The Agenda

Brief Note on the Student Loan Controversy

In light of the recent discussion of federal student loan policy, I thought I’d point you to:

(1) Jason Delisle’s excellent post on the federal student loan program and why we might want to limit subsidies:

To see why the government’s cost of borrowing doesn’t capture the full cost of making a student loan, consider an example similar to one that Debbie Lucas at the MIT Sloan School of Management uses. Let’s say the government issues $100 million in 10-year U.S. Treasury notes to finance $100 million in student loans with 10-year repayment terms. Assume that after the 10 years is up, the student loan portfolio has suffered losses such that the U.S. Treasury bonds cannot be fully repaid with the loan repayments alone.

Does the government then default on its debts? Of course not. It taps taxpayers to make up the losses and repays bondholders in full. Note that this makes taxpayers equity investors in the student loan program – it is their money that will be used to absorb 100% of any losses on the loans to ensure U.S. Treasury bond holders are always repaid.

That highlights a key point: the interest rate on U.S. Treasury securities tells us what investors want to be paid to lend with zero risk of default. Federal student loans are not, however, free of default risk. The U.S. Department of Education expects that about 19 percent of loans made to students in 2013 will default at some point. Yes, cost estimates can build those default rates in, and Congress can charge an interest rate on student loans that more than fully offset such expected losses. But any unexpected losses, those that might occur if the economy weakens, wouldn’t be covered, placing the default costs squarely on taxpayers.

(2) Katrina Trinko’s post on Senator Obama’s 2007 stance on subsidized student loans;

(3) and the article Vance Fried and I co-authored on “the college cartel.”

My brief take on the political controversy is that the president intends to mount a repeat of the recent debate over extending the cut to the Social Security payroll tax. A number of conservatives objected to the extension, on the grounds that it would undermine Social Security’s finances, while most congressional Republicans decided that an extension was acceptable if “pay-fors” were identified elsewhere in the budget. This proved to be a PR victory for the Obama White House. This time around, however, Mitt Romney has essentially agreed that current subsidy levels should be extended in light of the weak economy and high levels of youth unemployment. That won’t stop the president from trying to draw a sharp distinction on this issue, but it will make his life somewhat more difficult. 

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