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The coming depression blog | October 25, 2014

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Is There a Good Case For Doubling Student Loan Interest Rates?

Sarah Jaffe recently wrote a story about how yesterday was the estimated day student debt would hit $1 trillion dollars. President Obama has called for Congress to keep interest rates on subsidized student loans at 3.4 percent instead of letting them revert back to 6.8 percent as per the law passed in 2007. He has even started a twitter hastag for it, #dontdoublemyrate. It looks like Mitt Romney is also against letting the rate go up.

Is there any good arguments for letting interest rates on student loans double? I’ve been trying to find some, so let’s take a tour through the right-wing.

Douglas Holtz-Eakin essentially punts at National Review Online, saying that it is a distraction. “Americans would be better able to afford college if their budgets were less pressured by gasoline, food, and health-insurance premiums.” Umm, sure, I guess, though the rate matters quite a bit to those who will be impacted by it. What does that have to do with what the rate should be?

“Artificially” Low Rates?

Heritage quotes Eakins and adds a fun “None of this is to say that the federal government should be doing more to bail out students. It shouldn’t… But the current debate’s origins are in separate legislation passed in 2007 whereby the federal government set interest rates on student loans artificially low.” Bailouts! Yes, bailouts.

Are rates “artifically low,” thus bailing out student debtors? Right now, the United States can borrow for 10 years at real, or inflation-adjusted, interest rates that are negative. The 30-year conventional mortgage rate is the lowest its been in over 40 years. The market is using ultra-low interest rates to beg anyone who can make productive use of capital to borrow it Educating our young citizens in universities that are the envy of the world certainly seems like a productive use of capital. So how is not jacking up interest rates when 10 year government debt yields are at ultra-low 2 percent rates the equivalent of paying AIG creditors at par during the financial bailouts?

The implication is that they are below market rates. “Below-market” here is a troublesome phrase, as the private market for student loans is incomplete, prone to collapse, thin, and exists either through previous credit guarentees or a reworking of the various rules that govern debt in this country. This constitutes the government stepping up to do the things that the private market won’t. As Keynes said, “The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.”

Cost to Taxpayers

Cato tries harder to make a case if you can cut through a tangled web of metaphors about being “good parents” to kids. Neal McCluskey argues, “Finally, there’s the cost to taxpayers.”

I like how he doesn’t mention that this actually runs a profit for taxpayers. From the Department of Education student loan overview (R-10): “For Direct Loans, the overall weighted average subsidy rate was estimated to be -13.91 percent in FY 2011; that is, the overall program on average was projected to earn about 13.91 percent on each dollar of loans made, thereby providing savings to the Federal Government.” Unless you start making up discount rates, these loans make a profit for taxpayers.

As Alan White notes, according to the “Congressional Budget Office, $37 billion will flow IN to Treasury from student loans made this fiscal year at the 3.4% rate (on a net present value basis and net of about $1.5 billion to administer them.) ” If anything, we should make rates lower than 3.4 percent.

Lavishing Cheap Credit

Cato continues by arguing, “the reality is that policymakers have been lavishing cheap money on students for decades…all the cheap aid has enabled colleges to raise their prices at breakneck speeds, rendering the aid largely self-defeating and college pricing insane.”

For aid to be “self-defeating,” you’d have to imagine a completely inelastic, fixed supply of higher education, which I hope isn’t Cato’s argument against keeping current rates. But maybe the author’s on to something. If you look at, say, the maximum amount of Pell Grants, do they rise in proportion with increases in tuition? Ummm, no:

As Demos notes in its 10 points on how student debt is blocking mobility, “In 1980, 39 percent of federal financial aid to undergraduates was in the form of loans, and 55 percent was awarded in grants. By 2008, this had shifted to 64 percent of the funds awarded as loans and only 26 percent as grants. Moreover, today’s maximum Pell Grant covers just over a third of the costs of attending a public 4-year university, down from over two-thirds in 1980.”

Meanwhile, during the same time period, numerous legal restrictions have been put on student debt and protections have been stripped away, which means that the major government changes to student debt involve the it making it a harder, not easier, form of debt to manage. Nondischargeability went from five years to seven years in 1990, until it was revoked permanently in 1998 (when the statute of limitations was also removed). That was extended to for-profit student loans in 2005. Social Security became eligible for student loan collections in 1996. The argument that student debt became “lavish” during the past 20 years requires some additional work.

And though some of the lower rates are captured by increased tuition because of inelastic supply — an argument that is equivalent to saying that free, “public option” public universities would thus contain runaway costs — current tuition movements look like they are being driven more by states cutting support for public universities during the Great Recession. As the CBPP notes, at least 43 states cut services to public higher education. That’s what is going to drive serious tuition increases in the next few years.

(Digging into some of this research, the lack of decent empirical work linking increased aid to tuition increases is startling given how much movement conservatives rely on such an argument.)

There Are Better Subsidies

Friend-of-the-blog Josh Barro at Forbes has the another set of arguments against blocking rate increases. First Josh argues that we need to think of a low rate as a subsidy: “A below-market interest rate for Stafford Loans is just another subsidy mechanism—essentially, you can think of the present value of the interest savings as a partial subsidy of a student’s tuition payments.” Josh also notes that “Instead of extending the policy of holding Stafford Loan interest rates very low, why not let rates go back up and redirect the cost of the subsidy into an expansion of Pell Grants and refundable tuition tax credits?”

Sure, but right now these loans are profitable. As noted above, we spent the last 20 years stripping out protections from these loans to guarantee a high recovery rate. There’s no decent market rate to compare this to, given how thin and incomplete the private lending market is in this space. So why not fund it closer to where the government can borrow, adding in a small spread for administration and to cover losses?

Pell grants should be considered in their own right. But this is a specific conversation about what the government should charge when it is acting as a lender to young people, collecting the spread between the rate it can borrow and what students will pay. If that spread is very high because capital markets want the government to borrow, that doesn’t strike me as an excuse for the government to squeeze borrowers more and use the extra profit it makes at 6.8 percent to do something different. Even if it is a good idea to raise Pell Grants, that doesn’t change the nature of how low interest rates are right now, and how the government should approach the rates it sets for students in a way that is fair.

So what’s left as far as arguments go?

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