Day: 2011/12/04

Student Loan Bailout with a Whimper?

I listened to Cryn Johannsen and Robert Applebaum discuss loan forgiveness and a debtors strike on the Brian Lehrer show.

I’m not sure how loan forgiveness would be operationalized, but the easiest way would be for the government to pass legislation authorizing the Fed to buy student loans off the market and then cancel them. Essentially, the government would be buying SLM’s entire portfolio and saying to the debtors, “Think of it as a grant,” like a doting grandparent. SLM might not be too happy about this, but I doubt more diverse banks, like Citigroup, would lose sleep themselves. The Fed would either print the money or the Treasury would borrow it—much to the joy of America’s Treasury-hungry financial sector—and the government would take a large loss canceling the net present value of the loans.

Yet if you turn to ED’s FY 2012 proposed budget on the Office of Management and Budget Web site, you’ll find that ED intends to spend $37.704 billion in student loan acquisitions.

If you’re wondering whether ED is bailing out lenders, you’re essentially right, as evidenced in ED’s FY 2012 Budget Request (separate document on ED’s site). The acquisitions are a request by ED to allow people to convert guaranteed loans and Direct Loans into a single Direct Loan, the idea being that doing so would reduce defaults on the parts of people who pay to multiple lenders. It’s similar to the Ensuring Continued Access to Student Loans Act of 2008, which allowed ED to purchase guaranteed loans to ensure banks had the capital to make new ones. Instead of waiting for Congress to pass the budget, President Obama authorized ED to do this anyway, and it’ll knock off half a percentage point of interest to boot.

How is ED paying for this? Probably with the magical, mythical proceeds from its existing Direct Loans. Like any other creditor, when ED originates a Direct Loan, it can claim the net present value of the loan up front and use that interest to pay for other things. The problem is that the accrual accounting system ED uses is broken, underestimating the number of defaults and losses due to long-term IBR forgiveness.

Yes, ED is again bailing banks out of a few loans, but it ends before October 2012. Don’t be surprised if Congress quietly does something like this a third time.