NCPA - National Center for Policy Analysis

The Federal Student Loan Program Is Expensive

March 23, 2012

Advocates for the expansion of higher education claim that the federal government should broaden the availability of its below-market student loan rates.  Additional calls have been made to further lower the rates that are provided, which supporters say is an unarguably good policy.  After all, they say, these loans provide a societal good at no cost to the government, says Jason Delisle, director of the New America Foundation's Federal Education Budget Project.

This, however, is the inherent difficulty in assessing the costs of government-provided loans: complicated accounting techniques and dynamic interest rates make the process esoteric.  Specifically, they hide the costs of such programs and the enormous losses that government revenues will eventually have to cover.

  • Using fair value estimates, student loans are the government's most expensive loan program.
  • In most years, taxpayers will spend about three times as much on the student loan program as they do guaranteeing home mortgages through the Federal Housing Administration.
  • According to a 2010 Congressional Budget Office study, the fair value cost of student loans averages about $12 dollars for every $100 lent.
  • It is astounding, then, that an estimated $112 billion in new loans will be made this year.

These losses stem from the innate risks involved in lending.  The government is called upon to supply below-market interest rates because market rates are too high.  But market rates are high because they have accurately assessed the risks of default among the student population.

Debbie Lucas at the MIT Sloan School of Management provides an illustrative example:

  • The government issues $100 million in 10-year U.S. Treasury notes to finance $100 million in student loans with 10-year repayment terms.
  • The U.S. Department of Education expects that about 19 percent of loans made to students in 2013 will default at some point, but that is an estimate of average expected losses.
  • Losses could be higher, such that, after the 10 years is up, the student loan portfolio has suffered losses to the extent that the U.S. Treasury bonds cannot be fully repaid with the loan repayments alone.
  • General tax revenues are then expected to cover losses.

This demonstrates why federal loan programs are not without cost, and why calls to expand them must be tempered by financial considerations.

Source: Jason Delisle, "The Federal Student Loan Program," National Review, March 19, 2012.

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