NYT Gets It Wrong on the Student Loan Deal
A recent New York Times editorial gets it wrong by opposing a bipartisan student loan deal that would lower interest rates for all new students today while permanently addressing student loan rates in a sensible and fiscally responsible way.
The deal, as we've explained before, will replace the current system of fixed nominal rates which can only be changed through an act of Congress with a system that links new fixed-rate loans to the ten-year Treasury bond rate. Specifically, undergraduate Stafford loans would be set at 2.05 percentage points above the Treasury rate (with a 8.25 percent cap), graduate Stafford loans would be 3.6 percentage points above Treasuries (with a 9.5 percent cap), and GradPLUS and parent loans would be set at 4.6 percentage points above with a 10.5 percent cap. In practical terms, this means a 20-40 percent rate cut compared to rates that are currently in place for most new students this year, with rates gradually rising over time as the economy recovers.
The New York Times opposes this deal, arguing that the government should not be "making money off the backs of struggling student borrowers," that rates for "loans in future years could rise as high as 8.25 percent," and that the legislation requires "future college students to pay for the financial break enjoyed by students who precede them." Unfortunately, all of these claims are misleading, as are many other claims in the NYT editorial.
Student Loan Profits
The Times claims that the government will earn $184 billion in profit over the next decade from its student loan programs to make the case that the government should not be profiting on students.
They cite a Congressional Budget Office estimate, but get their numbers a bit wrong by looking over an eleven (rather than ten) year period and failing to account for administrative costs. In reality, the mandatory cost of direct loan programs is more like $137 billion. And it is quite important to understand where that $137 billion comes from.
About half of the $137 billion in alleged profit is due to the fact student loans are not currently linked to Treasury bonds, which means that they have thus far been unable to take advantage of low economy-wide interest rates. The New York Times suggests that the current law method for setting rates is "sensible" since they provide certainty to families. But the flip side is that they provide a benefit to the lender (the government) relative to the borrower (the student) when interest rates are low, a problem which would more or less be fixed under the Senate bill.
The other half of the alleged profit comes from a decision by Congress and the President to re-allocate funds from student loans to Pell grants for low-income students. Specifically, both the Budget Control Act and the reconciliation portion of the Affordable Care Act reduced spending by ending subsidized loans for new graduate students and by eliminating the guaranteed loan program in favor of direct loans, respectively. In both cases, the savings were used to finance Pell Grants and other education programs. One can argue about the relative merits of Pell Grants versus student loans, but it is a net wash for students on the whole and was a conscious choice that we cannot ignore in making future policy.
When one removes the effect of the lower rates and the legislative reallocations, the profit disappears (seen in the solid blue line in the graph below).
Net Outlays of Direct Student Loans, FCRA Method and Fair Value Method (billions)
Source: CBO, CRFB
Note: Fair-value estimate of BCA change is estimated to be the same as the traditional estimate, although in reality it may differ slightly.
"Steady State" estimate assumes the 2018-2023 subsidy rate applies for all years.
More fundamentally, it is not at all clear there was any "profit" there in the first place. By law, Congressional Budget Office estimates of loan programs aim to measure the lifetime value of the loan in the year it is made after accounting for defaults and adjusting future spending to the "present value." But current law does not charge the government for market risk, even though many experts believe calculations should include a risk premium which accounts for changes in macroeconomic conditions. CBO itself has made the case for this "fair-value accounting" before, and under this approach the $137 billion in profit becomes about $114 billion of government cost.
Rates as High as 8.25 percent?
One reason the New York Times opposes the student loan bill is because it would eventually allow subsidized student loan rates to rise beyond the 6.8 percent rate under current law to "as high as 8.25 percent." This is true in a technical sense -- if ten year Treasury rates rise to 6.2 percent then student loan rates could rise to 8.25 percent (due to the cap, they could not rise higher).
Of course, the New York Times fails to mention the flip side -- that if ten-year bonds are below 4.75 percent (they are at 2.6 today), then students would face a lower interest rate than under current law. They also fail to mention that neither budget agency is projecting student loan interest rates to be near the 8.25 percent cap. CBO's projections suggest a rate of 7.25 percent in 2023, and OMB a rate of 7.05 percent in that year. Note that neither are far from the 6.8 percent rate under current law.
As rates in the rest of the economy rise, however, it only makes sense that student loan rates rise. This approach keeps the subsidy roughly constant, rather than offering huge windfalls to some cohorts of students and generating profits from other cohorts.
Future College Students Paying for Current Students?
The Times claims that the Senate "bill pits students against one another, requiring future college students to pay for the financial break enjoyed by students who precede them."
CRFB is among the biggest advocates for future generations, but on this issue the Times has it backwards. Under current law, current students are subsidizing future students. That's why of the $137 billion of claimed profits over the next ten years, about $95 billion are in the first four years. When interest rates in the rest of the economy are low, those borrowing at 6.8 percent are being punished relative to those borrowing at 6.8 percent when interest rates are high.
Under the Senate bill, current and future students will pay interest rates based on the government’s cost of borrowing. This doesn't pit students against each other any more than today's new homebuyers are pitted against those who take out mortgages in future years. The Senate bill instead starts to even out the government subsidy over time, rather than having it fluctuate as Treasury rates change.
Estimates of Direct Student Loans With Senate Deal, FCRA Method and Fair Value (billions)
Note: Proposal Fair Value line may be slightly off due to differences in the estimate of the bill under fair value accounting.
The bipartisan student loan agreement being considered by the Senate a sensible solution for solving the current impasse on loan rates by allowing those rates to respond to market conditions. The nominal rate will go up and down, of course, but the government subsidy will remain stable. As currently constructed, the proposal is also fiscally responsible, paying for itself over the next ten years and getting policymakers out of the position of governing by crisis on student loans one year at a time. Yet the New York Times suggestions that the bill is profiting off of students, pitting those cohorts of students against each other, and driving rates to unaffordable levels are just plain wrong.
We welcome a debate on the future of higher education funding. But it should be an honest debate.