When Democrats took back control of Congress last year, one of their first priorities was to renew a battle with Republicans over the shape and direction of the federally financed student loan system.

After more than a decade of GOP leadership on Capitol Hill, banks and other private lenders accounted for 80 percent of all government-backed loans, drawing on federal guarantees and subsidies to make a profit. But the new majority party, in an effort led by Massachusetts Sen. Edward M. Kennedy, was determined to shift the bulk of the business to a parallel system of so-called direct loans that come straight from the government. Kennedy and his allies insisted that was cheaper for taxpayers and easier for borrowers.

Until recently, direct loan advocates have faced an uphill battle, with many lawmakers and lender advocates saying that students might not get the same services or benefits from the Department of Education that they do from private companies.

But now, turmoil in the national credit markets may do to many in the private student aid industry what a high-profile scandal didn’t a year ago: push them out of the business. Lenders in the privately operated Federal Family Education Loan, or FFEL, program rely heavily on the same sort of securitized loans that mortgage lenders use. That has given rise to concerns that some might not be able to raise the money that students need.

So far, no student has been denied a loan because the credit crunch is causing lenders to drop out of the program. But the high season for borrowing begins in July, and with the demand for new federally backed private loans exceeding $51 billion last year, the stakes are high. With lenders hurting and students and colleges worried, Kennedy and California Rep. George Miller are stepping up their pressure on the Bush administration to promote the direct loan program. Some say they may succeed in driving schools to abandon private lenders without specifically changing federal policy to do so.

“Rather than having a stated goal of eliminating the guaranteed loan program, which I don’t believe would have support from policy makers or the higher education community, it’s much easier to let the program wither on the vine by taking advantage of these larger market troubles,” said Alexa Marrero, a spokeswoman for Howard P. “Buck” McKeon of California, the senior Republican on the House Education and Labor Committee.

To students, this debate over private lenders vs. direct loans is not readily apparent. Most colleges operate just one program, so students borrow either from banks or from the government without realizing any difference. Schools decide which program to use, so most students never really have a choice.

On Capitol Hill, this has been a different story entirely since 1993, when President Bill Clinton and a Democratic Congress overhauled the student loan system, establishing the parallel programs of both private and direct lending. The Clinton administration strongly favored direct loans, and at one point they accounted for more than 30 percent of all lending.

But a succession of Republican Congresses and the Bush administration reversed that course, granting benefits to private lenders and imposing limits on direct loans. The result was that the market share for private loans soared. Now, the pendulum appears to be swinging again.

The trouble for private lenders started last year when New York Attorney General Andrew Cuomo showed that some were paying schools for their endorsements.

That scandal helped the direct-lending cause promoted by Kennedy, chairman of the Senate Health, Education, Labor and Pensions Committee, and Miller, chairman of the House Education panel. They pushed Congress to cut the federal subsidy for lenders by more than $20 billion. That, in turn, lowered the companies’ guaranteed profit and led credit agencies to downgrade their ratings, making it more expensive for them to borrow. The debt rating on student loan giant Sallie Mae, for instance, is currently just two steps above “junk” bonds.

Earlier this year, the widening global credit crisis began making it much harder for private lenders to get the capital they need to make loans. Essentially, the collapse of subprime mortgage lending also upended the financing route used by student loan companies. The market for securities backed by all sorts of loans, including mortgages and those issued to students, is frozen. And the value of securities backed by student loans has declined the past two months.

“The joke in the industry is that Congress took away half their profits and the credit crisis took away the other half,” said Mark Kantrowitz, publisher of FinAid.org, a Web site devoted to helping students get financing for college.

As a result, a growing number of student lenders are getting out of the business. Last week, the 15th-largest lender, New York-based CIT Group Inc., joined the Pennsylvania Higher Education Assistance Agency, New York-based M&T Bank Corp. and Minnesota-based TCF Financial Corp. in deciding to no longer make FFEL loans.

Some lenders, financial aid administrators and lawmakers — led by Democratic Rep. Paul E. Kanjorski of Pennsylvania — want the federal government to consider putting cash into the private loan market to keep it functioning. Kantrowitz said he expects that additional private lenders will drop out “if there is no government intervention on the liquidity issue.”

Kanjorski and almost three dozen other lawmakers have sent letters to Education Secretary Margaret Spellings, Treasury Secretary Henry M. Paulson Jr. and Federal Reserve Chairman Ben S. Bernanke in recent weeks asking them to explore ways to help lenders. Kanjorski has discussed the idea of giving money to lenders in the same way the Fed floated loans to rescue investment bank Bear Stearns Cos.

But private lenders who need help face a dilemma. “Lenders are sort of putting themselves in this weird spot, where on the one hand they’re raising huge alarms on the viability of their program, and on the other hand are trying to make sure they don’t scare schools into the direct loan program,” said Steven Burd, a senior research fellow at the New America Foundation.

So far this year, according to the Department of Education, 61 colleges have asked to become eligible for direct lending. Two of them — Penn State University and Northeastern University — specifically cited the credit crunch as the reason. While becoming eligible doesn’t necessarily mean they will switch, that’s roughly the same number of schools that moved to the direct loan program in the past two years, according to Kantrowitz.

For colleges, the key concern is whether their students will have access to loans. Those in the direct lending program, which relies on government capital and isn’t affected by the credit crunch, don’t have any worries. But schools that rely on private lenders are starting to wonder if enough will stay in the program.

Private colleges, community colleges and smaller institutions, which find it more costly to administer the direct loan program, are worried the most. They have long relied on the FFEL program because the lenders handle the administrative chores and costs.

Seventeen of the top 100 lenders have left the program since January, according to FinAid.org. In fiscal 2006, those lenders accounted for about 12 percent of federally backed private loans — amounting to more than $6 billion.

The dropout rate has driven the National Association of Student Financial Aid Administrators to warn Congress that there may not be enough lenders to pick up the slack from those that withdraw. “Low-income students, who are the least able to find alternatives, will be the first to face an inability to secure loans,” the group said.

Colleges are particularly concerned because of the time involved in switching to the direct loan program. The Department of Education says it can take anywhere from a few weeks to more than a month for a college to become eligible, and then they need to inform their students and enroll them in the program.

“There probably would be some delays and some rough edges,” Kantrowitz said. “If there’s a rush to the exits . . . you could have a few months where there’s a bureaucratic backlog.”

But instead of focusing on keeping private lenders in the program, Miller and Kennedy have told Spellings to make sure the government’s direct lending program is prepared to handle an increase in loan volume. They have also asked her to remind colleges of the direct lending option.

Rather than ignoring lender needs, or intentionally pushing direct lending, Miller and Kennedy say they are just trying to help students by using the tools they have. Miller “is focused on making sure that the contingency plans that are already built into current law . . . would be ready to become fully operational, if needed,” said spokeswoman Rachel Racusen.

Last week, Miller and Kennedy announced they would favor letting the department buy privately originated loans to help keep lenders in business. Private loan advocates said while that would help lenders in the short term, over time it would boost the government’s market share and aid the direct loan program.

“This shouldn’t be about giving one program a leg up,” Marrero said. “Whether or not that’s intentional, that’s what’s happening.”

Regardless of what Miller and Kennedy say is their intent, private loan advocates fear the result will be that the Department of Education may soon have a monopoly in the student loan marketplace. Once private lenders are gone, Marrero said, “I don’t think that’s something you can undo.”

FOR FURTHER READING: Democrats take aim at student lenders, 2007 CQ Weekly, p. 711; Congress trims loan subsidies (PL 110-84), p. 2620; dividing the student loan marketplace, 2006 CQ Weekly, p. 1460.