In July, Sen. Sherrod Brown (D-OH) introduced legislation that would allow some student loan borrowers to exchange private market loans for government-backed ones. The bill aims to help borrowers who have taken out high-cost private loans. While the Brown debt swap proposal is well intentioned and may serve a pressing policy need, it highlights an important problem with the way the government accounts for federal student loan costs.
The Private Student Loan Debt Swap Act (S. 1541) would allow borrowers with private student loans originating as far back as 1994 to exchange their old debt for new loans issued by the federal Direct Loan program up to current borrowing limits ($31,000 in aggregate undergraduate borrowing) minus what they’ve previously borrowed from federal student loan programs in the past. Lenders holding the private loans would be paid out in full by the government, and borrowers would get new federal consolidation loans with fixed 6.8 percent interest rates, 10 to 30-year repayment terms, and other benefits consistent with a federal consolidation loan.
According to a preliminary Congressional Budget Office (CBO) estimate obtained by Higher Ed Watch neither borrowers nor taxpayers would bear any cost if the Brown debt swap bill became law. In fact, CBO shows that the bill would earn the federal government $9.6 billion by taking loans off lenders’ books and giving borrowers more generous terms. In other words, the legislation appears to be a win for everyone.
Most eligible borrowers would jump at the debt swap offer given that federal loans generally have more generous terms than private loans. Student loan companies also stand to gain to the extent that the government pays them more than what their loans are worth in the private market. Colleges, particularly for-profit colleges, on the hook for a portion of private student loan default costs will be pleased to see their former students reduce their debt costs. And taxpayers win because they would earn interest totaling a net $9.6 billion off the new government loans.
But there is a big problem with this scenario: the $9.6 billion in direct loan earnings are an illusion. At Higher Ed Watch we’ve contended for some time that outdated budget rules make federal loan programs such as the Federal Family Education Loan program and the Direct Loan program in particular appear less expensive than they would if private market estimates were used. This issue also applies to the Student Aid and Fiscal Responsibility Act now pending in Congress, which under a market cost estimate would save $47 billion rather than $87 billion over ten years.
CBO, to its credit, recognized the intellectual debate surrounding federal budget rules and the inherent “everybody wins” problem with loan cost estimates like that for the debt swap bill. Can a bill that subsidizes both borrowers and even lenders also earn money for taxpayers? In two paragraphs of footnotes CBO included with its estimate, it explained that when private market values and risk assessments are incorporated into the estimate, the Private Student Loan Debt Swap Act costs taxpayers $700 million over 10 years. A $700 million cost is a remarkable difference from $9.6 billion in savings and shows the value of having CBO continue to publish market cost estimates for student loan proposals.
It is unclear whether Congress will consider the Private Student Loan Debt Swap Act in the near future. But regardless of the merits of the proposal, the bill’s supporters should resist the urge to pitch it as a way to generate savings that can be spent on other federal programs.