Alan White on the Federal Government's "Dirty Secret" Regarding Student Loans

At Credit Slips, Alan explains that the government makes a tidy profit on student loans. Here's a key excerpt:

As student loan debt passed the $1 trillion mark, President Obama, speaking at Chapel Hill yesterday, called the upcoming interest rate hike on student loans a tax.  He didn’t tell the half of it.  Congress’ dirty secret is that the government makes a huge annual profit on student loans.   According to the scrupulously nonpartisan 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.)   The President’s current dispute with Congressional Republicans is about whether to increase this annual profit next year.  The interest rate that students pay on the basic “subsidized” loan is slated to rise from 3.4% this year to 6.8% next year, unless the lower rate is extended by Congress. How does the government profit from student loans?  In two words, yield spread. Treasury can borrow money at 0.5% or less, and lends it to students at 3.4%.   Administrative costs are well below 1%. Prepayment risk is minimal; repayment stretches over many, many years, and the yield spread just keeps on coming.  Interest rate risk is also minimal, given that Treasury can issue debt in a range of maturities.

Comments

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[Jason Delisle]

Brian,

What about CBO's comment on the estimates you cite: "In CBO’s view, FCRA-based cost estimates [the one cited in this post] do not provide a full accounting of what federal credit programs actually cost the government because they do not incorporate the full cost of the risk associated with the loans." The CBO report from March 2012 is title "Fair-Value Accounting for Federal Credit Programs"

The CBO reports the numbers you cite because it is required to by federal law -- but given the CBO's March 2012 paper, the agency doesn't believe those are accurate numbers.

In 2010, CBO calculated that the subsidy for a typical federal student loan is about 12% using fair-value estimates. CBO is barred from using that figure -- which it believe is the more accurate one according to its 2012 paper -- in official estimates according to the Federal Credit Reform Act of 1990.

I'd also point out using official estimates like those for student loans (which shows erroneous profits) shows that Fannie Mae and Freddie Mac are very very profitable, too. So they rules are so misleading, Fannie and Freddie are profit machines. The CBO explained this in a public letter to Rep. Barney Frank in 2010. Letter is available on CBO's website.

Jason Delisle
New America Foundation