In 1992 the Clinton Administration proposed phasing out the federally guaranteed student loan program and replacing it with a direct lending program run entirely by the federal government, claiming that this approach would save taxpayer money and simplify a complex program. Opponents of the Administration plan argued instead for changes in federal laws so that budget targets set in 1994 would be met. Another approach, however, is suggested in this paper: setting up a competitive federal student loan system that would allow lenders to compete with the federal government in making new loans to students, and allow the federal government to compete with the private sector in buying up privately financed loans through secondary markets. At the end of a phase-in period, the final decision would be based on the experiences of both the federal government and direct lenders. Three additional ways to strengthen the Administration's proposal were also suggested: (1) using savings from reduced profits to cut the interest rate to borrowers and eliminate the insurance premium; (2) consolidating the number of federal student loan programs; and (3) restructuring guaranty agencies by making them agents of the federal government. An appendix examines whether direct government lending will save the federal government money. (DM)