Does This Explain Opposition to Market-Based Interest Rates?

As of this writing, it appears that the U.S. Senate has finally reached an agreement on student loan interest rates after subsidized Stafford rates doubled from 3.4% to 6.8% on July 1. The general terms of the agreement are similar to what President Obama proposed in his FY 2014 budget and what the House of Representatives agreed to back in June, with some compromises on each side.

The big difference between current law and the Senate agreement is that interest rates for nearly all student loans will be tied to the 10-year Treasury rate, which currently sits at about 2.5%.  (Undergraduates would pay a 2.05% premium above the Treasury rate on Stafford loans to account for program costs and the risk of offering the loans.) However, the Treasury rate is expected to increase to 5.6% by 2016, pushing the interest rate for undergraduates to 7.65% from less than 5%. The plan includes a cap at 8.25%, which may be reached according to the CBO report.

The Senate agreement is not without its critics, particularly on the political Left. Senator Bernie Sanders, a Vermont independent and a self-described “socialist,” criticized the plan as “dangerous” in an article in The Hill. His criticism lies in the fact that interest rates can rise well above the current 6.8% over time, a very real concern given the interest rate projections. While the plan is expected to pass the Senate (and the House), some other Senate Democrats will likely vote no as well.

At this point in the great interest rate debate, I have to wonder if there is another reason some politicians oppose market-based interest rates. Tying student loan interest rates to the 10-year Treasury note directly connects students’ future payments to the cost of federal borrowing. And that cost of federal borrowing is influenced by the federal government’s fiscal policy.

This connection between federal borrowing and student loan rates could potentially have the following repercussions. If loans are tied to Treasury notes—and there is no way to fix the rate as has been done for the past seven years—students should have an incentive to push for federal policies which lower the federal government’s cost of borrowing. (With the decline in home ownership rates among younger adults, fewer 20- and 30-somethings have mortgages, which are affected by federal borrowing costs.)

The policy that best reduces the cost of borrowing is a balanced budget, which reduces the need for additional borrowing. The passage of the Omnibus Budget Reconciliation Act of 1993, which reduced the budget deficit through a combination of tax hikes and spending cuts, had the effect of driving down long-term interest rates. (For more on this, I highly recommend reading Bob Woodward’s Maestro about Alan Greenspan’s role in the policy discussions.)

My question to readers is whether you think that some politicians may oppose market-based interest rates because more young adults may place pressure on Congress to find some legislative solution to balance the budget—although the solutions certainly vary by political persuasion. Say it’s 2016 and undergraduate Stafford rates are 7.5%, with hitting the 8.25% cap becoming more likely. Could we see student advocacy organizations pushing for a balanced budget to bring down interest rates? I don’t know how many people will think this way, but it’s something to consider.

Author: Robert

I am an a professor at the University of Tennessee, Knoxville who studies higher education finance, accountability policies and practices, and student financial aid. All opinions expressed here are my own.

2 thoughts on “Does This Explain Opposition to Market-Based Interest Rates?”

  1. That’s a really interesting thought, though feels to me that most students probably are not financially savvy enough to make that leap in logic about the connection between T-Bill rates and macroeconomic policy.

    What I wonder about is how much Congress doesn’t want a long-term solution because that means fewer opportunities to score political points. I vaguely recall that when there was talk of making Pell an entitlement, some legislators opposed it because they liked the idea of being able to claim credit each year for appropriating Pell. I’d like to think they wouldn’t go that far for vanity/political points, but its clear interest rates poll well and why not keep going back to that as a political issue to hammer folks on as often as possible?

  2. I don’t think the vast majority of students are savvy enough to tie T-Bill rates to fiscal policy, but I think that student groups (such as USSA) are savvy enough to do so and tell students what to say. However, this does require the groups to lobby for a solution that isn’t as simple as calling for near-zero interest rates.

    I completely agree with your point about there being generally fewer opportunities to score political points under a long-term solution. But the long-term solution in this case may give certain legislators more of an opportunity to score points. For example, when Stafford rates are 7% in a few years (a likely occurrence), Sen. Warren can introduce her bill to drop rates to 1% and get lots of positive press from activists–while knowing that she isn’t going to cost the federal government billions of dollars.

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