Update: What’s Behind New CBO Direct Loan Savings Estimate

The Congressional Budget Office (CBO) has made more details available to Congressional staff about how updates to its baseline estimates for federal program costs will affect a student aid proposal pending in Congress. Higher Ed Watch first highlighted this issue several weeks ago, noting that the proposal, which has passed the House but not the Senate, could be subject to a new set of budget estimates when the Senate debates the bill later this year. We learned last Thursday that student loans savings from moving all federal student loans to direct lending were unaffected by the update, but that a new Pell Grant entitlement would cost considerably more. Until now few details were available about the CBO findings, especially concerning the student loan estimates.

According to the CBO correspondence, eliminating subsidies to private lenders in the Federal Family Education Loan (FFEL) program and moving to 100 percent direct lending will save $87 billion over the 2010-2019 period, the same as the estimate under the March 2009 baseline and the estimate for the bill that passed the House last fall, the Student Aid and Fiscal Responsibility Act (H.R. 3221). Savings for the five-year period, however, are $39.7 billion, about $2 billion less than the March 2009 estimates.

CBO explains that a number of assumptions did indeed change in its January 2010 estimate, as we predicted, but that the changes offset one another, leaving the final savings figures for a switch to 100 percent direct lending nearly identical to those from a year ago. Here is how it all adds up.

CBO assumes that FFEL volume will be a smaller share of new loan volume in the future (60 percent instead of 70 percent) and this reduces savings because fewer loans will be switched into direct lending under the proposed legislation. This effect, however, is mostly offset by CBO’s revised estimate for total loan volume, which it says is now 16 percent higher. So it’s a matter of relative loan volume versus absolute volume. FFEL loans will make up a smaller share of future loans, but because there are more loans, the absolute volume of FFEL loans switched to direct lending is largely unchanged from last year’s estimate. Still, the changes do reduce the ten-year savings by $2.7 billion compared to the March 2009 estimate.

CBO also assumes under its January 2010 estimate that interest rate changes will make FFEL loans less expensive relative to direct loans, reducing the ten-year savings calculated last March by $1.3 billion. But similar to the loan volume component, this effect is more than offset by another change from last year’s estimate.

In the March 2009 estimate, CBO assumed that a new auction for Parent PLUS loans under FFEL set to begin later that year would “significantly” reduce the cost of a FFEL loan as lenders bid down the subsidy payments they would receive from the government. Under the January estimate, however, CBO assumes that bidding in the current market would not reduce the subsidy rate by as much, making FFEL loans more expensive compared to last year’s estimate. (It should be noted that the Department of Education cancelled the first round PLUS loan auction last year.) This means that switching this set of now more expensive future PLUS loans into direct lending yields even greater savings, producing an additional $4.0 billion in ten-year savings compared to what CBO estimated last year.

As explained, CBO-estimated savings for a switch to direct lending now pending in Congress remain largely unchanged from a year ago, despite all the changes in the landscape for federal student loans over that time. Now we know that even under the most up-to-date estimates, subsidizing private lenders still costs more than direct lending. It’s time for the Senate to move forward with its version of the House-passed Student Aid and Fiscal Responsibility Act.