First-term Senator Elizabeth Warren (D-MA) is a darling of the progressive Left, and she has been mentioned as a possible Presidential candidate in 2016 (although she has stated she’s not running). One of the ways she has gained support with the Democratic base is through her many public statements about the federal government’s purported profit on student loans, which she cites to be $51 billion in Fiscal Year 2013. Given the huge profit, she has introduced legislation to drop interest rates to the overnight borrowing rate at the Federal Reserve: 0.75%.
Her argument suffers from one main problem: student loans carry risk for the federal government. (She made my 2013 not-top-ten list for this reason.) The Congressional Budget Office, where the $51 billion estimate came from, uses federal borrowing costs as a discount rate. This discount rate is very low, in part because the federal government is viewed as very unlikely to default (even with the possibility of debt ceiling shenanigans). As a result, numerous groups have suggested the use of fair-value accounting, in which the risk of default is considered. Indeed, the Washington Post’s fact-checking blog gave Senator Warren’s statement of a $51 billion profit “two Pinocchios” because it did not consider fair-value accounting.
[On Twitter, the wonderful Libby Nelson notes that my explanation of fair-value accounting vs. federal regulations is unclear. Here is a nice CBO summary of the different methods.]
With the debate over student loan profits and accounting methods as a backdrop, the release of Friday’s Government Accountability Office report on federal student loans was eagerly anticipated in the higher education community. The title of the report succinctly summarizes the rest of the document: “Borrower Interest Rates Cannot Be Set in Advance to Precisely and Consistently Balance Federal Revenues and Costs.” This resulted in a few howlers from policy analysts, including this gem from Matt Chingos at Brookings:
Matt Chingos (@chingos) January 31, 2014
Karen Weise at Bloomberg was a little more diplomatic with her summary of the report:
Karen Weise (@KYWeise) January 31, 2014
The report itself is fairly dry, but it does emphasize something that should be kept in mind when considering the costs of student loan programs. Due to the growing prevalence of extended payment plans, increased rates of income-based repayment plan usage, and the continued risk of defaults, the actual amount of the subsidy or cost on student loans will not be known for 40 years after disbursement. Each of these individual variables could also have a large effect on the long-run subsidy or cost; for example, a higher-than-expected rate of income-based repayment participation could increase program costs.
The following paragraph on pages 18 and 19 sums up a key point of the report:
“As of the end of fiscal year 2013, it is estimated that the government will generate about $66 billion in subsidy income from the 2007 to 2012 loan cohorts as a group. However, current estimates for this group of loan cohorts are based predominantly on forecasted cash flow data derived from assumptions about future loan performance. As more information on actual cash flows for these loans becomes available, subsidy cost estimates will change. As a result, it is unclear whether these loan cohorts will ultimately generate subsidy income, as currently estimated, or whether they will result in subsidy costs to the government. This will not be known with certainty until all cash flows have been recorded after loans have been repaid or discharged—which may be as many as 40 years from when the loans were originally disbursed.”
I read this paragraph as providing possible evidence that interest rates may have been set relatively high compared to the federal cost of borrowing. (Recall that the interest rates for subsidized Stafford loans declined from 6.8% in 2007 to 3.4% in 2011, while Treasury rates were at historic lows.) The spread between the 10-year Treasury yield in May versus the interest rate on subsidized Stafford loans has been the following for the past seven years:
|Year||Stafford (pct)||10-yr T-note (pct)||Spread (pct)|
This interest rate spread is statutorily set at 2.05% for subsidized Stafford loans in the future, roughly the long-run average. So while future GAO reports a few years after disbursement may find similar results, what we’ll all be waiting for is longer-term data to see if the estimates hold true. The federal government doesn’t necessarily have a great history of long-run cost projections, so I’m expecting this spread to disappear over time. (And keep in mind this report doesn’t fully account for risk.)
Yet Senator Warren and eight other Democrats released a press release on Friday afternoon with the headline of “Democratic Senators Highlight Obscene Government Profits Off Student Loan Program.” They focused entirely on the initial projection of a $66 billion profit over five years and entirely ignored the long-run uncertainty highlighted by the GAO. This press release is a great example of selecting only the most favored parts of a report, while ignoring other important details along the way. Again, the Twittersphere (myself included) expressed its thoughts:
Wes Huffman (@WH_DC) January 31, 2014
Amazed Warren and friends claim to expect huge "profits" when report title says we don't know what will happen: gao.gov/assets/670/660…—
Robert Kelchen (@rkelchen) January 31, 2014
On a more fundamental note, I think that Senator Warren and colleagues are misguided in their efforts to continue lowering student loan interest rates. Given the reality that higher education funding is a zero-sum game, I would much rather see funds used to support the Pell Grant, work-study, and other upfront sources of aid for students than slightly lower loan payments after students have already left college. (The same argument holds against tax credits.) Senator Warren may not be running for President (yet), but she’s in the running for my 2014 not-top-ten list.