A Solution to the Student Loan Embarrassment
The House Committee on Education and Workforce examined the prospects for keeping college within the financial reach of young Americans last week. The hope was to find a longer-term fix for the Stafford loan interest rate hike coming this summer. If you recall, this same issue caused a fiasco last July, when the rate was due to double and the prospect of just a $10 monthly added burden for student borrowers caused an uproar. Ultimately the lower, 3.4 percent rate was extended for a year. That year’s almost up, and it’s time to decide the fate of Stafford borrowers again.
If we’re going to ask taxpayers to come up with the $6 billion necessary to pay for a fixed 3.4 percent rate, we should insist, this time, on durable reform that benefits both students and taxpayers over the long haul. Ideally, this would entail removing the government from the business of loans entirely, but for now, a variable interest rate that floats along with Treasury rates is the best alternative.
A variable rate is nothing new in student lending. They were the law of the land as recently as 2005, prior to the 2006 shift to the 6.8 percent fixed rate on Stafford and unsubsidized Stafford loans. Subsequent changes cut the rates to 3.4 percent over a period of several years, costing an estimated $6 billion a year to keep rates from going back up to 6.8. However, borrower rates on other types of loans, namely unsubsidized Stafford loans and Parent and Grad PLUS loans, were not lowered, creating an inconsistent and confusing interest rate formula for borrowers.
The students see a number of benefits with a variable rate. They’d immediately get lower borrower rates on Stafford loans, well below the 3.4 percent fixed rate in place today, let alone the 6.8 percent rate the law dictates. As long as the economy continues to struggle along and the Federal Reserve keeps in place a low-rate policy for growth, borrowers could actually take advantage of the lowest Treasury rates in recent history and reduce their own loan rates. This environment won’t last forever, but it’s possible for students to get an even better deal from Uncle Sam than they are getting today. At the end of their loan, they’d surely on net come out better than they would now.
Looking at the longer-term window, the variable rate also insulates the federal budget against the risk of fluctuations in Treasury rates. Right now, the Treasury is expected to make loads of money from borrowers as it borrows low and lends high. However, as the difference between borrowing and lending rates shrinks, the federal budget stands to take a hit. When the Congressional Budget Office looked at the issue in 2011, they found that a shift to a variable rate could save more than $50 billion over a 10-year window.
Still, this is not the best policy outcome, as it continues to create ongoing budget risk for the federal government’s trillion-dollar student loan portfolio. Currently we rely on inaccurate estimates of the risk placed on taxpayers through our federal accounting practices. Despite the musing of critics such as the Social Security and Medicare Trustee Robert Reischauer, who underestimates the risks associated with credit programs, shifting to fair-value accounting standards would paint a clearer picture for taxpayers of the risk to their dollars by directly lending to students. If we first accounted for that risk through credit reform, and then incorporated private capital back into the student loan programs, we would shift trillions of dollars of debt off of the federal budget, create private sector jobs, and generate savings that would significantly exceed those associated with a simple switch to a variable lending rate. These savings could be used to support Pell grants and other financial aid programs that so badly need fixing.
Providing students with the financial support they so desperately need to gain skills and compete in today’s workforce is crucial to our success as a country. The last few years have seen short-term fix after short-term fix, muddying the waters for lenders and the taxpayer alike. If we can’t get a permanent solution to our poorly managed direct lending program, a variable rate is a win we can settle for.
