AAF: Market-Based Student Loan Rates Benefit Students, Taxpayers

Using market-based interest rates for federal loans to college students would benefit taxpayers and students while trimming the federal bureaucracy, a new report by the American Action Forum finds.

The analysis comes as the House of Representatives is set to consider legislation intended to stave off a doubling of federal loan rates due to take place on July 1st. House Republicans are planning to pass a measure along the lines of the one the right-leaning American Action Forum (AAF) examined to prevent rates from rising from the current 3.4 percent to 6.8 percent.

Pegging the rates charged to the rate of interest on 10-year Treasuries plus 2.5 percentage points for undergraduate loans would save students receiving subsidized loans an average of $335 over the course of the loans, according to AAF. Ten-year Treasury notes have averaged roughly 1.9 percent yield so far this year, the study notes, meaning that borrowers would pay around 4.4 percent on loans, instead of the federally-set 6.8 percent that would apply under current law (graduate student borrowers would pay a separate, higher market-based rate).

The study’s authors, Chad Miller and Scott Fleming, cite estimates from the Congressional Budget Office to conclude that such a reform would also allow the federal government would shift risk off its own sheets and save up to $4 billion over the course of 10 years.

The process for setting student loans rate plan favored by AAF and Congressional Republicans is close to that proposed by President Obama in his fiscal year 2014 budget, although the president would tie rates to 10-year Treasuries at a lower level and lock in the initial rates until the loan matured. Rep. John Kline, (R-MN), the chair of the House Education and Workforce Committee and lead sponsor of the GOP legislation, said that his proposal “largely mirrors” the one included in the president’s budget.

Nevertheless, the White House has threatened to veto the Republican plan because it would have interest rates on student loans reset every year. The White House said that the GOP plan "would create uncertainty and lessen transparency for students and their families who are making decisions about borrowing for college."

Despite the conflict between the White House and Congress, analysts have suggested that the distance between the two sides’ proposals is bridgeable. Matthew Chingos and Beth Ayers, researchers with the Brookings Institution, suggested that it might be possible to reconcile the proposals set forward by the House GOP, the president, and Democratic senators Jack Reed and Richard Durbin. All three plans would base student loan rates on rates paid by Treasuries, although only the Republican proposal would allow the rate to reset each year. “[T]his is a rare example where proposals from our two political parties seem close enough that compromise on a good policy should be possible,” the  Brookings scholars wrote.

Massachusetts Senator Elizabeth Warren, a Democrat and newly-elected liberal favorite, made waves among progressive circles and set herself apart from other legislators with a proposal to limit student loan rates to the rates charged to banks on loans taken out from the Federal Reserve’s emergency lending window. Warren’s plan, however, likely won’t affect the eventual legislative outcome. Chingos and Ayers dismissed it as a “cheap political gimmick.”

Joseph Lawler is editor of RealClearPolicy. He can be reached by email or on twitter.

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