Any Loan Proposal Must Incorporate Fair Value Accounting

Once again, Congress is considering what to do about the looming student loan interest rate hike. Last week, the House passed the Smarter Solutions for Students Act, which would peg interest rates on federal Stafford loans to the high-yield 10-year Treasury note plus 2.5 percent. For Parent Plus loans, the proposal pegs the interest rate to the high-yield 10-year Treasury note plus 4.5 percent. Both interest rates would be capped, at 8.5 percent and 10.5 percent, respectively. The measure is an effort to stave off a doubling of the interest rate on federal student loans, slated to increase from 3.4 percent to 6.8 percent on July 1, 2013.

But absent fair value accounting, it will be nearly impossible for Congress to evaluate the true cost of any of the various proposals put forward to deal with interest rates.

The federal government’s current accounting practices, by and large, fail to account for market risk, likely understating the cost of student loans to taxpayers. Unlike the federal government, private lenders take into account factors such as the quality of university a student attends, how likely a student will be to pay back the loan, the student’s credit history and major, and whether the student has a co-signer.

Because federal student loan programs fail to take these factors into account, it is likely that federal student loans cost the government money, as opposed to making money, as is currently claimed. Employing fair value accounting would help determine exactly how much federal student loans cost taxpayers, and how heavily subsidized the program is.

As long as the federal government is in the student loan business, any loan program should use a non-subsidizing interest rate, i.e., the rate at which the program breaks even. But absent fair value accounting, it is impossible to tell the extent to which the student loan program is providing a subsidy.

What policymakers should be considering are ways to encourage the Congressional Budget Office to use fair value accounting. At the same time, the Department of Education should be required to use the FVA analysis from CBO and adjust the loan rates accordingly going forward on an annual basis. This would help determine whether the loan programs are costing taxpayers money, and where to set interest rates to ensure the programs break even.

Continuing to subsidize interest rates on federal student loans is bad policy, as such subsidies do nothing to fundamentally reduce the cost of college. Students are now borrowing double what they borrowed a decade ago, with student loan debt now exceeding credit card debt (approximately $1 trillion). Limiting federal subsidies while better targeting Pell grants would do more to limit increases in college costs than increasing such aid would.




Posted by: Lindsey Burke

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