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.

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5 Responses

  1. Congress’ attitude is really unacceptable,they must do something but not pretend that nothing has happened,it’s so impenetrable.

  2. For those of us who paid off our student loans, do we get a refund with interest?

    How about public school tax on my house? I never attended public schools and I do not have children.

  3. This is just avoiding the problem; the government needs to understand that the student loan industry is a giant scam, demolish it., and run the loans themselves. An Austrialian-style income based payback system would be far better than what we have now. The profit motive in student loans needs to end.

  4. Congress didn’t act on that budget. Actually most parts of the federal government have no FY 2012 appropriation and are on a “continuing resolution.” That is the reason the Obama Administration a few weeks ago implemented a very limited consolidation program which it can do without any legislative changes. (It is NOT an acquisition program.) The program proposed last winter would have been simpler for students and lenders. However there are still lenders who don’t want to give an inch and want to wait it out. Shows what trying to throw a bone to the lenders gets them. And of course there are politicians who don’t want to give the Administration any victories.

    The basic reason why it is always a money maker for the taxpayer when regular FFEL borrowers consolidate into Direct Loan or when DoEd purchases FFEL loans is that (1) the interest goes to the Treasury, not to the loan holder or guaranty agency and (2) the government doesn’t have to pay the loan holder and guaranty agency subsidies for the following 10 or 20 years.

    It is not clear why people think when the government acts as a bank it has to use an accounting system different from the one banks have been using for hundreds of years. You can’t have it both ways. On the one hand you are saying the government makes money after loans default. On the other hand you are saying the accounting method is over-optimistic because you think it under-predicts defaults. Wouldn’t that be over-pessimistic because the govt profits on defaults?

    Although a direct program makes money in comparison to a guaranteed program, assuming the borrowers are the same, the point was irrelevant. The baseline was usually the issue. If the baseline was that most new loans will be guaranteed, then there are savings to be reaped. Now that all new loans are direct already, the only savings to be reaped are converting (acquiring) or consolidating the large existing legacy FFEL portfolios.

    Now that they are getting rid of subsidized loans for graduate students (and subsidized grace periods for undergrads – at least for two origination award years), there are fewer areas for budget savings. It is not clear what Washington will do when it is done harvesting savings from the student loan program. They may have to raise taxes!

    That is not to say that nothing in the accounting system is broken. They got rid of a longstanding Direct Loan on-time repayment incentive (which, by the way had been ignored by lenders and schools which falsely claimed there were more borrower benefits in FFEL). Wouldn’t it be a money maker to incent borrowers to pay on-time and thus disincent delinquency and default? Nope, because they assume program features do not impact how borrowers and loans perform.

    Yes, it is possible that an honest, “fair-value” accounting system would make direct lending more expensive. What advocates of such a change are missing, though, is that such system, if done honestly, would increase the costs of guaranteed lending far more. CBO didn’t look at that in 2010 because the bill on the table was for 100% direct lending. Don’t fall for the fakery of “fair value” accounting. It is (was) the last gasp of Team FFELP and its amen corner on Capitol Hill.

    And what’s all the hubbub about imagined IBR “losses”? If people choose IBR, most are paying something, and the forgiveness is taxable under current law. In 1994 they estimated that one-third of DL student borrowers would choose ICR. It was more like one or two percent. Why would IBR be any more popular than ICR?

    Yes, an Australian-style choice of repayment plans would be better. IBR/ICR only works when it is the only choice of repayment plan. Otherwise the “fear, uncertainty and doubt” crowd defeats it. In the 1990s it was the FFELP lenders and guarantors, who couldn’t offer it and didn’t want schools running to DL. They used their vast marketing resources (paid for by the taxpayer) to tell the college financial aid administrators that ICR was bad for the student. Even a pro-lender GOP Congress couldn’t give ICR to the lenders because the IRS would not allow non-IRS folks to have access to confidential federal tax data — a logical position that protects the public’s view of the sanctity of this data. In Australia, everyone repays based on income and the loan repayments are deducted through the payroll system. It is mildly progressive, as the more successful former students somewhat subsidize those who are not. Because no one can predict how successful they will be, this is an objective, “blind” process (and, yes, many who major in the humanities and liberal arts are more successful than “more practical” majors such as business management, engineering, cosmotology, and medical assistant).

    • I don’t have a lot of time to respond to your comment, but you make this point:

      It is not clear why people think when the government acts as a bank it has to use an accounting system different from the one banks have been using for hundreds of years. You can’t have it both ways. On the one hand you are saying the government makes money after loans default. On the other hand you are saying the accounting method is over-optimistic because you think it under-predicts defaults. Wouldn’t that be over-pessimistic because the govt profits on defaults?

      The government is different from banks because it makes its money by taxes, not profits on interest rates as banks do. Comparing government issued loans to T-bills misses the point because it can always print money to cover its debt, which is just a flat tax on currency. Consequently, the interest rate government loans are compared against is a meaningless measure because the government takes on no risk issuing debt in its own currency. That’s why it should use fair-value rather than accrual accounting. While you’re right that banks were making fortunes as middlemen on FFELP loans, the CBO explicitly projected losses on Direct Loans. The CBO runs the fair-value estimate in Table 3 and the numbers are still positive, meaning the government loses less money than under the FFELP, but it’s not making money as the accrual accounting estimates below suggest.

      Next, the “government is making money on defaults” argument is Alan Collinge’s, not mine, and I’ve seen no evidence that it applies to direct loans, unless ED sells defaulted loans to collection agencies for more than their net present value, which could only work if collectors could slap excessive fees onto the loans. Even if this were the case, if the loans are still bad (and many, many are) then the money paid to the new creditors is money that isn’t spent expanding the economy, e.g. buying houses and toys. This is why student loans, like all unsecured debt, should be dischargeable in Chapter 7. I don’t want to pay bankruptcy judges to spend time deciding who recklessly took on debt for a non-performing degree versus who was a moron to loan them the money in the first place, so the only reasonable option is to place the risk on the moron and tell the reckless person they can’t refile for several years. If you’re in favor it, the Chapter 7 means test is a reasonable block to preventing people from unfairly discharging debts they can actually pay off.

      Ultimately, the federal government’s purpose is to provide for the general welfare, not to make a profit on unsecured, overvalued, nondischargeable loans to pay for other programs. If it needs revenue, it can simply raise taxes as you suggest. The rentier class won’t miss it if we do.

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