The True Cost of Student Loan Reform

Shhh. Be vewy, vewy quiet. I’m hunting refowm.

Perhaps you haven’t heard of the new student loan plan. It was a mere footnote tacked onto the health care bill in order to make the overall CBO score more palatable. Just because little was said does not mean little was done. In fact it represents a complete overhaul of the student loan industry – removing private and nonprofit lenders and replacing them with a sole originator and servicer – the federal government.

In theory student loan reform makes sense. The current system makes an adulterated mess out of free market principles. The problem began in 1993 when the federal government first got involved in offering student loans by creating the Direct Loan program to “compete” with private lenders. Unsurprisingly, when competing with someone who doesn’t face the same market pressures, private lender profit margins suffered and they raised their interest rates to compensate. The federal government, who deserves praise for their desire to keep loans affordable for students, stepped in and mandated a low interest rate.  The government, realizing that it may have just killed an industry, they began subsidizing private lenders so that they could maintain affordable loans without going under.

The Frankenstein-ish system doesn’t make much sense. Subsidizing businesses should not be the business of government. That said, is originating student loans really the business of government either? Senator Mitch McConnell recently lamented the government’s expansion into traditionally private sectors saying,

“We have the government running banks, insurance companies, car companies, health care and now the student loan business.”

Certainly there are some positives for young adults. The law allows for lower monthly caps on student loan payments – down to 10% of discretionary income. It also shortens the forgiveness period to 20 years after which the balance may be forgiven.

That said the bill is not all rainbows and butterflies. The initial CBO projection that the student loan reform bill would save $62 billion was recently downgraded after a more “comprehensive” assessment. The new CBO score explains that the original figure was determined using a procedure specified by the Federal Credit Reform Act of 1990. However, “estimates made under the FCRA do not provide a comprehensive measure of the cost to taxpayers of the federal student loan program” because it doesn’t include factor in “certain risks involved in lending” or “administrative expenses.” When scored under this “fair value basis” the CBOconcludes that:

“CBO recently estimated that whereas loans issued in the direct loan program between 2010 and 2020 would reduce the deficit by a total of $68 billion under FCRA accounting, those loans would increase the deficit by $52 billion on a fair value basis . . . The savings from implements the President’s proposals . . . decline from a total of $62 billion . . . to $40 billion.”

Moreover, the debate on savings has overshadowed the fact that the planned reforms still add to the deficit. As the CBO explains,

“Whereas on average over the 2010-2020 period a representative loan issues in the direct loan program has a negative subsidy rate of 9 percent under FCRA (meaning that it reduces the deficit), the same loan has a positive subsidy rate of 12 percent on a fair value basis.”

So while the reform may (if many of the CBOs assumptions prove true) reduce the deficit compared to the current broken system of a private-public hybrid, that is not the same thing as saying it will actually end up in the black. In other words, we’re just making something less awful…maybe. I say maybe because the government’s track record on staying on budget is shaky at best. Fannie Mae and Freddie Mac, as government-sponsored housing finance giants, may be the closest analogue to the government’s involvement in ensuring affordable student loans. Together these two firms have burned through $125 billion in taxpayer money and the CBO now predicts that the final price tag may exceed $380 billion.

Students will one day be taxpayers. As taxpayers they will be required to fund the liabilities of their government. So while a lower cap on payments sounds great in the short term we may be asked to make up for that plus interest in taxes to pay down our national debt. Perhaps this is why a new Rasmussen poll shows that only 35% like the new student loan plan while 49% think it is a bad idea.

True reform would have removed the government from the process, not gotten them more deeply involved. As with health care reform, we should have worked to make the student loan market more like a free market in that it is price sensitive. When government first got involved, by creating the Direct Loan program, it distorted the market, eliminated competition, and hid the price of an education from consumers. The new reforms will only worsen these problems with the likely effect being that colleges will capitalize through higher tuition and costs. After all, if the student, having been removed from the responsibility of costs, is not concerned with tuition price in their college decisions, there is very little incentive for colleges to compete for lower tuition.

The government snuck one by the American public. While health care reform was on the main stage nobody bothered to see what else was behind the curtain. The few words that were spoken made it seem impossible to like – after all who doesn’t want to save hard-working, Ramen-eating, college students some money. But this covers up the scary reality…we’ll be paying for this one way or another.

by Brandon Greife, Political Director of the College Republican National Committee

Read More: www.collegerepublicans.org