The Student Loan “Crisis” In Context

I’ve been doing some long-over-due cleaning out of old files and papers the past week or so (call it the flooded-basement stimulus program). Among the documents I rediscovered were my student loan payment records. (You’d think that etched stone tablet would be hard to miss, right?) Yes, I did actually pay off my student loans–ahead of time, even. But what struck me was the interest rate I was charged on my subsidized federal student loans: a whopping 8%.

It got me wondering about the current “crisis” over student loan interest rates, which yesterday jumped to a fixed 6.8% (from 3.4%) for most subsidized loans in the coming school year, and how this new rate compared to historical student loan interest rates. A quick look at‘s report of historical student loan rates is very revealing:

  1. 6.8% is the fixed rate that Congress had originally approved for the 2006-07 and 07-08 academic years, before Congress started cutting it down to the recent fixed 3.4% rate. So the jump essentially restores the pre-recessionary interest rates.
  2. Prior to 2006, subsidized student loan rates were substantially lower, but were adjustable-rates, not fixed. Congress set the fixed rate for 2006-07 because the adjustable rate formula was resulting in higher interest rates that year (7.14% in 06-07 and 7.22% in 07-08). Congress apparently foresaw a future of higher interest rates, making a fixed 6.8% seem like a deal. Nice job, Congress!
  3. But then a funny thing happened on the way through the recession–all those adjustable rate loans from pre-2006 suddenly got a lot cheaper as Bernanke and gang pushed interest rates down. Just when Congress thought they “fixed” the student loan problem by fixing interest rates, they instead cost students (and taxpayers) millions of dollars in extra interest payments (or loan defaults, in the case of taxpayers). Students paying on loans made prior to July 2006 paid only 2.47% interest in 2010-11 compared to 4.5% for loans made that year….or 6.8% for loans made in 2006-08. FinAid doesn’t have numbers up for 2011-12, but given where interest rates have been it is a safe bet that the adjustable rate was still below the 3.4% for loans made that year. Nice job, Congress!

And therein lies the heart of the current debate: Republicans–and Mr. Obama–want to go back to adjustable interest rates that will at least reflect some sort of economic sanity, moving up and down a bit as the market interest rates move. Set aside the fact that those two parties want rather different formulas, and both would continue to undermine the financial well-being of students long-term…though Obama’s would do worse. Democratic Congressional leaders, on the other hand, want to stick with very low fixed rates, even as the cost of money is increasing. But Congress in general–and Democrats in particular–have a long-standing penchant for ignoring economic reality, or acting in economic ignorance, or both.

Which brings us to the final revelation: Congress’s student loan accounting fraud. According to a recent Congressional Budget Office report, the student loan program (including the rate increases that just went into effect) will help reduce the deficit by $37 billion in FY 2014 and by $184 billion from 2013-2023…as long as you ignore the economic reality of those loans. Congress (in the Federal Credit Reform Act of 1990) forces CBO to ignore fair-value accounting principles when it calculates the budget effects of subsidy programs like student loans. In their report on the effects of different student loan policy options, CBO makes this clear:

On a fair-value basis, CBO projects that the student loan program will yield $6 billion in savings in 2013 and will have a cost of $95 billion for the 2013–2023 period as a whole, compared with projected savings of $37 billion this year and $184 billion for the entire period on a FCRA basis.

In other words, even with the jump back to 6.8% (current policy) the student loan program is expected to increase the federal deficit by $95 billion over the next 10 years, despite the rosy numbers generated by Congress’s imposed accounting standards. That deficit ding increases to $136 billion if Congress reverts back to the fixed 3.4% rate.

Now you may say, “what’s a measly $136 billion to a $17 trillion total federal debt?” Fair point. Of course, that kind of thinking is why we have a $17 trillion debt to begin with.

Critics of the increase in student loan rates fear that higher interest rates will make college unaffordable for students. By historical standards, this argument is pretty weak. College participation rates increased substantially even before the rate cuts that got us down to 3.4%. Moreover, as I argued here, cheap money and increased demand only serves to drive up the cost of higher education, which results in even more student debt. As long as Congress continues to artificially manipulate the cost of student loans, ignore economic reality, and inaccurately account for the costs of the programs, the student loan “crisis” is never going to be resolved.


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