Senator Gregg Helps Expose Student Loan Industry Falsehood

By now it’s common knowledge in Washington that the proposal pending in Congress to move federal student loans to 100 percent direct lending generates savings by eliminating subsidies to private lenders under the alternative program, the Family Education Loan (FFEL) program. The student loan industry is now trying to draw attention away from those subsidies by arguing that it is actually student borrowers who will generate the savings when the government charges them interest on their direct loans. Take for example a comment that an ardent FFEL supporter posted on this blog last week.

First, under current law, the government will not pay lenders $87 billion [in subsidies] over the next ten years to make federal student loans — in other words, that’s not where the savings from eliminating FFELP comes from, and Second, the projected costs savings from eliminating FFELP represents profit, the margin, what’s left over, whatever you want to call it, after the government lends money that costs it about 2 percent to families that would pay 5.6, 6.8 and 7.8 percent…

Thanks to Senator Judd Gregg (R-NH) and the Congressional Budget Office, however, we know that this argument is merely a distraction in the form of a half truth.

Earlier this year, Senator Gregg requested that the Congressional Budget Office (CBO) calculate the savings from a 100 percent switch to direct loans using “market cost” estimates. The approach (which Higher Ed Watch supports) calculates government costs using the same methods and values that the private sector would apply. As such, it better captures the risks and costs loan programs pose to the government than does the approach required by law.

Using these methods, the CBO reported in July that the loan proposal would save $47 billion over 10 years, not $87 billion as stated in its official estimate. Many FFEL supporters championed this new estimate… but it seems that they did not fully understand the implications of what CBO reported.

Market cost estimates — like the one done by CBO — show that direct loan borrowers collect a subsidy on their loans from the federal government, not the other way around. In other words, under 100 percent direct lending the government won’t be “overcharging borrowers,” nor will the loans “make money for the government.” Rather, students will get loans at terms more generous than those offered in the private market, which results in a cost to the government. The results are largely due to a key adjustment that CBO made to its original estimate. In its market cost estimate, CBO assumed that the federal government can borrow only at market interest rates available to private companies — not the below-market rates (i.e. U.S. Treasury bonds) that make direct loans appear profitable for the government. Put another way, the riskiness and potential costs of the loans are evaluated using market-based values, not risk-free government rates.

The estimate, therefore, reveals that $47 billion of the savings in the loan proposal has nothing to do with the federal government making money off direct loans or borrowing at U.S. Treasury interest rates. The $47 billion is purely and simply the private market value of the government subsidies offered to private lenders under the FFEL program over 10 years. A switch to direct loans eliminates those subsidies, producing $47 billion in savings.

To be sure, the official CBO estimate of $87 billion in savings does include the assumption that the federal government makes money on direct loans — an assumption Higher Ed Watch does not agree with. But the point of the market cost estimate, which FFEL supporters have missed, is to correct for this assumption.

Thus, thanks to the CBO market cost estimate, we know that $47 billion of that $87 billion in projected savings is the price taxpayers pay to subsidize lenders under FFEL, and that the same $47 billion has nothing to do with the federal government’s low cost of borrowing or the interest rate it charges borrowers.

Thank you, Senator Gregg, for exposing the latest half truth the student loan industry is peddling.

Disclosure: The author worked as a staff member for the U.S. Senate Budget Committee and Senator Judd Gregg.