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A Consolation Prize for Student Loan Companies
The student loan reform bill released by the Democratic chairman of the House Education and Labor Committee includes a consolation prize for the student loan industry. The bill cuts private lenders out of the administration of newly issued federal student loans almost entirely -- a major defeat for the industry and its lobbyists. It appears, however, that the bill's crafters have granted the industry one concession. They would allow lenders to change the index used to calculate the federal subsidies they receive on all outstanding FFEL loans issued since 2000. While this proposal raises some concerns and questions, it might actually be a fair solution to vexing interest rate problems caused by the credit crisis.
The LIBOR Switch
Currently, interest rate subsidy payments made to private lenders holding federally backed student loans are indexed to commercial paper interest rates. Lenders, however, usually need to finance the loans using LIBOR, a different index. When credit market disruptions hit full tilt last year, the two interest rates diverged radically, even though 3-month LIBOR historically had been only slightly higher. Spiking LIBOR interest rates squeezed the return lenders earned on loans. Although rates have since come back in line, the risk of another divergence remains.
We reported last year that the student loan industry was working the back rooms of the Capitol to persuade lawmakers to switch the index for all outstanding loans made since 2000 to the higher LIBOR rate. And in January we pointed out that the provision had been snuck in to an early version of the economic stimulus bill, but was then quietly dropped.
Now the provision has been included in the House-proposed student loan reform bill, but with one significant change. While the loan industry had lobbied for the 3-month LIBOR index, the House bill would use the 1-month LIBOR index, which given its shorter duration, reflects lower interest rates. In fact, the index has historically tracked the 3-month commercial paper rates quite closely. In other words, the future costs of such a change may be a wash.
Let This Be a Lesson
If the change is indeed cost-neutral, then it is hard to argue that the interest rate subsidy the federal government provides to lenders should not be based on LIBOR. After all, these rates better reflect the cost of capital for lenders financing federal student loans than commercial paper rates do. Yet the LIBOR saga perfectly illustrates why the House bill makes the right choice to end the FFEL program.
To get private lenders to make loans under FFEL, Congress must adequately compensate them. But Congress is not skilled at setting a payment rate that is neither too high nor too low, or that encourages the optimal number of lenders to make loans to all students. Worse yet, congressional subsidy setting is subject to dangerous amounts of student loan company influence. This is particularly true when issues are steeped in financial complexity, such as yield spreads between commercial paper and LIBOR, or interest rate swaps and asset backed securities.
The LIBOR issue is an important reminder to Congress and the Obama administration that ending the FFEL program and replacing it with the Direct Loan program is good public policy. The Direct Loan program has never required continuous, ad-hoc legislative tinkering and subsidy setting, nor does it invite the rent seeking, lobbying, and loophole exploitation that has led to so much waste and abuse in the FFEL program.
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I must take issue with this
I must take issue with this statement: "The Direct Loan program has never required continuous, ad-hoc legislative tinkering and subsidy setting, nor does it invite the rent seeking, lobbying, and loophole exploitation that has led to so much waste and abuse in the FFEL program." Really? If you review the recent history of legislative action on FFEL, you will find that almost every bill or amendment was prompted not by "rent seekers," but by efforts to extract "savings" from the program because Congress and successive administrations appear unwilling to consider increasing Pell Grants an investment worth making without claiming to pay for it through student loan savings. Even those amendments sought by the student loan community--things like ECASLA--were prompted in part by damage done to FFEL by short-sighted and sometimes incompetent legislation produced by Congress and the executive branch.
And what about the Student Aid and Fiscal Responsibility Act? It includes troubling legislative language granting specific non-profit agencies servicing rights on Direct Loans even in cases where the borrower may prefer another servicer or where the Department of Education has contracted with another servicer at a lower cost. Here is what your own blog had to say about the provision: "The legislation would essentially give each and every one of EFC's members a no-bid contract to service the [Direct] loans of up to 100,000 student loan borrowers in their home states."
Frankly, Chairman Miller, Arne Duncan and Bob Shireman should be ashamed of writing a bill with this provision in it. And NAF should try to occasionally set aside your glee about the possible demise of FFEL and try to focus on the real issues involved. Is the Miller bill good policy? We're finding a lot of people in the higher education community--people who I would assume you would not consider "rent seekers"--question the abandonment of a Pell Grant entitlement, direct grants to one segment of higher education over another, and politicized student loan provisions in the bill.
Heads, the banks win. Tails, the banks win.
A _retroactive_ change in student loan bank subsidies?!? Hmm. Secretary Spellings told us that the government couldn't retroactively change student loan bank subsidy levels when it came to the 9.5% loan scandal. The government was contractually bound. The lenders would sue. The taxpayers had no choice. Now of course there's no problem in changing the terms of a contract to give lenders a little extra.
More important, whether it scores or not, this change is another example, like the initial shift in the lender subsidy base to commercial paper, of heightening lender profits on guaranteed student loans and shifting the hedging of risk from banks to taxpayers.
Heads, the banks win. Tails, the banks win.
The absurd...never in short supply at the NAF!
"But Congress is not skilled at setting a payment rate that is neither too high nor too low, or that encourages the optimal number of lenders to make loans to all students."
How preposterous is this statement in light of current events folks? Do the scholars at the NAF live in an alternative universe? Or is this just more FFELP bloodlust courtesy of the Captain Ahab mentality of this blog when it comes to the private sector? Let's see here...Congress is trying to control how 17% of the economy will operate--health care ring a bell? How about cap and trade NAF? Congress seems to think it can determine the Earth's temperature for the next 100 years and therefore winners and losers in the realm of energy. (And Jason thinks Congress can't set a simple subsidy rate on student loans!) Perhaps I'm being too harsh here with the scholars at the NAF. Maybe a trip over to the local Government Motors car lot will clear my head! I hear the new Chevy Volt is a real winner!
NAF is right on target this time
It is a completely obvious statement that the lawyer-legislators of the Congress simply do not have the skills to set a payment rate to loan holders that is neither too high nor too low, or that encourages the optimal number of lenders to make loans to all students. Greenspan, Volcker and their top analysts did not have those level of skills, so how would amateurs in Congress be able to do it? It is obvious that the subsidy level, for example, set in 1998 (T-bil) or 1999 (CP), was based on lobbying rather than analysis. The members of Congress didn't even wait for the completed analysis which they specifically had requested to hold off to do their things and pump up the subsidies.
Bott is way off and shows his inherent dislike for competition and the whole idea of introducing market forces into federal student lending. The lending industry has had 15 years to get on board with market mechanisms (whether auctions or some other type of bidding process). DL is the only other option. Continuing with 1986 FFELP is NOT an option and never was. At least the market forces in DL (inter-agency borrowing interest rate and discount rate) are not subject to program-specific lobbying. (Someone could certainly suggest that the rates that federal agencies pay Treasury are too high overall, but this would not be student-loan-specific.)