A Hot Knife Through Butter

Today, Democrats take their first step in achieving a major campaign promise: passing a bill in the House of Representatives to cut student loan interest rates in half.

The Democrats' plan would reduce gradually the interest rate for federally-subsidized undergraduate Stafford loans from 6.8 percent to 3.4 percent over the next five years. Democrats largely pay for their interest rate cut estimated to cost about $5.85-billion by trimming government subsidies to the largest student loan providers (i.e. banks).

Student loan industry officials are having fits over the proposed cuts and expect Republican leaders whom they have handsomely rewarded with campaign cash over the last several years to look out for them.

In November, we predicted that House Republicans would work to: make the popular student loan interest rate proposal unpopular; curry favor with the banks; and make every effort to not get triangulated. Here are the main arguments we think theyll make on the House floor.

Argument #1: If Congress cuts lender subsidies, students will suffer because loan providers will reduce borrower benefits.

Expected response: Students will win a whole lot more from the Democrats' interest rate cut than borrowers will lose if the already small level of lender provided benefits is cut.

First, the proportion of student loan borrowers who actually obtain these bank provided discounts is pretty small. Most lenders require students to make a certain amount of on-time payments to receive a discount on the interest rate these borrowers are charged. Lender discounts typically [require] 48 monthly payments on a 10-year student loan. But the deal is usually off if borrowers are late with even one payment, according to the Wall Street Journal. And even if the borrower makes it to the milestone to qualify, the benefit could still be rescinded if payments are late at any time down the road.

Mark Kantrowitz, the publisher of FinAid, a website for financial aid professionals, estimates that only about 10 percent of all student loan borrowers qualify for these lender provided discounts by making all of their payments on time. And only about 15 percent of borrowers take advantage of another type of discount that many lenders offer a small reduction in the interest rate for borrowers who have their payments directly debited from their bank accounts.

Our review of Sallie Maes Securities and Exchange Commission filings reveals that on average, their borrowers are getting a benefit equal to about one-fourth of one interest rate percentage point. Got that? One fourth of one percentage point. That's tiny. The House Democrats are moving to cut subsidized Stafford loan interest rates by more than 13 times as much.

(And note: our numbers are conservative. Kantrowitz puts the lender provided benefit at a level equal to one tenth of one interest rate percentage point.)

Second, don't be fooled. Lender provided benefits are not going to go away. Few lenders will want to risk suddenly providing markedly less generous benefits to students than those that are offered by competitors in the Federal Family Education Loan Program or by the competing Direct Loan program. Those that do will see their market share shrink. In short, the House Republican argument on borrower benefits is a scare tactic.

Argument #2: Increasing funding for Pell Grants will help kids go to college, whereas cutting student loan interest rates won't.

Expected Response: The Democratic agenda is about increasing college affordability and college access. Slashing student loan interest rates and raising the maximum Pell Grant are not mutually exclusive goals. In fact, Democrats have said that they are committed to increasing the maximum Pell Grant to $5,100. And President Bush said something very similar same back in the 2000 campaign.

Regardless, its hard to take the House Republicans seriously considering their record on Pell Grants. Under their watch, the maximum Pell Grant has remained stuck at $4,050 the last four years in a row, while public college tuition spiked 35 percent after inflation during the same period.

Argument #3: Interest rates aren't the problem; skyrocketing tuition is the real problem.

Expected Response: No one would deny that the skyrocketing growth in college prices is a great cause for concern. Given that college prices are going to keep on growing, however, its also undeniable that slashing the interest rate on student loans will make college more affordable for millions of students, who will see the cost of their loans drop by thousands of dollars.

And House Chairman George Miller (D-CA) has said that he wants to work with students, colleges, and other relevant stakeholders to examine increasing tuition costs. In fact, Republicans in the House and Democrats in the Senate have offered proposals over the last couple years that would provide an incentive for states to stop cutting funding for higher education and in turn hiking public college tuition levels.

Analysis: Make no mistake. The Democrats proposed student loan interest rate cut will pass the House like a hot knife through butter. The Democratic Majority will dismiss the House Republican arguments quickly, focus on how lenders have been getting rich off excess taxpayer subsidies, and bang home the message that financial aid is for students, not banks.

In the Senate, there are aspirations for a more comprehensive plan that tackles college access and affordability simultaneously. But to win filibuster-proof support from Republicans for a comprehensive plan, Senate Democrats will have to do some horse trading. What will they be willing to trade? What should they trade?

We at Higher Ed Watch have some predictions and suggestions, which we will outline in future posts. For now, stay tuned.