Loan industry officials aren't the only ones who believe that the federal budget has made the direct loan program appear to be much less expensive than it really is.

Annual reestimates by the Office of Management and Budget every year have increased the cost of direct loans.

We need no better evidence than that that federal budget scorekeeping under the Credit Reform Act -- the Holy Grail for direct lending advocates -- is flawed and unreliable.

It seems we're still not talking about the same thing. There's a distinction made by NBER, Holtz-Eakin and Gillen regarding market risk, economic cost, and arbitrage rates. Switching terms as if they were interchangeable, as you have done here, does not clarify the debate at all.

The NBER paper is a convenient side bar, but an updated analysis of their conclusions would yield dramatically different results now that new FFELP loans don't qualify for SAP allowances. The artificially suppressed 3-month CP rate ensures that FFELP lenders receive no SAP on loans made after January 1, 2000. Eliminating that one factor from the cost analysis done in the NBER paper would show FFELP to be cheaper than direct lending by about 200 bps (18.1 for FFELP v. 20.1 for direct lending). Accordingly, a student lending model that does away with SAP but continues to originate loans through the private sector would be more cost effective for the government than a switch to 100% direct lending.

That's still a distraction however, since the real issue, and where NBER, Holtz-Eakin and Gillen all appear to agree, is whether direct lending can actually achieve the arbitrage spread necessary to generate the savings CBO projects. The fact that 10-year Treasury notes are already higher than CBO estimates for 2010 and are closing in on the rate assumed for 2011 suggests that "savings" from direct lending for FY10 and FY11 will be substantially overstated. In fact, inflationary pressure may erase most of the arbitrage earnings assumed by CBO before the bill even becomes law, and that's assuming a one-day shift, rather than a phased in approach as has been described by some policymakers recently.

Coincidentally, CBO also assumes only 8.8 percent unemployment for 2009, a figure that would sound like good news if it ever came back to visit.

A quick look back over the past 8 fiscal years shows a $31 billion cash flow shortfall in the direct loan program account - something not taken into account at all in the NBER paper. Even the most ardent supporters of direct lending would be compelled to admit that the program has never lived up to its budget expectations.

All excuses aside, is the government really going to erase an entire industry over savings that everyone knows will never materialize? Policymakers deciding that real people should lose real jobs to capture make believe savings seems like a bad policy choice to me.

Jason, can you explain the extraordinary volatility in student loan program estimates under the Credit Reform Act? For example, why do the two official budget scorekeepers (OMB and CBO) arrive at such different cost estimates for the same loan programs over the same time period? What's the explanation for the sharp decline in OMB's projected cost savings from $46 billion over ten years to, just a few months later, $41 billion? If Credit Reform budget scorekeeping has, as you say, "symmetrical" effects on both direct and guaranteed loans, then why are OMB reestimates so asymmetrical--increasing over the years Direct Loans' costs by $12 billion and reducing FFELP's costs by $12 billion? Sounds like an inherent asymmetrical advantage for direct loans to me.

I argued just the opposite, actually. Please note that I referenced the NBER paper, and that interest rate changes under Credit Reform rules do NOT have symmetrical effects on DL/FFEL cost estimates. Market cost estimates, such as the one done in the NBER paper, DO HAVE symmetrical effects, however, because they correctly model loan program cash flows and risk. The risks to the taxpayer are nearly identical under both programs, so interest rate changes and default estimates changes will have similar effects on both programs. Remember, the issue here is market costs. Under Credit Reform rules, which I criticize in the paper featured here, interest rate changes have asymmetrical effects on cost estimates, as you correctly point out, but this outcome is wrong due to the incorrect treatment of FFEL cash flows. Thus, the asymmetric effects are incorrect. Again, this is discussed in the NBER paper and the New America Foundation paper. I agree that credit reform is wrong. And I believe the NBER paper is a better approach to the cost estimates.

Lenders cannot make arguments about "volatility" of direct loan program estimates when they (along with guarantors, secondary markets, and the many schools they induced to go along with them) lobbied quite vocally against the very interest rate structure which would have minimized or eliminated that volatility. That would seem to be the very definition of chutzpah!

Interest rate risk, market risk and hedging costs have provided a scoring advantage to FFEL since 1999 and, yes, have been explicitly ignored by CBO as beyond the scope of its mission of estimating tangible costs. A provision tucked into a 1999 social security reform bill quietly shifted the index for providing lender subsidies from short-term Treasuries to short-term commercial paper. While the tangible cost did not change significantly, as argued by CBO, this lifted a huge weight from loan holders -- hedging the risk that the two rate indices would diverge. Hedging, interest rate risk and market risk were quietly shifted from the lender to the taxpayer!

In addition, the last major student loan reform 16 years ago had scheduled a transition to unified rate structure where borrower interest rate, lender interest rate and discount rate would all be long-term Treasury bond. The lending community lobbied against this scheduled change and prevented it from occurring, arguing that, although, yes, student loans are long-term financial instruments, that loan providers raise their capital on short-term overseas markets.

In particular, if the borrower index and the index used when the Educ. Dept. borrows capital from the U.S. Treasury would have removed most of the market risks and interest rate risks from the direct lending program and greatly improved the accuracy of cost estimates because everything (borrower rate, discount rate and Educ. Dept. rate) would have been on a longer-term Treasury bond index. Apparently Washington believed it was more important to respond to lenders' needs. After preventing the implementation of something that would greatly ease direct loan cost estimation lenders cannot at the same time argue that it imposes risks of re-estimation.

In addition, under the OMB method, but not the CBO method, guarantors and lenders can "re-score" the direct loan program by consolidating defaulted and delinquent loans into direct loan and at the same time inducing direct loan's stafford/plus borrowers (who are "higher quality" than ffel's) to consolidate into ffel.

Lender groups deftly shifts from CBO to OMB, a totally different methodology. One reason that Congressional Budget Office tends to find more savings from shifting to direct lending than Office of Management & Budget is that CBO does not consider consolidation loans to be new loan capital but rather a repayment plan option. For many years consolidation lenders would market consolidation loans to the direct loan Stafford and Plus borrowers, who have a better track record than the FFEL Stafford and Plus borrowers. The "crossover" consolidations which occurred for many years involved low risk borrowers being moved from DL to FFEL and high risk borrowers being moved from FFEL to DL (through both pre-default and post-default consolidations). These efforts resulted in the OMB re-estimations cited by Mr. Bruns and others. However, they would have no impact on the CBO estimations, because CBO counts a DL consolidation default against FFEL if the borrower started out with a FFEL Stafford or Plus loan. In addition, CBO would count a FFEL consolidation loan in good standing as a successful DL repayment in progress if the borrower started out with a DL Stafford or Plus loan. Regardless of how prophetic you believe OMB could or should be, it is difficult to imagine that they could have predicted in the mid-1990s the level of consolidation gamesmanship which would occur in the 2000s.

The cost issue is not really all that complex. In FFEL, borrower repayment goes to the loan holder; in DL, it goes to the Treasury. It is impossible to see how how FFEL could be cheaper. In addition, the temporary liquidity programs are apparently the opposite of the "market-based" approach advocated by conservatives for many years. According to market experts, whether you agree or not, the US government is better at funding loans (has the lowest cost of funds anywhere in the world) and the lenders are better at service. In fact, in the temporary liquidity programs we have lenders providing the funding (with large subsidy from the taxpayers) and then potentially selling the FFEL loans to the government to servicing for the next 20 or 30 years. Yet there are now proposals out there to make this temporary program the long term approach to student lending (private funding plus government service!). Isn't this what they used to say about combining the empathy of the IRS with the efficiency of the post office?