Government Loansharking

Last November when I first wrote about student loans for Boston Review, the Department of Education estimated it would be pulling in around $25 billion in revenue from its higher education lending programs. It seemed ridiculous, since the DoE had started lending directly to students rather than guaranteeing private loans partly to give students a better deal. Seven months later, the Congressional Budget Office has estimated the student lending haul for 2013 at just under $51 billion, higher than the annual profits of Exxon Mobil or Apple. Rather than leveling off, government surpluses from student loans are following the exponential trajectory of higher education costs.

These revenues are profits—the government is profiting from student debtors. That some commentators have objected to this terminology illustrates widespread denial about the nature of the student-debt crisis. Even the political leaders who are rightly disgusted by such profiteering and favor lowering interest rates on student loans do not grasp the problem. These epic profits are merely the tip of a huge cost iceberg, formed from the skyrocketing baseline costs of education. No lawmaker has proposed a genuine, long-term solution to the crisis.
 

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The huge profit flows from the divergence between the government’s borrowing rate and the interest rate at which borrowers repay their loans. While student borrowers do pay a low interest rate as compared to commercial loans, the Treasury’s 91-day Bill Rate has been stuck under one percent since the 2008 financial crisis; right now it’s at a historical low of .07 percent. If you can get money for nearly free, as the Treasury can, lending at even a small interest rate yields a significant profit when multiplied across hundred of billions of dollars in loans. The federal government’s stated intention was never to make money from the direct lending program, and all their projections have the T-Bill rate recovering to pre-2008 levels any year now, which would eliminate the profits, but so far this hasn’t happened. Nor has there been a wave of defaults and nonpayments commensurate with the slow economy that the low Treasury rates could have helped offset. Instead, borrowers are stuck with the worst of both worlds: stagnant wages, escalating costs, and no exit in sight.

Some commentators—such as Jason Delisle at the New America Foundation and Dylan Matthews at the Washington Post Wonkblog—have used the new CBO report on the 2013 student loan “subsidy” rate as an opportunity to suggest some different accounting procedures. They suggest that the baseline by which the Treasury measures profits on student lending is flawed, since it doesn’t properly account for the risks involved. Instead, they want to use what’s called a “fair value” model, which would recalculate the subsidy estimates as if the U.S. Federal Government were not the U.S. Federal Government but were instead a private lender. The profits mostly vanish because fair value accounting includes investor compensation required to incentivize them to make the loan. Fair value metrics construct an imaginary competitive market and estimate from there.

There are a number of reasons not to use fair value accounting for government student lending. First, the government, as pointed out by Mike Konczal of the Roosevelt Institute, is not a private firm. It is instead the government. As the government, it can borrow capital at near-zero rates, doesn’t have investors demanding gains on their investments, and has a low risk of folding any time soon. Fair value accounting treats public servants like loan officers, citizens like shareholders, and student borrowers like car buyers. But the collection law doesn’t.

Despite some confusion, even under a fair value accounting, the DoE would still be pulling in $5 billion—$3 billion after administrative costs. Technically it’s not supposed to work that way; if there’s a fair value profit to be made, then according to the model, private lenders jump in and make the loans themselves. One of the rhetorical purposes of fair value accounting is to suggest that the government isn’t as efficient as it thinks it is by making it play by the same rules as private firms. But once again, the government is not a private firm, partially because private firms don’t (ostensibly) create their own laws. When forced to explain how three of four federal student lending programs could be making a fair value profit, the CBO admits “the federal government has tools to collect from delinquent borrowers that private lenders do not have, giving federal programs a real advantage over private-sector competitors.” These tools, more than administrative costs, high barriers to entry, or miscalculations on recovery rates, are the logical source of student loan profits.

In November, I looked at the extraordinary powers and regulatory loopholes that enable the federal government to collect far more from student borrowers than they would be able to otherwise. When the Treasury assumed direct responsibility for government-backed student loans—around 85 percent of total student debt—the assumption was it would be better for Americans to owe their own government than greedy private lenders. The state paid off the banks, and promised to take care of the rest. But even the powerful finance industry doesn’t quite have the power to exempt itself from regulatory laws; the government does.

