POLITICS: PennAve

Elizabeth Warren takes on student debt, but there's a catch

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Congress,Education,Brookings Institution,PennAve,Joseph Lawler,Economy,Student Loans,Janet Yellen,Elizabeth Warren,Magazine

The Senate's crusading liberal Democrat from Massachusetts, Elizabeth Warren, once again is pushing legislation intended to alleviate the burden of student debt. This time, her measure exposes a serious problem in the federal government's accounting.

With other Senate Democrats, Warren has introduced a bill that would allow student borrowers to “refinance” their existing student loans to the current lower interest rate on federal student loans: 4.66 percent.

That rate was established in last year's showdown over the government's subsidized student loan programs, when the rate was set to double to 6.8 percent if no action was taken. Ultimately, Congress voted to tie the interest rate on direct student loans to the 10-year Treasury security rate, which remains depressed thanks to the weak economy and the Federal Reserve's monetary easing efforts.

During that debate, Warren had submitted the radical proposal of charging for student loans what the Fed charges banks at its emergency lending window — 0.75 percent. A Brookings Institution researcher called it a “cheap political gimmick.”

The same researcher, Matthew Chingos, wrote this year that Warren’s new plan is “largely regressive and not the least bit progressive” because it would provide more relief for borrowers with larger balances, who tend to be wealthier people seeking more advanced degrees.

The problem of student debt, which has reached $1.1 trillion and is climbing, is one that top officials take seriously. Most recently, Fed Chairwoman Janet Yellen warned that high student loan debt could be preventing young Americans from buying homes and cars.

And Democrats have been consistent in wanting to further reduce borrowing costs for college students, even after last year’s agreement.

But Warren’s election-year legislation, in the unlikely event that it advances, would raise a few fundamental questions about student loan programs.

One is it would be a “fundamental shift from a federal lending program that has historically acted more or less like a bank -- with the goal that student loans will be roughly budget neutral in the long run -- to something that more closely resembles an entitlement program,” as Chingos and Beth Akers wrote for Brookings.

A related problem with Warren’s proposal is that it casts doubt on the claim that the government profits off its student loans. Warren and company assert that the government will receive $66 billion in subsidy income from the 2007 to 2012 group of student borrowers.

But the notion that the government reaps profits from its loans is hard to square with the reality that its terms are already more generous than those available in the private sector.

A student who took out federally subsidized Stafford loans in recent years probably has loans with interest rates ranging from 5 to 6 percent. While that’s high in relation to today’s 4.66 percent, it’s low compared with rates offered in the private sector. For example, Discover advertises fixed-rate student loans starting at 6.74 percent.

The subsidies inherent in federal student loans are disguised because in calculating the costs of its student loan programs, the federal government is required by the Federal Credit Reform Act of 1990 to use rates on U.S. Treasury securities in discounting cash flows from the loan programs.

Using rates on risk-free bonds in the accounting process, however, yields only a partial estimate of the cost of the risks associated with the loans, according to the nonpartisan Congressional Budget Office and financial economics experts.

The CBO has said that to more accurately reflect the costs of the loans, federal credit programs should be assessed with fair-value accounting, using comparable market securities to determine the proper rate for discounting cash flows. In such an analysis, the government’s student loan book would appear to be a costly transfer to borrowers, not a source of profits.

In proposing that it’s possible for the federal government to “refinance” borrowers who already enjoy rates too risky for the private sector, Warren might resurrect a debate she would rather avoid.

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