Hidden in the Stimulus Bill

Last December Higher Ed Watch caught wind of back-room maneuvering on Capitol Hill to retroactively change the way the federal government sets lender subsidies in the guaranteed student loan program. Education Secretary Margaret Spellings sent a letter to key members of Congress asking them to quickly enact legislation to change the index used to determine the quarterly interest rate subsidy paid to lenders. The change would calculate the subsidy based on LIBOR instead of commercial paper

No action was taken…until now. The stimulus bill released today by the U.S House of Representatives Appropriations Committee would make the change. Specifically, it would recalculate the subsidy for last financial quarter (October through December 2008) owed to private lenders. And the change would also apply to all loans issued since 2000.

According to our estimates, the change would retroactively increase the subsidy paid to lenders by about 0.50 percentage points. Multiply that across hundreds of billions of dollars in outstanding loans and the extra payments could reach into hundreds of millions. Strangely, the Appropriations Committee reports that the cost will be only $10 million.

In our earlier post, we did not oppose the change, especially given the break down in the commercial paper markets. However, we expressed concern that the change sought by the Secretary (and the student loan industry) was being debated out of the public eye. For example, while the Department of Education regularly publishes on its website important policy letters the Secretary sends to lawmakers, this particular letter is suspiciously absent from the site. We also noted that the proposed changes would be unprecedented, as loan subsidy changes have always applied to new loans, not previously issued loans. We argued that such a proposed change should be thoroughly and publicly debated by Congress, not buried in a huge omnibus, must-pass bill.

Well, it looks like our concerns were warranted, as the change is tucked away in a 258-page stimulus bill. Readers will note that the subsidy change is not touted in any of the press materials released by the House Appropriations Committee.

As we wrote in our earlier post, the index issue and proposed changes are a dangerous symptom of the guaranteed student loan program disease. To get private lenders to make loans under the program, Congress must adequately compensate them. Yet Congress is not skilled at setting a payment rate that is neither too high nor too low, or that encourages the optimal number of lenders to make loans to all students. Worse yet, Congressional subsidy setting is subject to dangerous amounts of influence by student loan company lobbyists. This is particularly true when the issues are steeped in financial complexity, such as yield spreads between commercial paper and LIBOR, or interest rate swaps and asset backed securities.

The index issue should serve as an important reminder to Congress and the incoming Obama administration that they must adopt a system for setting lender subsidies that does not rely on continuous, ad-hoc legislative tinkering and loan industry lobbying. An auction where lenders bid for loan volume or subsidy payments is the best way to avert loan subsidy inefficiencies, crises, and lobbying bonanzas.