Will Student Loan Forgiveness Programs Be Capped?

PHOTO: Will student loan forgiveness be capped?

The Brookings Institution just threw another log on the smoldering student loan problem.

In a recently published report by its Brown Center on Education Policy, the institution sets out to estimate what the various government relief strategies for student loans might end up costing taxpayers.

The news isn’t good.

The BCEP estimates that the price for these programs is likely to be much higher than originally thought, especially if many more borrowers seek to take advantage of them. To drive that point home, the center’s admittedly back-of-the-envelope calculation suggests that a universally adopted Pay As You Earn relief plan alone could end up spilling $14 billion in red ink each year.

To be fair, it is hard to project the long-term costs for programs that are subject to fluctuating influences — such as future earnings (on which the relief plans are based), the rate of inflation for higher education costs, relief-plan enrollment levels and other factors. Still, the center manages to propose some tough solutions to the legitimate concerns it raises.

The Pitfalls of Forgiveness

The government has established a variety of relief programs in an effort to help student-loan borrowers who are struggling to make ends meet. For example, the Income Based Repayment and PAYE plans each reduce monthly payments by extending the repayment durations of the original 10-year terms that are par for the course.

There’s also an added benefit.

Unpaid principal balances are forgiven after 25 and 20 years for the IBR and PAYE plans, respectively, and after 10 in the case of the Public Service Loan Forgiveness program. The think tank believes this benevolence engenders “moral hazard” by encouraging students to borrow to the hilt with the expectation of dodging what remains of the entire bill later on. It’s also concerned that all this would do little to reverse the spiraling cost of higher education.

The center recommends replacing the “forgiveness” feature with favorable tax policies that inspire students to choose careers in public service and increasing Pell Grant funding to support the financially underprivileged. The Obama administration has also weighed in with a proposal of its own to cap the amount of debt that would be eligible for forgiveness at $57,500—all ideas that deserve more discussion and debate.

Can the Government Afford to Forgive?

What the report doesn’t take into account, however, are three important considerations: two that are relegated to the End Notes section and one that isn’t even mentioned.

Note 8 acknowledges the rancorous back-and-forth on the matter of federal student-loan profitability. Although a reasonable case can be made for taking into account certain market risks that are attendant to longer-term financings, there are offsets to that which should to be factored into the analysis.

Take, for instance, the fact that the government is, at this time, taking noteworthy advantage of the yield curve by borrowing short and lending long: selling one- to three-month Treasury Notes to fund the student loans it then prices based upon 10-year rates, plus upcharges.

Sure, there’s no guarantee these massive spreads will persist throughout the repayment durations of these loans. But then again, there’s nothing to prevent the government from hedging its funding costs at any time (as financial institutions routinely do) or, even, to sell all or part of its student-loan portfolio next week or next year in order to lock in the gains. As long as Congress resists revisiting the interest rate legislation it passed last summer that could lead to a huge increase in costs to student borrowers, the mega profits that continue to make headlines could be used to defray the cost of the relief programs. (Programs which, ironically, may be all the more necessary if and when those higher interest rates kick in for borrowers.)

The second consideration—current tax policy—is mentioned in Note 14. As it now stands, the IRS views forgiven debt the same as it does fresh income: eminently taxable. Therefore, should a student borrower remain enrolled in any of these relief programs long enough to realize the aforementioned end benefit (forgiveness), he should also expect a knock on the door from the taxman. More to the point, these prospective revenues weren’t taken into account by the BCEP study either, even though these too could be used to counterbalance costs.

What the report doesn’t take into account, however, are three important considerations: two that are relegated to the End Notes section and one that isn’t even mentioned.

Note 8 acknowledges the rancorous back-and-forth on the matter of federal student-loan profitability. Although a reasonable case can be made for taking into account certain market risks that are attendant to longer-term financings, there are offsets to that which should to be factored into the analysis.

Take, for instance, the fact that the government is, at this time, taking noteworthy advantage of the yield curve by borrowing short and lending long: selling one- to three-month Treasury Notes to fund the student loans it then prices based upon 10-year rates, plus upcharges.

Sure, there’s no guarantee these massive spreads will persist throughout the repayment durations of these loans. But then again, there’s nothing to prevent the government from hedging its funding costs at any time (as financial institutions routinely do) or, even, to sell all or part of its student-loan portfolio next week or next year in order to lock in the gains. As long as Congress resists revisiting the interest rate legislation it passed last summer that could lead to a huge increase in costs to student borrowers, the mega profits that continue to make headlines could be used to defray the cost of the relief programs. (Programs which, ironically, may be all the more necessary if and when those higher interest rates kick in for borrowers.)

The second consideration—current tax policy—is mentioned in Note 14. As it now stands, the IRS views forgiven debt the same as it does fresh income: eminently taxable. Therefore, should a student borrower remain enrolled in any of these relief programs long enough to realize the aforementioned end benefit (forgiveness), he should also expect a knock on the door from the taxman. More to the point, these prospective revenues weren’t taken into account by the BCEP study either, even though these too could be used to counterbalance costs.

Making Underperforming Schools Accountable

As for the forgotten consideration, isn’t it about time that the government asked for its money back from the schools that failed to produce outcomes that justify the expense? Much has been made of a plan to punish those colleges and universities with high cohort-default rates (post-graduation loan defaults) and even sub-par completion rates (roughly half of all college students end up earning a degree). But that’s on the come. What about the taxpayer dollars these schools have already banked? Wouldn’t it make sense for the feds to claw some of that back?

With all that in mind, here’s the real question worth contemplating: To what extent would any of these relief strategies even be necessary if loan interest rates were fairly set, repayment terms were appropriately lengthened, and higher education institutions were held financially accountable for their results?

Now that would be a study worth undertaking.

This article originally appeared in Credit.com.

Any opinions expressed in this column are solely those of the author.

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