When asked what she thought of the student-loan program she helped create 50 years ago, Alice Rivlin, who in the late 1960s headed a task force that decided whether to finance students directly or to finance the schools — before she became the head of Congressional Budget Office and the vice chair of the Federal Reserve — responded, “We unleashed a monster.” Well, that monster could very well rear its ugly head sooner or later, and when it does, it will cost us.
The Wall Street Journal has a story about one banker’s calculations of what the program may cost when the time comes:
The federal budget assumes the government will recover 96 cents of every dollar borrowers default on. That sounded high to Mr. Courtney because in the private sector 20 cents would be more appropriate for defaulted consumer loans that aren’t backed by an asset.
He asked Education Department budget officials how they calculated that number. They told him that when borrowers default, the government often puts them into new loans. These pay off the old loans, and this is considered a recovery, even though in many cases the borrowers haven’t repaid anything and default on the new loans as well.
In reality, the government is likely to recover just 51% to 63% of defaulted amounts, according to Mr. Courtney’s forecast in a 144-page report of his findings, which was reviewed by The Wall Street Journal.
Mr. Courtney’s calculation was one of several supporting the disclosure in a Journal article last fall that taxpayers could ultimately be on the hook for roughly a third of the $1.6 trillion federal student loan portfolio. This could amount to more than $500 billion, exceeding what taxpayers lost on the saving-and-loan crisis 30 years ago.
We can debate whether this number is accurate since modeling is more art than science but the bottom line is that some large amount of money may come due to the federal government and it is not prepared because of accounting rules, unique to Uncle Sam, that allow the liability to look like a potential profit:
Before , the budget treated student loans as an expense. If the government lent $1 billion, the deficit rose by that amount, absent offsetting measures.
The law changed in 1990 to incorporate expected future repayments. Suddenly, loans became a potential source of profits, by assuming that most borrowers would repay with interest. This created an incentive for Congress to expand student lending. Doing so would increase access to higher education either at no cost to the government or with a gain in federal revenue, at least on paper.
Add on top changes in eligibility and repayment rules and, boom, we get this monster.
The worst part is that all of this — bad accounting, use of projected profits that may never materialize, and ultimately a system that incentivizes students to borrow more and more money they may never be able to repay — was just a way for Congress to make it look as if it was reducing federal deficits. And, of course, the projected profits don’t really materialize:
The federal government extended $1.3 trillion in student loans from 2002 through 2017. On paper, these would earn it a $112 billion in profit.
But student repayment plummeted. In response, the government revised the projected profit down 36%, to $71.5 billion. The revision would have been bigger except for the fall in interest rates that let the U.S. borrow inexpensively to fund loans. . . . For fiscal 2019, it projected it would lose 4 cents on each dollar of new loans, federal records show.
Now repeat that scam over many loan-guarantee programs and you understand that the federal government is in even bigger debt than it looks on paper.