The Student-Loan Deal: A Mixed Bag

by Jason Richwine

On Friday, President Obama signed the student-loan deal that was more than a year in the making.

With the interest rate on federal student loans set to double from 3.4 percent to 6.8 percent last summer, the Obama campaign seized on the issue as part of its outreach to young voters, and the GOP quickly relented and agreed to extend the 3.4 percent rate for one year.

Facing the same problem again this summer, Congress initially took no action and let the rate reset to 6.8 percent. But now, under the new law, the rate will rise and fall with the yield on the ten-year Treasury bond, with a ceiling of 8.25 percent.

Is this good? Well, linking the interest rate to market conditions makes costs more stable for taxpayers. This is an improvement over the old system, and it’s certainly better than some of the alternative “reforms” floated around Congress. (Senator Elizabeth Warren wanted to set the rate below 1 percent, for economically incoherent reasons.)

It’s not much of a victory, however, for those of us, like NR’s editors, who would like to see the federal government get out of the student-loan business altogether. Subsidizing our existing higher-education system will exacerbate its structural problems. The costly four-year college track, for example, does not suit the interests and abilities of many young people who are pushed into it.

The subsidy may also relax the pressure on schools to ensure their courses are affordable and relevant. The president said the new law helps make college less costly for students, but what he really meant is that costs are transferred from students to taxpayers. The law does nothing to reduce the actual price of higher education.

One thing that everyone should agree on, conservatives and liberals alike, is that the cost of the federal student-loan program should be accurately measured. But, as the Congressional Budget Office has warned, the costs are severely underestimated right now, and the new law won’t change that. The reason, in short, is that the government does not adequately account for the market risk it incurs after estimating expected loan repayments. (This is the “fair value” accounting issue, which I wrote about recently for Forbes. For even more gory detail, see here.)

Even if Congress insists on extending generous loan terms to students, it should at least be honest with taxpayers about how much it costs to do so.

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