About a week ago, I wrote about how the government recently made $50 billion off student loans, arguing that given the $1 trillion in debt held by students already, this large a profit was wrong. While I didn’t mention it in the article, the implication of my argument was that student interest rates should be lowered for the foreseeable future, and that as long as administrative costs were covered, rates at the very least shouldn’t go up. Unfortunately, due to congressional inaction, student loan rates recently doubled, from 3.4% to 6.8%. There have been calls to lower this rate back to 3.4%, but some argue that rates should not be lowered. A recent Wall Street Journal editorial espoused this view, arguing that, even given the rate increase, student loans will actually end up costing taxpayers $95 billion over the next 10 years.
The source for the WSJ is a recent CBO report. This report, the WSJ says, reveals the flawed accounting of those who claim that student loans are making the government money. The editorial points to this quote in particular:
“CBO projects that direct student loans issued between 2013 and 2023 would cost $95 billion on a fair-value basis, in contrast with the projected savings of $184 billion under FCRA accounting”
The report gets pretty incomprehensible pretty fast, so lets break it down. We have two numbers for how student loans will affect the budget: either a $95 billion cost or $184 billion is savings. What’s causing this $279 billion difference? The Fair Credit Reporting Act (FCRA), whose accounting produced the savings number, calculates profit by looking at the discrepancy between government borrowing rates and student loan rates. The WSJ claims, accurately in fact, that FCRA accounting doesn’t take into account market risk, which is the risk that rising interest rates and poor economic conditions would cause more student loan borrowers to default. Fair-value accounting, which came up with the more costly estimate, does account for this market risk, hence the extra $279 billion in costs compared to FCRA accounting.
While fair-value accounting seems like common sense, it completely misrepresents how federal student loans actually work. Market risk really isn’t as much of an issue for the federal student loans system because it is structured in a completely different way than the private loan market. For starters, borrowers cannot default on federal student loans. If the WSJ had read just one paragraph further in the CBO report, they would have seen that the government has all sorts of tools for handling defaults that the private market does not. If a student can’t make their payments, the government can “deduct loan payments from the wages, federal tax refunds, and Social Security benefits” according to the report. Fair-value accounting ignores the use of all of these unique tools.
What the WSJ is basically saying in its editorial is that by not raising interest rates the government is making about $279 billion less over 10 years than if it were a private lender. But, as I argued in my last post, taking on the role of a private lender is not what we want the government to do. Recouping the entire $279 billion difference would require raising interest rates and turning the federal student loans program into a full-fledged, for-profit institution instead of the coincidently profitable institution it is today.
I stand by the point I made earlier, that the $50 billion profit the government is making off student loans is too much, and that in times of low borrowing costs for government the interest rate should be lowered further, while still covering administrative fees. However the profit under the old 3.4% rate is more palatable than using whatever rate would be necessary to eradicate the supposed cost of student loans under fair-value accounting. When borrowing rates start to rise for the government again, I believe we should revaluate the student loan rate. Until that happens though, focusing on the imaginary burden federal student loans impose on taxpayers, instead of the burden they impose on struggling students, is both a misleading and unproductive approach to understanding the issue.