House Democrats on Wednesday will start work on legislation that would cut private lenders out of the federally backed student loan marketplace, with the U.S. Education Department replacing them as the main provider of student loans.

The proposal was a central feature of President Obama's budget request to Congress in February.

According to the nonpartisan Congressional Budget Office, the policy change could save taxpayers $94 billion over the next decade. That money would then be reinvested in federal grants for lower-income students to help offset the cost of going to college.

The House Education and Labor Committee on Wednesday will first hear testimony from Education Secretary Arne Duncan, followed by a Thursday hearing that focuses on the proposed changes to the student loan market.

Rep. George Miller, D-Calif., the chairman of the panel, has signaled his support for the Obama plan. A spokeswoman for Miller said he believes the existing program is too reliant on the ability of lenders to borrow money from the capital markets.

"The fact of the matter is that the program is not working right now, that private capital isn't available for these loans," said Rachel Racusen, communications director for the committee.

The federal government stepped in last year to provide capital to private-sector student lenders after the credit markets dried up as a result of the financial crisis. No student was unable to get a loan, said Racusen, but Miller wants more stability in the provision of financing for students.

Bob Shireman, deputy undersecretary at the Department of Education and the Obama official who is leading the push on the student lending reforms, said the tightness of the credit markets had effectively shined a light on the shortcomings of the existing lending program.

"The credit crunch brought home the fact that the program doesn't provide a reliable source of capital," Shireman said in an interview.

The Department of Education currently accounts directly for about 30% of the guaranteed loans made each year, with the private sector making up the rest. Colleges generally choose whether to work with the government or private lenders to provide financing to their students.

Shireman sought to dispel the notion that it would be government employees administering the lending under the new plan. He said that Accenture Ltd. (ACN), the business consultancy, has a contract to originate all the lending done by the Department of Education.

Student lending by commercial financial institutions has shrunk in the last 19 months as a large number of players have withdrawn from the market.

But active lenders and schools that rely on private lenders for the bulk of their guaranteed loans have strongly opposed the proposed changes, arguing the Obama plan would end private involvement in a market that has worked well for students and for colleges.

"Once you dismantle an entire sector of private industry, it's going to stagnate or disappear," said Brenda Dillon, head of student lending at Cleveland-based KeyBank, a unit of KeyCorp (KEY), which lent around $500 million in federally backed student loans in 2008.

The nation's largest student lender - SLM Corp. (SLM), or Sallie Mae - has circulated an alternative plan that would allow private lenders to continue to play a significant role in the market.

"We need a lot more details, but it would seem that our role would be dramatically reduced," said Martha Holler, a spokeswoman for Sallie Mae.

Joe Russo, who has worked in financial aid at Notre Dame University for 30 years, is a strong advocate of the current system.

"Literally millions of borrowers have borrowed billions of dollars, and it's been one of the best examples of public-private partnerships in American history," said Russo, director of student financial strategies at Notre Dame.

Nancy Coolidge is a financial aid planner at the University of California system and a proponent for changes to the student lending system.

"The fact is the student lending program has suffered hugely because of the shortage of cash; now the feds have to give the lenders the cash to make the loans," said Coolidge. "What is the point of the program continuing?"

Opponents have raised questions about the savings that could come from altering the student loan system, arguing the $94 billion figure is optimistic and implies that the current historically low borrowing costs will continue.

According to one industry source, the CBO could in the next couple weeks lower its estimate to around $85 billion. A spokeswoman for the CBO didn't return phone calls seeking comment.

Others have questioned the way Obama administration officials have characterized the savings as savings for taxpayers coming from the end of federal subsidies paid to private lenders. The reality, according to the Consumer Banking Association, is that the bulk of the savings will actually be profits the federal government makes on the loans once it owns them.

"My blood starts to boil when the administration talks about this [savings] as subsidies to lenders, because none have been paid," said John Dean, a special counsel to the consumer banking group.

-By Corey Boles, Dow Jones Newswires; 202-862-6601; corey.boles@dowjones.com