Here's how the program works: Banks and other private companies lend money to students. The federal government pays part or all of the interest—currently 7 percent or 8 percent. The government also guarantees the loans.
What is wrong with this picture? Well, the government itself borrows the odd nickel to finance the national debt. This borrowing, obviously, is also guaranteed by the government. For that reason, it carries an interest rate of only 3 percent or 4 percent. If the government can borrow money at 3 percent or 4 percent, why should it be paying 7 percent or 8 percent for the privilege of guaranteeing loans to someone else? Wouldn't it make more sense for the government to loan out the money itself?
That is the $4 billion question (the approximate annual cost of the interest subsidy). ...
It seems that kickbacks were being paid to university financial aid officers who delivered customers. Some of them even got stock in some of the more specialized, and dubious, student loan companies. When the government is giving away free money—which is what the program amounts to (and I mean giving it away to the banks, not to the students)—it's worth a good deal to get cut in on such a good deal.
--Michael Kinsley, Slate, on no-arbitrage violations in government borrowing