Are Big Direct Loan Savings a Freak Occurrence?

Despite all of the evidence to the contrary, the student loan industry has always denied that loans made through the Department of Education’s Direct Loan program cost taxpayers less than subsidizing private lenders under the Federal Family Education Loan (FFEL) program. With a bill pending in Congress that would eliminate FFEL in favor of 100 percent direct lending, the loan industry is again claiming that billions of dollars in savings projected by non-partisan budget experts are a mirage.

In one recent claim, the loan industry suggests that direct loan savings, as estimated this year by the Congressional Budget Office (CBO), are a sort of stars-are-aligned anomaly arising from historically low U.S. Treasury interest rates. The interest rates are indeed a key component of program costs. Thus, the loan industry argues that under “normal” circumstances, eliminating FFEL would not generate savings — or at least not the shocking $47 to $87 billion over 10 years (depending on the estimate) that CBO projects.

There is a simple, albeit crude, way to check the accuracy of such a claim. Every year, CBO calculates the subsidy rate (i.e. cost to the government) of the average loan made under the two programs in its 10-year baseline estimate. Under these projections direct loans have always had a lower rate than FFEL because the Education Department doesn’t have to make payments or provide insurance to private lenders and guaranty agencies under the program. Thus, the subsidy rate difference is a measure of direct lending’s lower cost to the government, and CBO uses that figure when calculating the savings from switching to 100 percent direct lending.

The 2009 estimate, which determines the savings under the proposal pending in Congress, shows that the gap in subsidy rates for the two programs averages 12.3 percentage points over the next 10 years. If the student loan industry’s argument was correct, that would be an unusually large difference compared to estimates from earlier years. But just the opposite is true.

According to a Higher Ed Watch review of CBO estimates, the 2009 subsidy rate difference is actually the second lowest in seven years. The loan industry argument about low interest rates looks silly given that in 2007, when U.S. Treasury interest rates were relatively high, the average difference was nearly identical to the 2009 figure. Furthermore, this year’s difference looks small compared to 10-year estimates from 2004 and 2005.

There’s another reason why this year’s estimates can’t be dismissed as anomalous. Thanks to rising enrollments and ever-growing college prices, new federal loan programs (Grad PLUS), and higher Stafford loan limits, federal student loan volume has been increasing rapidly in recent years. New FFEL loan volume projected for the next 10 years is $809 billion, twice the comparable figure under CBO’s 2003 estimate. Moving $809 billion in future FFEL loans into the Direct Loan program can produce enormous savings even with program cost differences at historic lows. What’s more, no federal student loan borrowing slowdown is in sight, making it a stretch to argue that this year’s direct loan savings are a freak occurrence.

Student loan industry officials have always been desperate to explain away the FFEL program’s higher costs given that the Direct Loan program provides nearly identical loans. Calling direct loan savings an anomaly shows just how desperate they have become.