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April 28, 2013

Student Loan Program's Costs are Unknown


The Congressional Budget Office has applied a risk-appropriate discount rate to student loans based on what private lenders would offer for a similar level of risk. In contrast to the government's current accounting practices, which show student loans making a "profit" for the government of 9 percent, the CBO's alternate -- but more accurate -- analysis found that between 2010 and 2020 the program would cost 12 percent more than it brought in.

A similar analysis conducted by the CBO, just for FY 2013, also shows a large difference between current accounting practices and the fair value approach. Interestingly, however, the CBO still found a small net budgetary gain in 2013 from student loans even with the fair value approach.

If the federal government is truly able to turn a profit from its student loans in 2013, that raises the question of why private lenders have not offered similar loans to students. The lack of private competition suggests (but does not prove) that the CBO is using a fair value discount rate that is still too low, not fully reflecting the risk that private lenders perceive.

It may be useful to query private lenders about the interest rate they would need to charge if they were to offer student loans on the same terms that the federal government does. That rate may be higher than even the CBO's fair value discount rate, but it is likely the more appropriate rate to apply.

The federal government claims that student loans make money for taxpayers, but there is a strong possibility that they actually cost the government money. ... If Congress again acts to prevent interest rates from rising to 6.8 percent, the extended subsidy would likely increase participation in the program, creating even more unknown costs. Congress should not expand the student loan program before the cost to taxpayers is fully understood.

First appeared in The Washington Examiner.

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