‘If the Federal Reserve can float trillions of dollars to large financial institutions at low interest rates to grow the economy, surely they can float the Department of Education the money to fund our students, keep us competitive, and grow our middle class.”
That is the logic behind the first piece of legislation from Harvard Law School professor-cum-Massachusetts senator Elizabeth Warren, introduced in the Senate two weeks ago. The Bank on Students Loan Fairness Act seeks to extend to students the same loan interest rates allegedly offered to the country’s chief financial institutions. Among the problems with the bill? Said interest rates for said greedy banks do not exist. But that is a minor detail in Warren’s latest exercise in cheap populism.
During the summer of 2012, as Barack Obama and Mitt Romney competed in a game of “How Low Can You Go?” on federal student-loan interest rates, Congress tussled to a stalemate on the issue, settling for a one-year extension of the 3.4 percent interest rate on subsidized Stafford loans, those available to students with demonstrated financial need. The government pays the interest on subsidized Stafford loans while the student is in school (hence “subsidized”). But the current rate extension is set to expire July 1, and if Congress does not act, the interest rate will double for 7 million students.
“We can’t afford to wait,” Warren has said, doing her best to rally supporters to action in a made-up crisis. We are in need of a long-term solution, but Warren’s bill is not it.
Brookings Institution fellows Matthew M. Chingos and Beth Akers dismiss the proposal as “a cheap political gimmick.” Not only would it be in effect for only one year, but, as they neatly summarize the proposal’s approach, it “confuses market interest rates on long-term loans (such as the ten-year Treasury rate) with the Federal Reserve’s Discount Window (used to make short-term loans to banks), and it also does not reflect the administrative costs and default risk that increase the costs of the federal student-loan program.”
In pushing her bill, Warren, for her political convenience, has studiously misrepresented the interest rates extended to banks. “The banks pay interest that is one-ninth of the amount that students will be asked to pay,” she complained. “That’s just wrong. It doesn’t reflect our values.” Warren derided the notion that “the banks get exceptionally low interest rates because the economy is still shaky and banks need access to cheap credit to continue the recovery,” adding, “our students are just as important to our recovery as our banks.”
What Warren is alluding to is the Federal Reserve Discount Window, which the Fed defines as “an instrument of monetary policy that allows eligible institutions to borrow money, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions.” Warren may have been a professor in a past life, but even the most rabid deconstructionist is unlikely to associate an “institution” that has “temporary shortages of liquidity” with a typical college student.
But it is not confusion; it is misrepresentation. The Discount Window is an emergency measure used to prevent runs on banks; it is offered “short-term.” And these measures are typically very short-term: frequently, overnight.
As the Daily Beast’s Megan McArdle observes, “No one except possibly a lunatic has told Elizabeth Warren that banks are getting 0.75 percent at the discount window as a thank-you for all the hard work they’re doing helping the economy.” Banks get those low rates for three sound reasons: “The borrowers have assets and income that are easy to seize, the loans are quite short term, and the banks are required to put up collateral. . . . Students, on the other hand, are borrowing for a decade, and the only thing they’re putting up as a guarantee is their character.”
One could argue that all of this is a bit wonky for the senior senator from Massachusetts, but she claims her argument is based on “the numbers.” Numbers like these, for instance: The predatory federal government makes a 36-cent profit for every dollar it lends to students.
But, as might be expected, Warren’s numbers are partial. The Congressional Budget Office typically measures the cost of a loan according to the standards of the 1990 Federal Credit Reform Act, but that act does not account fully for the cost of the risk the government assumes when it issues a loan. An alternative is the “fair value” approach, which does take into account “market risk,” that component of financial risk that remains even when every caution is taken — the risk of simply being in the market. When student loans are assessed using the fair-value approach, it is clear that the government is not making money on lending, as Warren claims; it’s losing money. The CBO projected that every dollar lent in 2010 by the William D. Ford Federal Direct Loan Program (FDLP), administered by the Department of Education, would add 13 cents to the federal deficit. Given that the government disbursed $27.7 billion in subsidized Stafford loans, that 13-cents-on-the-dollar ended up costing $3.6 billion. Subtract what the government made back at the current student-loan interest rate (a paltry $91.8 million), and the Department of Education added $3.5 billion to the federal deficit in 2010, only on subsidized Stafford loans. And that was with an interest rate nearly ten times what Warren wants.
But it gets worse. One of the numbers Warren conveniently forgot to consider was the cost of student-loan defaults. In fiscal year 2011, 9.1 percent of students defaulted on their federal student loans within the first two years of payment. Moreover, the Department of Education anticipates that 23 percent of the subsidized Stafford loans it makes this year will default. Jason Delisle, director of the New America Foundation’s Federal Education Budget Project, notes that this makes Stafford one of the federal government’s riskiest loan programs. The Federal Housing Administration mortgage program, which also lends to high-risk borrowers, expects only 7 percent of its borrowers will default. Delisle explains:
To be sure, the student-loan program should serve high-risk borrowers. By their nature, students generally do not have collateral, earnings, or credit histories. But when nearly a quarter of the loans are expected to default, charging a 6.8 percent interest rate is hardly the usury Senator Warren suggests. A non-profit credit union would charge at least double that rate.
But all of these numbers are tiresome for Warren, whose first Senate bill turns out to be a rehash of her campaign: shameless populist demagoguery.
— Ian Tuttle is an intern at National Review.