Setting the Record Straight on Student Loan Costs

President Obama’s 2016 budget estimates that the outstanding portfolio of federal student loans will be $21.8 billion less profitable than previously thought over the loans’ lifetime.  This reestimate doesn’t mean that the program “had a $21.8 billion shortfall last year,” as a Politico story stated.  Nor does it justify adopting an alternative accounting method (so-called “fair-value accounting”) that would artificially inflate the program’s cost.  The reestimate is, indeed, completely unrelated to the accounting method. Here, briefly, is what the reestimate does and doesn’t mean. Lending programs appear in the budget with up-front estimates of the net costs or profits to the government over the loans’ lifetime.  In the case of student loans, the government makes a profit, even after accounting for defaults, which is why student loans are a good deal for both students and the government.  If the government later concludes that its earlier estimates of lifetime costs were too high or low, it reestimates all outstanding loans.  The reestimate is recorded in the year it’s made (in this case, 2015), not in the many past years in which the loans were issued. The recent $22 billion upward reestimate is the net result of three factors:

• The President’s decision to permit students who borrowed before 2008 to switch to the Pay-As-You-Earn (PAYE) repayment plan will raise future costs by an estimated $9 billion.  PAYE caps monthly loan payments at 10 percent of borrowers’ incomes and forgives the remaining debt after 20 years of payments.
• More student borrowers than originally expected are switching to other repayment plans that tie payments to borrowers’ incomes, raising future costs by an estimated $15 billion.
• Expected defaults are down (that is, more borrowers are expected to repay their loans than previously estimated), lowering future costs by an estimated $2 billion.

This isn’t a “shortfall.”  No cash is missing, nor are the 2015 inflows and outflows of student loans $22 billion lower than initially thought.  Rather, the $22 billion reestimate is a new, and slightly less sanguine, view of the net profits that the government will make over the next few decades on the student loans that are now outstanding. The reestimate isn’t particularly large in percentage terms, either.  It’s about 2.9 percent of the outstanding portfolio of student loans, which is three-quarters of a trillion dollars. Also, while Senator Deb Fischer (R-NE) cited the reestimate in introducing a bill requiring the use of “fair-value accounting” for student loans and other credit programs, “fair-value accounting” would make student loan accounting less accurate, not more, and it wouldn’t have avoided these reestimates. Here’s why.  By law, the government estimates the costs or profits of its loans based on the difference between what the government will pay out in loans (including the cost to the Treasury of financing the loans) and the interest, principal, and associated fees that borrowers will repay over time, accounting for expected defaults.  “Fair-value” proponents say that the budget should reflect the higher financing and other costs that a private lender would incur if it, not the federal government, made the loans.  This approach would record loans as less profitable (or more expensive) to the government than they really are by including costs in the budget that the federal government never has to pay.  For these reasons, we strongly oppose “fair-value accounting,” as we’ve explained here, here, and here. Importantly, even if the government had been using phantom “fair-value” costs in its initial estimates of student loans, it still would have needed to make the same upward revision in 2015 due to the three factors described above.  “Fair-value accounting” would not have affected that reality in any way.