In a few weeks the president will issue his budget proposal to Congress for the upcoming fiscal year. While all eyes will be on President Obama’s funding requests for major education programs like Pell Grants and Stafford loans, we’re hoping the Office of Management and Budget and the Department of Education take the opportunity to finally set the record straight on the most misused, misunderstood, and misleading numbers that appear every year in the federal education budget. We’re talking about the numbers buried in the appendix and supplemental tables that suggest the federal government makes money when borrowers default on their federally backed student loans.
We’ll be the first to admit that the Department of Education and the White House Office of Management and Budget (OMB) have certainly done a good job of making it look like the government makes money off of its student loan collections. In a table included in the President’s fiscal year 2011 budget titled Loan Guarantees: Assumptions Underlying the 2010 Subsidy Estimates, the recovery rate for a student loan in default is 122 percent. That is, for every $100 in loans that default, the government ultimately collects $122. A footnote in the table advises that the figures reflect “interest and penalties or other income.”
These budget numbers have misled reporters, student-loan borrower advocates and industry lobbyists alike. For example, the Wall Street Journal recently reported that “Defaulting on federal student loans may not be such a bad thing – at least, not for the federal government.” The for-profit college industry and its lobbyists have used the figures to argue that their schools aren’t a burden on taxpayers. High default rates among their students they say don’t actually cost taxpayers a dime. Many borrowers who have defaulted on their loans, and the advocates who represent them, point to the budget figures on loan recoveries as proof that the penalty fees the Department of Education assess on unpaid loans is part of a cruel and nefarious money-making scheme.
Sadly, nothing in budget documents tell readers that the default recovery rates are not what they appear. That is, the figures don’t represent the real cost of a default because they don’t factor in how much the government spends to collect a delinquent loan or when the funds are actually collected. Both OMB and the Department of Education will admit that once those costs are included, the recovery rate falls well below 100 percent. In other words, a defaulted student loan has real costs for taxpayers. In fact, a 2007 Congressional Budget Office study that examined student loan collection information in the National Student Loan Data System found that after accounting for collection costs and the time it takes to collect on a loan, recovery rates are actually only about 50 percent. That’s even after the government uses all of the extraordinary powers it has to collect on student loans, like garnishing wages and seizing tax refunds.
Why should collection costs and the time it takes to collect a delinquent loan be included in the loan recovery figures? First there is the theoretical case.
Investors in the private market assess the costs and risk of making loans to college students and other consumers in part by determining how much it will cost to collect delinquent loans and how long that process might take. Furthermore, investors care that there is a lot of uncertainty to these factors as well – some loans may take a lot of resources to collect and a lot of time, while others may not, or they may all be difficult to collect. In other words, we know that individuals, when using their own money to make loans, assign a value to collection costs and the time a takes to collect on a loan, as well as the general uncertainty around those activities. It’s therefore safe to assume that these same individuals (i.e. the market) would assign the same values for similar costs when the government makes loans with their money. Or put more succinctly: capital has one cost no matter who is using it.
Now let’s consider the practical argument for including collection costs and time in the recovery rates for federal student loans. When the government spends $16 to collect $100, few if any taxpayers would believe that they got their $100 back. This is akin to a business stating its earnings without first deducting any costs it incurred to generate that income. And collecting on a defaulted student loan is no simple task. Anyone who has experienced the onslaught of collection calls is well aware that the government has deployed ample resources and man hours to this task.
Finally, there is the issue of time in collection activities. Most people are aware that they themselves implicitly value their own money differently based one when they receive it or spend it. Getting $100 today is worth more to an individual right now than getting $100 ten years from now. What’s more, the value of that $100 ten years from now is uncertain, and people consider that a cost too. Why would anyone suddenly stop caring about these costs when the government uses their money to make student loans?
Now consider a report that was prepared for the Coalition for Educational Success – a lobbying group representing for-profit colleges – that argues taxpayers incur little cost from a defaulted student loan because the “government can collect the delinquent loans during the entire lifetime of the borrower.” In other words, the authors are telling taxpayers that it could take a lifetime to get their money back, but there are no costs for such a wait. That is hardly reassuring.
It’s a mystery to us at Higher Ed Watch that the White House Office of Management and Budget and the Department of Education have not acted to clear up what has become a major misunderstanding. They should set the record straight on how much defaulted student loans really cost taxpayers in the president’s upcoming budget request. Until they do, lobbyists, consumer advocates and journalists will continue to point to the president’s budget documents and erroneously claim that the government makes a profit on borrowers who default on their student loans.