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April 02, 2010

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Craigie

All of these discussions seem to start with a status quo of 2009 or 2010 and then posit a change in that status quo with resultant revenue and cost implications. While those comparisons may be important for policymakers looking to make a change in the status quo, they are not necessarily relevant at all for comparing "FFEL vs. DL." Even under the so-called "fair value" version, switching from 100% FFEL to 100% DL would result in significant savings.

Another aspect which has been lost is that there are several other federal agencies which have credit programs -- guaranteed and/or direct. This has always been an obstacle for student loan program participants wanting to "cook the books" for student loans only. If anything, one of the changes which should be made is for the Treasury to charge a lower financing rate to Education than to other agencies; it is apparently a uniform rate across all the agencies. Consider the agencies which offer both a guaranteed and direct version of the same basic lending program. If you look on OMB's website the performance of other agencies' direct loan programs is generally quite poor because these are generally individuals and firms who could not find a bank willing to issue them a guaranteed loan; it is a lender of last resort situation. In contrast, direct student lending provides credit to a representative national pool of borrowers -- ranging from those at schools with microscopic default rates to those at schools with default rates in the very high range reminiscent of the other federal agencies' direct lending programs.

The latest CBO report, which for some reason focuses solely on lenders, omits all the payments flowing from the federal government to guaranty agencies. Most (not all) of those payment flows will continue long after July 1. It is not clear whether these omissions are for the interests of brevity, or whether the actual program cost estimates omit them as well.

FCRA is the closest possible method to how a private individual or bank would estimate the net present value of lending situation. It leaves out some of the less tangible costs that CBO mentions and some that it has avoided. The highly intangible costs, such as the risks of 25% unemployment or 15% interest rates are not appropriate for the official cost estimates but can be assessed through rigorous stress-testing of FCRA-based methodologies.

It is correct that longer repayment plans add taxpayer costs in FFEL but generally reduce taxpayer costs in DL (because borrowers pay interest for a longer period of time). While the simple extended regular and graduated repayment plans have proven popular, the American government has a track record of grossly overestimating the appeal of repayment plans related to income. American borrowers do not seem interested in income-related repayment approaches. This could always change, but don't hold your breath. If CBO is assuming a high uptake rate for income based repayment, that may end up being off the mark. In the rare cases in other countries where income related repayment has been used by lots of borrowers, it has been because it was the only "choice" for repayment.

It is also correct that fixed borrower interest rates introduce unnecessary uncertainty into the cost estimates for FFEL and DL. A variable interest rate with a maximum is still not ideal but at least can float a little bit with the external market conditions. Going back to a somewhat variable borrower interest rate adds more cost advantages for DL over FFEL (and explains partially why fixed borrower rates were phased in by a GOP Congress/Administration several years ago). What would remove the most uncertainty from estimations (for DL at least) would be to have borrowers pay a variable long-term related interest rate and (if new FFELs are ever issued) to pay lenders based on a long-term interest rate. The Treasury doesn't lend to agencies at a short-term rate, so there is a mismatch when paying lenders on a short-term rate. You can of course add less to the long-term rate to make it the same as a short-term rate on the day you enact a particular law, but the reality of the interest rate markets is that short-term and long-term rates frequently don't go up and down at exactly the same proportions; interest rate risk and hedging costs have been shifted from the private sector to the government over time.

The big difference in financing cost, conceded by the major lenders, is that the entity with the lowest borrowing costs around is the U.S. government. This will continue indefinitely unless the government defaults on its debt service payments and possibly even after that. While this doesn't mean the government should finance all types of consumer and business credit, it does mean that when you have the choice between two "big government" social programs whose main difference is how the funds are delivered you probably don't want to choose the one with the higher cost of capital.

Finally, FFEL has been by far the largest loan program for many years, so its administrative costs have been grossly understated. It could easily be reasoned that most of the federal employees involved in any way with student aid have been spending their time administering the different aspects of the FFEL program; you've got salaries, benefits, travel, and so on. In contrast, the administrative costs of direct lending are more skewed towards payments to contractors. While the cost structures are different, they both exist, and it would be a mistake to claim that all of the federal government's FFEL admin costs are blended in with the FCRA financing costs. Some of them are, but some of them are not. The only way "that the move to Direct Lending will increase the deficit by $52 billion on a fair-value basis" would be if the point of comparison is that both FFEL and DL completely stop making new loans.

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