Last Friday, the President signed into law the student loan “compromise,” promising it would help rein in college costs.
The bill pegs interest rates on federal student loans to Washington’s cost of borrowing (the Treasury rate) plus 2.05 percent and caps interest rates at 8.25 percent. Congress says that this bill will cover 18 million loans, totaling about $106 billion this fall, and reduce the deficit by $715 million over the next decade. But Congress’s promises do not account for the $500 billion in student loans that are currently not being repaid and the one-eighth of students defaulting on their loans.
What will the unpaid loans and student defaults do to Congress’s promise? Likely force Congress to break it—at the expense of taxpayers.
The details are in the accounting practices. The Congressional Budget Office (CBO) has used two different accounting measures to evaluate the cost of the student loan compromise: the Federal Credit Reform Act (FCRA) and fair-value accounting (FVA). Currently, the CBO evaluates student loan costs under FCRA accounting practices, which require that the cost of federal student loans be estimated on “market rates,” but this accounting method does not account for the risk that some students receiving loans will not pay back the government as expected. This is especially problematic when about $180 billion of the $1 trillion in student debt is in default or forbearance.
FVA, on the other hand, accounts for the risk of default, reflecting the full cost of student loans and other federal credit programs. It is the standard accounting method for academic economists.
In June, the CBO released cost estimates using FCRA and FVA for federal student loans. Under FCRA practices, a loan deal using the Treasury rate plus 3 percent—not that different from the new deal passed by Congress—would yield savings of $37 billion this year and $184 billion from 2013 to 2023. However, under FVA, the student loan program will yield $6 billion in savings in 2013 and will cost taxpayers $95 billion from 2013 to 2023. That’s a major difference for taxpayers.
Because FVA practices account for market risk, it is likely that this calculation measure would recognize the 1/8 of students defaulting and the $500 billion that is not being repaid, and factor that risk into the interest rates—providing a more honest account of the program’s costs.
Americans today owe more on student debt than they do on their credit cards or auto loans. Over the past 20 years, college enrollment has increased from 13.8 million to 21 million. In 2011, the average borrower who graduated from a private university left with $28,000 in debt; public college graduates didn’t fare much better, leaving with roughly $22,000 in IOUs.
Continuing to expand higher education subsidies through subsidized federal student loans and grants does nothing to put pressure on colleges to lower costs. In fact, access to easy money does the opposite, enabling universities to raise prices, knowing students can return to the federal trough for more financing. Although Congress will sleep easy now on the student loan interest rate issue, they should not delude themselves into believing they’ve done anything to fundamentally reduce the cost of college.