Federal Student Loan Program Saves Government Money, For Now
Student advocates who argue for generous federal loan interest rates got a boost this week with a new study from the Congressional Budget Office that says the current makeup of federal financial services for college students actually saves the federal government money.
The report likely will be influential as Congress considers how best to address the impending July 1 interest hike on the subsidized Stafford loans millions of students rely on to pay their way through college. In the past month, the House passed a bill to overhaul how these rates are set while the Senate has introduced several bills of its own. And in April, the White House set the tone with its plan that would prevent student loan interest rates from becoming a political bargaining chip again.
Earlier in June, Senate leaders failed to pass dueling fixes to the imminent interest rate increases.
The CBO, which serves as the fiscal fact-checker for Congress, projects that between 2013 and 2023 the deficit will shrink by $184 billion due to savings from federal student loans. That estimate is based on the assumption that the interest rate for subsidized Stafford loans will double on July 1 from 3.4 to 6.8 percent. However, if any of the handful of the interest-rate proposals by the White House and Congress become law, the CBO’s projections will change.
The CBO also considered some of these scenarios that have been proffered by advocates and lawmakers who wish to overhaul the federal direct lending program. Below are a few:
- “Keep the current rate of 3.4 percent on subsidized loans rather than allowing it to double as scheduled under current law. That option would increase the cost of the student loan program to the government by $41 billion between 2013 and 2023;
- “Restrict access to subsidized loans to students who are eligible to receive Pell grants while allowing the interest rate to rise to 6.8 percent, or eliminate the subsidized loan program altogether. Those alternatives would increase the government’s savings during the 2013–2023 period by $21 billion and $49 billion, respectively;
- “Keep the rate on subsidized loans at 3.4 percent and restrict access to subsidized loans to students who are eligible to receive Pell grants. That option would increase the cost of the student loan program to the government by $1 billion between 2013 and 2023.”
The projected savings are largely explained by the discrepancy between the interest rate the government uses to borrow money and the rate it charges students. Right now, the U.S. Treasury borrows at a very low percentage, due in part to the slow economic recovery and the determinations of the U.S. Federal Reserve. But with most economists expecting a rosier economic picture down the line, federal borrowing rates will rise. As a result, the difference between what the government borrows and what it charges lenders will converge, eating into the savings created by the federal direct loan program. The budget report states that savings from the program will decrease in the second half of the next decade.
There’s a snag in the calculations, though: Unlike budget projections for most federal agencies, the government uses a method of estimating the price tag for issuing loans that’s different from what the private sector uses to set its fiscal forecasts and interest rates. Whereas the fair value approach takes into account the risk the lender undertakes for issuing loans to borrowers (especially young ones with little to no credit history), the Federal Credit Reform Act of 1990 (FCRA) told government budget crunchers not to factor in those risks the same way. The federal student lending program falls under the FCRA. Last year, EWA wrote an explainer on this legislative art; the quick takeaway is that the fair value model turns the loan program into a $95 billion loser for the government, according to the CBO.
Background on the competing bills
Known as H.R. 1911, the proposed act, which passed the House in May along mostly party lines, would create a tier of interest rates on student loans built around the 10-year Treasury bond. For all Stafford loans, subsidized or not, a 2.5 percent point surcharge will be added to the market of the Treasury note, and will be capped at 8.5 percent. For PLUS loans, a 4.5-point surcharge will be assessed and capped at 10.5 percent.
While similar to the president’s proposal that was first floated in his April budget, the House version is different in several ways. For one, it would assign a variable rate to the interest on each loan. Rep. George Miller (Calif.), the education committee’s top-ranking Democrat, voiced the concerns of his party when he said H.R. 1911 would “create a huge amount of uncertainty for students and families thinking about financing their education.” The House bill also includes language that permits borrowers to consolidate their outstanding balances.
Any proposal tied to the 10-year Treasury note will be a mixed blessing for students. Presently, federal borrowing rates are so low the proposed student loans would actually save borrowers money. But as the economy heats up and the interest rate on the Treasury bond rises, those same student loans will become pricier than they are now. The CBO expects federal borrowing rates to rise in the second half of the next decade.
House Democrats, like some of their colleagues in the Senate, favor extending current rates through 2015. On the Senate side, the leading bill is called “Student Loan Affordability Act,” which would keep last year’s down-to-the-wire law on the books for another two years. The Congressional Budget Office has calculated that bill’s effect on the national budget—mixed in with other portions of the bill, the CBO calculates the bill will save the federal government money.
Confused by the terminology? The Center for Budget Policy and Priorities has a breakdown.
Sen. Elizabeth Warren, (D-Mass.) struck a populist nerve with her student loan fix. If enacted, the “Bank on Students Loan Fairness Act” would peg the subsidized Stafford loan rate to what banks are charged by the Federal Reserve through the “Discount Window”—an overnight lending mechanism that gives banks access to liquidity that they repay soon after. While popular among student interest groups and some liberals, many analysts ridiculed Sen. Warren’s bill for what they say is a conflation of long- and short-term lending realities. Loans with terms that stretch out a decade or more tend to have higher interest rates that the current .75-percent rate offered through the Discount Window.
And Sen. Kirsten Gillibrand (D-N.Y.) proposed a bill that would refinance any federal student loan with an interest rate above four percent into a fixed four percent loan. Nine out of 10 federal loans would be affected.