New America Foundation Releases Report Exposing Spin on Student Loan Costs

A highly regarded personal-finance columnist recently attempted to answer the question, Should investors sell all their stocks and mutual funds and get out of the stock market?

In answering the question, he went back to the basics:

"Do you believe in capitalism?"

Do you believe that most of the companies that make up our economy have the desire to weather this storm, invest again in their businesses and succeed? Do you believe that the stock prices of companies with strong fundamentals will eventually recover?

New America Foundation, do you believe in capitalism?

Do you believe that the private sector should carry out the functions in a modern society that are within its core competency and where there is no market failure? Or do you believe the government should take over entire areas of commerce, just because under some obscure, narrow and highly subjective budget scorekeeping rules, the government theoretically can do it cheaper?

There is more to life than being cheap.

In what construct would FFEL be considered "private sector" operations or free market capitalist? In the same construct that direct loan or military helicopter construction would be considered "private sector"? (After all, they are private contractor operations with a tiny group (some say too tiny) of government overseers.)

Accrual accounting is the way that the world works. It is not obscure or narrow. Those who are against the way guaranteed and direct loans are estimated would have to say that every time a bank makes a loan it is a revenue loss. That is simply not the case. The bank figures out what the future revenues and costs from that asset are going to be. Just like the government is supposed to do for its own credit programs.

The interest rate environment changes frequently which causes more changes in federal credit estimates than otherwise would be the case. Much of this volatility results from the wide variety of financial instruments involved in an unnecessarily complex program. One solution to eliminate some, if not most, of this estimation risk has been rejected by student lenders: Use the same financial instrument as the basis for setting the interest rate students are charged, the interest rate the loan holder is paid, and the discount rate. This would be some type of treasury bond, such as the 10-year bond. Although student loans in all senses of the world are long-term instruments, student lenders have argued that they finance their operations with short-term capital sources. That is their choice, but it should not necessarily wag the dog.

Anonymous doesn't get it.

No one has a problem with accrual accounting.

The problem is that the federal government uses a bastardized form of accrual accounting. It always wins. It's no different than a Las Vegas casino--the house (the government) always wins because it doesn't have to account for market risks (that loans won't get paid back or will be prepaid, that operations will have problems, and so on). Private banks hedge against such risk; the Direct Loan program looks the other way.

If the government used textbook-accrual accounting -- the same way the law requires every financial institution that lends money over time to account for market risk -- direct loans would cost more.

The cost of direct loans would possibly increase but the cost of guaranteed loans would increase more. For example, when Congress switched the lender payments from T-bill-based to commmercial-paper-based nearly a decade ago, CBO explicitly refused to score the basis risk. In other words, without any notice, the American taxpayer quietly assumed all the basis hedging costs that loan holders had traditionally borne. Is hedging basis risk a role that the U.S. Treasury is naturally good at? Nope. Yet taxpayers were asked to assume the risk that T-bill and commercial paper rates could occasionally become out of whack, and those market costs are missing from the guaranteed loan cost estimates.

The risks that loans won't get paid back or will be prepaid are already included. They arguably cannot be updated fast enough to keep up with all the changes in the programs that occur and are always a step or two behind. This is an issue that does not occur in say, car loans. The part which is sad not to get is that loan performance is actually a very minor factor in the net costs. The interest rate environment and loan volumes drive the vast majority of the net costs. The irony is that the profit incentive leads guaranteed lending to have a more attractive front end -- from the point of view of the schools for student and parent loans and from the point of borrowers for consolidation loans, yet direct loan is better on the boring back end. There is little economic incentive for those in the guaranteed loan sector to invest in the back end because it is not a selling point when marketing to new customers.

