The Federal Government is NOT Making Money on Student Loan Defaults

Homer: And you didn’t think I’d make any money. I found a dollar while I was waiting for the bus.

Marge: While you were out “earning” that dollar, you lost 40 dollars by not going into work. The plant called and said if you don’t come in tomorrow, don’t bother coming in Monday.

Homer: Woohoo! A four-day weekend!

The Simpsons, “Lisa’s Rival”

Observers of the student debt bubble quickly point out that the Department of Education expects to make a gross recovery of $1.02 to $1.22 on every dollar of defaulted loans, and when collection costs are included, the net recovery is 85¢ on the dollar. This, of course, is madness, especially when credit card defaults give the creditors a more realistic 10¢ on the dollar. Often, debtors pay off some student debt before going into default, so the 85% recovery only applies to the remaining balance. The government can often make a profit anyway. According to the Wall Street Journal:

[T]he government stands to earn $2,010.44 more in interest from a $10,000 loan that defaulted than if it had been paid in full over a 20-year term, and $6,522.00 more than if it had been paid back in 10 years.

FOX Business blithely asks, “Default Rates Climbing for Student Loans: Who Pays?

[A]ccording to government officials [WHO???], the default rates should not cause alarm, as they argue the profits brought in from student-loan programs more than offset the balance on loans that went under.

Picking on FOX isn’t particularly challenging (though its business channel is milder and gets credit for quoting the Chronicle of Higher Education’s Kelly Field), but combined with the WSJ article above, its sentiment isn’t as uncommon as one might think: Some loans are going into default, the government isn’t losing much money on them, and even if it is, the profits from the rest of the system make up for it. Everything’s fine; borrow responsibly.

NOT TRUE!

First, the default rate is higher than the media realize because the DoE only tracks defaults that occur two years into repayment rather than defaults system-wide. As Alan Collinge ominously puts it, though using outdated data:

Based on Inspector General Data initially reported on by Nick Perry of the Seattle Times, and in view of recent 5-year default data, We are confident that the true default rate across all federal student loans is between 25 and 33 percent (perhaps even greater) – clearly higher than described in the Chronicle article, and higher even than the default rate for sub-prime home loans, payday loans, credit cards, or any other lending instrument in this country.

Second, we turn to the Simpson’s exchange that pops into my mind whenever I think of opportunity costs in economics. When people are forced to repay a loan rather than save money or spend it on consumer goods, they’re not contributing to economic growth. They’re also discouraged and often barred from fully participating in the labor force, which means they’re highly unproductive too.

If the government claims the system is working well overall and taxpayers aren’t losing their shirts, it should compare its student loan “profits” to the lost tax revenue from zombie debtors. Money going to the DoE is the dollar that Homer Simpson found; the federal government lost more in potential tax dollars and overall economic growth by standing at the bus stop than by accepting the fact that an uneducated productive workforce is better for everyone than an educated (if that) unproductive one. The situation benefits no one, and as a result that underused indicator of economic unhealth, the ratio of total economic debt to GDP, rises.

The obvious solution is to rescue student debtors and do a 180 on student lending laws and the bankruptcy code, for bankruptcy redistributes capital from unproductive uses to productive ones. See, that’s what makes capitalism better than feudalism. Astonishingly, debt peonage injustices the scope of the consequences. There’s a word for what happens when people are forced to pay down debt instead of saving or spending money: Disinflation.

If only we could give FOX Business’s government officials a “four-day weekend.”

4 comments

  1. The feds aren’t really making money on the defaulted loans, because the feds pay other costs. But the private lenders who made guaranteed loans ARE making money. They made a no-risk loan, that can never be discharged by the debtor, and in many cases will be immediately repaid by the government if the debtor defaults.

    So it’s not a good deal for the feds to force debtors into default, but it’s a very good deal for the private lenders to do so, and no one seems to be talking about that. The student loan regulations FORCE private citizens to pay INDEFINITELY to private corporations that took on NO RISK in making the loan.

  2. Collinge has been passing around the same misinformation for years. That is not “Inspector General data”. It is the same source Collinge continues to slam. OIG is merely parroting ancient forecasts from OMB. Those forecasts have been updated twice a year for almost a decade since that tired old document.

    Why doesn’t Collinge simply use the updated info? He’s not stupid. Because, just like the OIG “data” doesn’t support Collinge’s argument, the newer data is even less favorable to him. The student loan program of the 2010s is not the same as the student loan program of the 1980s and 1990s (the source of the backup data used for the budget projections).

    The bottom line is yes, there are market segments which have a 20-year default rate of 33 percent, but those segments represent only 5 to 10 percent of loans, and Collinge knows it. There are other, larger segments that have a 20 year default rate of 10 percent or less, so the composite is about 15 percent.

  3. The “budget lifetime default rates” linked below are the updated figures corresponding to the older ones that OIG cited from OMB nearly a decade ago. Unfortunately this chart does not indicate the percentage of loan volume attributable to each sector, although that break-out has been available in the press which has obtained the loan volume figures of recent years from the government. I am not claiming that, at some point in the future, for profit students will never represent the majority of postsecondary education students. We simply aren’t there yet. If we do get there, then Collinge’s suppositions may come true, in that the high proprietary school (for profit) default rate begins to become a proxy for the summary composite rate.

    http://ifap.ed.gov/eannouncements/122010CDRlifetimerate2010.html

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