Privatize Student Loans
On July 1, interest rates on newly issued federal student loans increased from 3.4 to 6.8 percent. But the recent news out of the Senate is that a deal was reached to address the jump. That deal would allow borrower interest rates to float based on ten-year Treasury instruments, with a cap of 8.25 percent, which was previously set as the maximum rate on student loans when all borrowers paid a variable interest rate. The American Action Forum projects that the Senate compromise could save the average student more than $3,200 over a typical ten-year repayment period when compared to the current 6.8 percent rate.
The Senate's agreement follows a series of failed votes on alternatives. One bill, for example, would have simply frozen rates at 3.4 percent for a few years, kicking the can down the road at a cost of roughly $7 billion per year when compared to the 6.8 percent rate.
It doesn't have to be this way. Congress is playing with one hand tied behind its back: Legislators seem to assume that the only viable approach is one where borrowers pay a bit more, taxpayers are on the hook for a bit less, and everyone walks away grumpy. A better solution would be to toss out the old model and shift from a bureaucrat-run, government-financed system to a private-capital-based program. Then we'd see substantial savings.
The reality is that the government isn't actually making money on student loans. It never was, despite Congressional Budget Office findings to the contrary.
When assessing the costs of credit, the experts at the CBO prefer to use what's called fair value accounting (FVA). This method takes into account market risk. Unfortunately, the law requires them to use Federal Credit Reform Act (FCRA) standards instead, which have underestimated the cost of the direct-loan program for two decades.
Over the next ten years, the federal government expects to originate over $1.37 trillion in new student loans. The gap between the FCRA and FVA estimates on those loans is $274 billion. Under the CBO's FCRA-based projections, we're supposed to see a net gain for the government of $184 billion. But FVA tells us that what we will get instead is a loss of $95 billion. That's a lot of money, even in Washington.
It would be better to simply ask the private sector to step in and offer the loans to students at the same rates, and backstop the private providers against default. There would be a cost associated with backstopping the loans, but the last time it was measured it ranged from 0.25 to 0.50 percent. On a $1.37 trillion portfolio that's not insignificant, but on an annual basis students borrow about $110 billion, which works out to around $550 million per year.
Meanwhile, this would move $1.37 trillion off of the federal balance sheet, avoid the associated costs of refinancing that portion of the national debt while students repay their loans, and potentially save $95 billion, a $274 billion improvement over the current system, in the process. The federal government could use those savings to benefit borrowers in other ways: buy down rates, increase grant funding, support institutions committed to controlling costs -- you name it.
If we really want to provide a benefit to students, why does it matter who makes the loan? With lending handled by private entities, the government can still manage the terms of the loans (even though recent history suggests it really shouldn't), and students can be protected by the terms Congress sets for participants. It's time Congress stopped playing around the edges and looked at a meaningful reform that could benefit everyone instead of forcing everyone to give their pound of flesh.
Chad Miller is director of education at the American Action Forum.