The goal of the net cost process is not to look at how a particular lender, or, even direct lending, is doing. The goal is to look at the net costs of the whole system from the point of view of the taxpayer. It boils down to: in direct lending the interest payments go back to the taxpayer while in guaranteed lending they go back to the party that owns the loan. In addition, all lenders concede that uncle sam has a lower cost of funds even on his worst day. There are those who believe that jobs are more important than taxpayer efficiency, and they would support guaranteed lending -- which as at least one Congressperson has mentioned provides jobs in at least three dozen states, while direct lending only has contractors in four or five states. Others in Congress want to count the taxes that federal subsidies to lenders and guarantors generate -- in other words the taxes paid by all of those who hold the jobs in all those states. They never seem to mention the taxes paid by the direct lending contractors.

Does this mean that all types of loans should be a federal program? Nope. In this case you've got two government welfare programs which provide almost identical loan products. Do you want to choose the one that provides more jobs or the one that provides lower costs? Does someone whose kids are fighting in the war overseas and not planning to go to college really want to subsidize a fancy front end for loan disbursement products? Probably not. They would want the bare bones, even if it means no choice for the financial aid officer.

If there is an accounting area where the government is sorely lacking it is the ability to assign administrative costs to programs. A series of administrations simply assigned most of the costs of administering the guaranteed program (from program reviews and oversight to data systems and payment processing) to direct lending for simplicity's sake and that a hundred million dollars in administration has little impact on net costs in a half-trillion dollar combined loan program.

Dear anonymous,

The issue isn't entirely about whether the American people are entitled to consumer choice. [Your argument is borrowers should be told where to borrow because consumer choice is a luxury that taxpayers and soldiers shouldn't have to pay for. That line of reasoning could be applied to choice of doctors in Medicare. That program would be a helluva lot cheaper if seniors went to the VA for all their care. Federal housing programs would be cheaper if low-income and middle-income families were forced to live in government-built housing. But of course you probably support those ideas.]

As important is which program does a better job in serving students and schools.

Why is it that Direct Loan advocates would rather talk about green- eyeshade issues like credit reform than program performance?

Program performance is better in DL, but one suspects you again are not talking about program performance but rather the marketing of the program to students and schools.

Many of the approaches used for "serving schools" were and are inducements. It is a slippery slope. Until recently some companies actually touted their ability to place additional bodies in the school financial aid office during "the busy season." This was never permitted, but everyone looked the other way.

Housing would be cheaper if the mortgage interest deduction, property tax deduction, and other attempts to "tilt the playing field" did not exist. When tax reform was underway in 1986, it became clear that the beneficiaries of these features are realtors and developers, not homebuyers. The price of homes simply rises to account for these additional "benefits" of buying a home.

Americans who receive home heating assistance do not get a choice of vendor, and those of all political stripes agree that the program functions fine, although they may disagree with the level of the funding.

Section 8 may or may not be a better option than public housing for enabling the poor and disabled to access housing. It depends on the economic situation in the community. If it is a community with high rental prices, then Section 8 may not be a realistic option for most landlords. To say that public housing never works is a slap at the many communities -- both blue and red communities -- across the nation that have made it work and have inspired residents in many cases to go out and buy their own homes after getting on their feet in public housing.

Americans do not get a choice of social security vendor; it is SSA. Whether or not you agree with the current design of the social security program, the program's design is not SSA's responsibility. The system tracks payroll tax "contributions." Retirees and the disabled receive their payments each month.

It would seem impossible for one doctor to serve all Medicare patients, even in a small town, if that is the idea. Most doctors participate in Medicare. Some doctors refuse to serve Medicare patients. Sure, we could probably force them to, as a requirement of keeping their medical licenses, but that is not on the table. Again, Washington tinkers with the structure of the program for political and other reasons, but CMS keeps on administering what ever they throw at it. Each state has non-federal companies that run the medicare program. In many states it is Blue Shield.

The variety of government programs you are talking about terminating is interesting, but it is not clear that any of them are more socialistic than ffel. Colleges and lenders seem to be saying, "just give us your money and leave us alone; we know how best to do things." Would you do take that approach with a nephew who has some of your money? There were years and years of oversight hearings on dl. Yet the idea of having unannounced program reviews at schools and lenders and guarantors is viewed as an intrusive "audit mentality." And why does Sallie have 30 times the staff of dl for a similar-sized volume and holdings? Is that efficient?