Obama�s Student Loan Takeover Adds $52 Billion to Deficit According to �Fair Value� Accounting, Says CBO

CNS News (Link) - Edwin Mora (March 31, 2010)

The student loan overhaul legislation signed into law by President Barack Obama on Tuesday could add $52 billion to the deficit between 2010 and 2020 when the cost of the market risks and administrative expenses of the loans are taken into consideration, the non-partisan Congressional Budget Office (CBO) reported.

�CBO recently estimated that whereas loans issued in the direct loan program between 2010 and 2020 would reduce the deficit by a total of $68 billion under FCRA accounting, those loans would increase the deficit by $52 billion on a fair value basis,� reads the March 2010 CBO study, Policy Options for Federal Student Loan Programs. ( See p. IX of the Summary.)

The CBO report further notes that it explained its calculations about the budgetary impact of the administration�s plan to change the federal student loan programs and the $52-billion addition to the deficit in a March 15 letter sent to Sen. Judd Gregg (R-N.H.), the ranking member of the Senate Budget Committee.

In the study, the CBO explains how the accounting mandated through the Federal Credit Reform Act (FCRA) is the standard procedure used to record the budgetary costs of the government�s direct and guaranteed loan programs.

However, the CBO notes that FCRA cost estimates exclude the value of �market risks� and the loan programs� �administrative expenses� while the CBO�s �fair value� estimates takes them into account.

This discrepancy between the two estimates results in the FCRA figure being a less �comprehensive� appraisal of the true cost to taxpayers of the federal government�s direct student loan program, according to the CBO report.

�Fair-value subsidy estimates, which include the cost of risk and administrative costs, provide a more comprehensive measure that allows the costs of the two programs to be compared on a level playing field,� states the study.

It further reports, �The FCRA methodology does not include the costs to taxpayers that stem from certain risks involved in lending -- risks that private investors would require compensation to bear.�

�In particular, although the FCRA methodology accounts for average losses from defaults, it does not recognize a cost for the risk that losses from defaults will be higher during periods of market stress, when resources are scarce and hence most valuable,� reads the report. �Such �market risk� is excluded from FCRA estimates because that methodology discounts expected future cash flows at Treasury borrowing rates rather than at higher interest rates that incorporate the price of risk.�

Furthermore, according to the study, the �FCRA estimates do not include administrative expenses, which are recorded separately in the budget each year on a cash basis (that is, undiscounted). That treatment mixes together current year administrative costs for outstanding loans and for newly originated loans.�

Education Secretary Arne Duncan. (AP Photo/J. Scott Applewhite) The federal government operates two student loan programs. One is the Federal Family Education Loan program (FFEL), which refers to the government loan guarantees to private lenders that offer student loans. The other is the William D. Ford Federal Direct Loan Program (FDLP), in which the Department of Education issues direct loans to borrowers.

On Tuesday, Mar. 30, President Obama signed into law his proposed changes to the student loan program as part of the Health Care and Education Reconciliation Act of 2010 that passed the Senate last Thursday by a 56 to 43 vote, with Republicans unanimously voting against it.

Despite the CBO highlighting that under �fair-value� estimates the direct loan program would increase the deficit between 2010 and 2020, the student loan overhaul calls for eliminating the federal government�s loan guarantees -- which subsidize private banks and other financial institutions for making loans -- and replacing them with direct loans made by the Department of Education. The new law apparently will place more strain on the direct loan program.

As of July 1, all new government-backed student loans will come directly from the federal government. The Department of Education will hire private companies, under performance-based contracts, to disburse and collect the new loans.

Nevertheless, after signing the student loan overhaul bill at the Northern Virginia Community College in Alexandria, Va., the president said: �By cutting out the middleman, we�ll save the American taxpayers $68 billion in the coming years. That�s real money.�

During a telephone conference on Tuesday, former Virginia Gov. Tim Kaine, now the chairman of the Democratic National Committee (DNC), said the new student loan law would reduce the deficit as well as spending.

�What we�re doing is we�re taking a program and we�re going to save $68 billion dollars in subsidies that were being paid by the federal government to financial insitutitions,� said Kaine.

�We�re taking that $68 billion over the next 10 years out of the system, we�re going to use $10 billion of it to pay down the deficit,� he said, �and we�re going to use north of $50 billion of it to expand college access to more students and make the Pell Grant amount higher. � So this is a net benefit in terms of reducing the deficit and reducing spending.�

Savings for taxpayers stemming from the new student loan law are about $22 million lower under the �fair-value� assessment than they are under the FCRA estimate.

According to the CBO study, �The savings from implementing the President�s proposal to replace FFEL loans with direct loans decline from a total of $62 billion over the 2010�2020 period under FCRA accounting to $40 billion on a fair-value (accounting).�

�The savings are smaller on a fair-value basis because that measure, which takes into account the risk associated with those payments, assigns them a lower cost to the government and thus finds a smaller benefit from eliminating them,� said the CBO.

Furthermore, the CBO study revealed that under the �fair-value� estimates, the overall student loan program, including both direct and loan guarantees, would add to the deficit.

�CBO�s calculations indicate that if subsidies were computed on a fair-value basis, student loans made in both the direct and guaranteed loan programs would impose costs on the federal government, and those costs would represent a significant share of the principal value of the loans issued,� stated the study.

While a direct loan program may have �a negative subsidy rate of 9 percent under FCRA (meaning that it reduces the deficit), the same loan has a positive subsidy rate of 12 percent on a fair-value basis,� said the CBO.

Nevertheless, the study indicated that under the �fair-value� and FCRA assessments, the government guaranteed loan program ends up being more expensive.

The study also noted, �CBO�s fair-value subsidy estimates are highly sensitive to assumptions about a variety of uncertain factors, such as the effect of risk on discount rates and the allocation of federal administrative costs between programs.