There is a common narrative that the federal government earns billions of dollars in “profit” from the student loan program. But evidence shows the reality is not quite that simple. Many Americans are sinking under the weight of student debt. Currently, more than one-fifth of borrowers with scheduled monthly payments are over 90 days delinquent, and less than half of new borrowers are able to chip away at their principal balance within three years of entering repayment.
Meanwhile, the federal government continues pumping loans into the higher education system, issuing roughly $100 billion each year, which has led to total outstanding debt that now exceeds $1.4 trillion. Given these trends, it should be little surprise that around a one-fifth of borrowers have at least $40,000 in outstanding loans. Members of Congress are also not immune. A recent report by CQ Roll Call revealed that 53 lawmakers have student loan debt.
The latest Congressional Budget Office projections, based on accounting rules in effect for decades, suggest that the federal student loan portfolio benefits taxpayers, generating over $30 billion in savings between 2019 and 2028. This estimate, however, relies heavily on assumptions regarding future repayment trends. Default rates could simply be higher, or repayment rates lower, than expected. This would reduce actual savings compared to those projections. In fact, CBO estimates over the past five years show projected savings have dropped considerably.
Contributing to this uncertainty is the recent expansion of income-driven repayment plans, which cap monthly payments as a percentage of a borrower’s income, and the advent of public service loan forgiveness, which clears the remaining student debt of borrowers who spend 10 years in public service. These programs are important for reducing risk among students who shoulder high levels of debt, but they have put taxpayers increasingly on the hook. The CBO has indicated as much in its recent savings estimates, revising them downward by billions of dollars, in part due to higher than expected enrollment in these plans.
To make matters worse, the Department of Education’s projections, which inform the president’s annual budget request, have not been updated to reflect current realities. The department continues to use an outdated model that was built when the federal government offered only one income-driven repayment plan. Today, it offers four repayment plans. That means an additional element of imprecision is inherent to any of the department’s budget estimates for student loans.
Another factor clouding projections is sensitivity to interest rates. Federal Reserve Chairman Jerome Powell has signaled that the central bank plans to raise interest rates several times over the course of 2018. The CBO acknowledges that its latest student loan savings projections have been reduced in anticipation of faster interest rate hikes.
Amid this uncertainty is one constant: Borrowers are less likely to meet their monthly payments during an economic downturn. This “market risk” is not accounted for under current estimates, which are tied to the interest rates of U.S. Treasuries. Those securities are assumed to be free of market risk, so therefore the rules assume the same of student loans.
A different approach for estimating loan costs is known as fair value accounting, which incorporates market risk and alters projections considerably. According to the latest CBO estimates, the fair value method leads to $232 billion in costs to the federal government over 10 years, which translates to a $264 billion difference when compared to the other accounting projections.
Jumping down the rabbit hole of federal government accounting can be cumbersome, but in this case, Americans need to understand the unpredictability when it comes to the massive student loan program. Borrowers take a risk when they shoulder student loans, and while most students see a return on their investment, federal policy mitigates this risk and provides support for students when the investment doesn’t pan out.
The risks facing federal taxpayers are less straightforward, as little agreement exists over how much the federal loan portfolio will end up saving, or costing, the government. Not only is the modeling outdated, but it is sensitive to interest rates, and various forecasting approaches elicit wildly different projections. Given that the government carries over $1 trillion in student debt, it’s time for Congress and the administration to rethink our student loan policies and how the portfolio is estimated. Otherwise, taxpayers may unknowingly be the ones left holding the bag.