Whether it’s borrowers not being able to discharge student debt in bankruptcy, collectors exempted from the Fair Debt Collections Practices Act, or the debt itself never expiring, a number of special rules make student debt to the government a uniquely brutal type to owe. The government can even deduct payments from borrowers’ pay or Social Security checks. When Dylan Matthews writes that the government is “better at making collections than private lenders,” it sounds like he’s talking about economies of scale. But the government is more like a loan shark who can make “riskier” investments than private lenders can because they “have tools to collect from delinquent borrowers that [other] lenders do not have.” Borrower protections increase risks for lenders, selectively undermining these protections offsets the lender risk. That’s why the average defaulted student borrower still ends up paying the Treasury more than 100 percent of their loan’s principal.

The fair value measure, therefore, isn’t useless. It does not—as its proponents claim —explain away tens of billions in revenue. But it does show us something else. While all the other federal credit programs show a narrow swing in the numbers between Federal Credit Reform Act (FCRA) accounting and fair value accounting, education is the only category of lending with a double-digit change between the two methods both in percentage and absolute measures. What does that difference represent if not the profit incentive Congressional representatives worried about government spending require to make the loans? There are a lot of ways to offset risk: A lender can demand a high enough reward to make it worth the chance, as proponents of fair value accounting suggest. They can take a counter-position in the market, hedging their risk against possible misfortune. They can take collateral, like a pawn shop or a bar that gets your credit card before issuing a tab. It’s been legal for a long time to charge reasonable interest on loans, and there’s no rule against hedging your bets, but if a lender is willing to break the law, they can also offset risk by changing the conditions of repayment.

When you look at a loan, it’s important to consider the calculation going on for a borrower who can’t afford to pay it back. For law-abiding lenders, there’s not much variation: The borrower measures the cost of repayment against crushing and onerous default and bankruptcy. It’s no picnic, especially since the onerous Bankruptcy Reform Act of 2005, but America doesn’t technically have debtors’ prisons, and there’s only so much private collectors are allowed to try before they have to write a customer off as a loss. Criminal lenders, on the other hand, can offset a greater risk by setting more unpleasant consequences for nonpayment. A loan is a lot less risky to issue if instead of relying on a credit report, a lender can rely on the borrower’s desire to live or see their family go unharmed. Given the right incentive structure, lending cash to a gambler can be as safe as a T-Bill.

The Mafia aren’t the only lenders who make their own rules, the government does as well. Through the use of its own special set of compliance tools—particularly wage garnishment—the federal government has tied student loan repayment very closely to the continued growth of the U.S. economy. As long as enough college-educated workers survive to work more, they will pay their loans. And for a series of complex reasons I outlined in November, the Treasury doesn’t need borrowers to hurry on repayment as long as they can count on getting the money back someday. These conditions make student loans effectively just as safe as Treasury Bills, which are themselves low-risk investments in the continued expansion of the American economy. Thus the discrepancy between the standard and fair value subsidy rates for student debt represents not the profits some penny pinching bureaucrat demands—I’m sure the Treasury would be happy to see the economic growth that would necessitate a boost in T-Bill rates, even though it would significantly dampen student lending profits—but rather the government’s extraordinary ability to collect beyond what a private lender could under the same conditions.

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The same government that has given itself such extraordinary powers to collect is debating changes to the interest it charges. President Obama, Senator Warren (D-MA), and Congressional Republicans have offered different plans that tinker with rates and/or tie them to the Treasury’s borrowing costs. These solutions might depress the embarrassing government profit and save borrowers a few here or there, but none of them even begin to address the root causes of the student debt crisis. They’re Band-Aids on broken limbs, and any answer that includes former students—it’s important to remember not everyone who takes out debt graduates with a degree—paying back the entire trillion-dollar outstanding total is downright cruel. And until policymakers start talking about forgiving existing debt and actively reducing higher education costs, anything else is simply a distraction.

In The Merchant of Venice, Shylock knows (or rather, thinks he knows) that since his loan can be redeemed in flesh, the only way Antonio can fail to pay back his debt is if he’s already dead. It’s a grisly suggestion, one that plays out dramatically in the Danish movie Pusher when a drug addict chooses quick suicide rather than commit armed robbery to settle his debts with the titular lender. The federal government, with its cosigners and non-expiring loans, is not as generous. The Economic Hardship Reporting Project cites the story of Jan Yoder, an Illinois woman who had to continue fighting with her son’s collectors even after he, unemployed and $100,000 in student debt, decided to take his own life. Six months ago I ended my piece by saying student debtors had no hope for relief short of expatriation, revolt, or suicide. It seems upon further reflection that I was being a little too optimistic.

For more on the student-debt crisis, read Pomp and Exceptional Circumstance: How Students Are Forced to Prop Up the Education Bubble.