Basic Educational Opportunity Grants for low-income students. The grants were later renamed Pell Grants, in honor of Sen. Claiborne Pell of Rhode Island, who helped create them.

As the cost of college ratcheted upward in the 1980s and 1990s, Congress extended the bill’s benefits to parents and to middle- and upper-income students, creating Parent PLUS loans (1980), unsubsidized loans (1992) and tuition tax credits (1997).

The Role of Financial Aid in College Quality Control

To protect the growing federal investment, and shield students from shoddy programs, lawmakers cut off aid to programs with high cohort default rates (1990) and limited the amount of aid flowing to for-profit colleges and correspondence schools (1992). Under the 85/15 (now 90/10) and 50 percent rules, proprietary colleges could receive no more than 85 percent of their revenue from federal sources, and programs could offer no more than half of their programs by telecommunications.

The crackdown worked in the short term: Hundreds of for-profit colleges and correspondence schools shut down in the mid- to late-1990s. Over time, though, the survivors found creative ways to “manage” their default rates and began to aggressively recruit veterans to stay under the 85 percent cap (since DOD and VA funds weren’t initially counted as federal funds). It would take almost three decades for Congress to close that latter loophole.

When online learning took off in the early 2000s, Congress abolished the 50 percent rule, fueling an explosion of large, publicly-traded for-profit corporations that offered online courses. In the years since, Congress and the Education Department have seesawed between stricter and looser regulation of the for-profit sector, depending on which party — Democrat or Republican — was in charge. An effort by the Obama administration to cut off aid to programs with poor employment outcomes — known as the gainful employment rule — was overturned by the Trump administration and is likely to be revived by the Biden one.

Default rates, meanwhile, remain a weak accountability measure, disqualifying only a couple programs each year.

The Loan Wars

Though the first student loans were issued by the federal government, most lending through the 1980s was done by banks, through the federally subsidized Federal Family Education Loan Program (FFELP, for short).

The creation of a Direct Loan program in the mid-1990s set off a decades-long fight over student lending that divided colleges into camps — DL and FFELP — and led to a “pay to play” scandal that shook the student aid profession and brought down a half dozen college administrators in the first decade of 2000.

Faced with increased competition for borrowers, banks and state-based lenders fought among themselves for a coveted spot on colleges’ “preferred lender lists,” sometimes offering kickbacks, such as revenue-sharing, to secure one.

Those practices came to an abrupt end in the mid- 2000s, following an investigation by the New York attorney general that prompted the Education Department to issue new rules around prohibited “inducements.” In 2010, the Obama administration ended the bank-based program altogether, arguing that the millions the government was spending on subsidies was wasteful and inefficient.

To combat the swelling student debt, lawmakers have continued to tinker with loan repayment and forgiveness, layering new programs on top of old ones. The resulting complexity has been blamed for under-enrollment in income-based repayment, though participation in the programs has risen in recent years, to 1 in every 3 borrowers.

The Bennett Hypothesis

One of the longest-running debates in higher education policy centers on whether federal aid fuels rising tuition. The fight goes back to a 1987 editorial in the New York Times by former Education Secretary William Bennett, who argued that the growing federal investment in student aid was enabling “greedy colleges” to raise their prices — undermining the government’s goal of making college more affordable.

This theory has been tested many times, and the evidence is mixed. Though the data show a clear correlation between increased aid and rising tuition, it has been harder for researchers to prove that one causes the other.

Debt Relief and Free College

As the nation’s collective loan burden has grown, the calls for federal student debt relief have grown louder, and more mainstream. Yet advocates disagree on how much — and whose — debt the government should cancel, and some say the money could be better spent on making college free or doubling the Pell grant. These fights are unlikely to be resolved during the Biden administration, and will continue to shape the conversation around student aid for years to come.

Updated May 2021.