On March 30, President Obama signed the Student Aid and Financial Reconciliation Act (SAFRA) into law, following a long and controversial battle in the Senate. Much of the debate involved the proposal to terminate a program that provided subsidies to private lenders, and to move all federal lending to the Direct Loan (DL) program, with the savings from eliminating the subsidies being used to fund a number of other initiatives.
Many who opposed SAFRA were concerned that the actual savings from converting all loans to DL would be much lower than the Congressional Budget Office’s estimate of $61 billion–and possibly non-existent. The CBO had to score the bill using some dubious assumptions, such as ignoring interest rate and market risks, as well as administrative costs. With the government overseeing a total student loan portfolio of $621.1 billion and growing, deficit hawks were concerned that the new spending initiatives would inflate the deficit.
One SAFRA item that hasn’t generated much concern, but is likely to result in significant losses for the government, is the income-based loan repayment (IBR) plan. This program will allow students to reduce their federal student loan payments (excluding Parent Plus Loans) to no more that 10% of their income above a basic living allowance–defined as 150% of the national poverty line for a given family size (the current basic allowance is $16,245 for a single individual and $33,075 for a family of four). Under IBR, any remaining debt will be forgiven after 20 years, or 10 years for so-called public service workers.
I performed some calculations to determine the maximum monthly payment that a single individual would be responsible for given a certain income under IBR, and compared that to the monthly payment associated with a given level of debt (assuming a 6.8% fixed interest rate). The difference between IBR and regular monthly payments indicate the monthly savings for a person with a given income and aggregate loan amount.
The savings associated with IBR for a single individual with $15,000 in student loans begins to fade away when income exceeds $40,000, but not until income begins to exceed $60,000 does an individual with $25,000 in student debt fail to achieve savings under IBR. Even individuals earning $150,000 can achieve savings if they managed to rack up $75,000 or more in federal student loans by attending graduate or professional school.
Taxpayers are already on the hook for losses that result from the increasing number of borrowers who default on their loans (federal data projects that 15.3% of student loan dollars originated for 2007 will be defaulted on within 20 years). Under SAFRA, they will now be the backstop for losses that occur as more heavily indebted students face grim employment prospects and move onto IBR.
A letter from the White House projects that more than 1.2 million borrowers who enroll in 2014 or later could qualify to participate in IBR. The average student debt is already $23,000 and will likely continue to grow, so it is conservative to estimate that the average debt level of these 1.2 million IBR participants will be $25,000. This means that taxpayers face potential losses of up to half a billion dollars a month or more from the IBR program.
In addition to the imminent taxpayer losses, another problem with SAFRA is the incentive to seek "public service" employment, since borrowers enrolled in IBR will have their loans forgiven after only 10 years of net loss payments. It is highly questionable as to why public service workers receive more favorable repayment terms than those in the private sector, especially given recent reports that public sector compensation has risen nearly 50% faster than private sector compensation since 2007, and that the average hourly public sector compensation was 45% higher than the private sector average in 2009. Implicit in this discriminatory policy is a signal from the Obama administration that working for the government or non-profit world is good and will be rewarded, while taking employment in the private sector is inherently bad.
This demonstrates the Administration’s disdain for private enterprise.
As you can see, IBR is a sweet deal for students, especially those wishing to pursue a public sector career. But it will likely only exacerbate the rapidly inflating tuition bubble and growing levels of student debt that are a product of the government-backed subprime student loan era. Knowing that they have an escape route from the burdensome debt trap, students will have little incentive to be cost-conscious in choosing a college and area of study, or in monitoring the level of debt that they accumulate and considering whether they will be able to find employment that provides them with sufficient income to repay it.
These changes are sure to be welcomed by a higher education community that has an insatiable appetite for no-strings attached wealth transfers, and will work counter towards holding these institutions accountable for student outcomes and fiscal prudence. Nor will it motivate colleges to counsel students about the dangers of taking on too much debt. Instead, it continues to drop taxpayer money out of airplanes over college campuses, without instilling a mechanism to ensure that our scarce resources are used in the most cost effective manner possible, and to produce the best possible results in educating the future workforce.
By Daniel Bennett