WASHINGTON (MarketWatch) -- The Obama administration told House lawmakers Thursday that participation by private lenders should be curtailed in the federal student-loan program because the government "is now the sole reliable and sufficient source of federal student-loan capital."

For federal student loans, the president has proposed ending private lender subsidies through the Federal Family Education Loan Program, and using federal funds to originate all new loans beginning in the 2010-2011 academic year through the government's Direct Loan program. While the administration says this step would save money, the private-lending industry warns that students' access to loans could be disrupted, according to witness testimony at a House hearing on Thursday.

"Instead of maintaining this elaborate web of programs designed to prop up the [Federal Family Education Loan] Program, we should originate 100% of new loans through the less costly Direct Loan program," said Robert Shireman, deputy undersecretary of the Department of Education, at the hearing of the House Education and Labor Committee.

The administration's proposal would minimize the layers between the source of loan capital and the borrower, he said. Shireman added that the recent credit crunch points to the private market's unreliability, and that "reliable access" to loans is important for students and the economy as a whole.

"We have seen the guaranteed federal student loan system, known as the Federal Family Education Loan Program, come close to collapse this past year." Shireman said. "Repeated interventions by the Congress and the department were required to ensure that every student and parent who needed a federal student loan received one...As for capital acquisition for federal student loans, it is clear that the federal government is now the sole reliable and sufficient source of federal student loan capital."

According to FinAid.org, a Web site offering financial-aid information, most of the transition risk would be in quadrupling the origination volume in the Direct Loan program, but not with the amount of loans entering repayment.

"Since loans enter repayment as students graduate, the number of new borrowers entering repayment in the Direct Loan program will increase more gradually," according to FinAid.org.

Competitive edge

Also, it's important to maintain a "competitive delivery network," said Jack Remondi, chief financial officer of student-loan provider Sallie Mae, at the Thursday hearing.

"We believe that the best program for the long term is one that allows consumer choice and competition to drive efficiency, innovation and improvement," Remondi said. "By combining choice, competition and innovation with low-cost and stable direct government funding, we will have a system that serves the needs of students, schools, taxpayers, and the 35,000 people who work directly for student loan providers -- all without risk of transition problems or unnecessary additional school expenditure."

He suggested "enhancements" to the administration's proposal, such as:

• Allowing schools to choose their loan delivery platform and originator
• Introducing a new risk-sharing program to require all servicers to have "skin in the game" to minimize defaults
• Requiring the Department of Education to set origination fees via market mechanisms that would preserve broad participation of originating lenders