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: Will the federal student loan program need a $500 billion bailout?

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Few topics in public policy generate as much heat as the debate over student-loan debt cancellation, a proposal first put forward by Massachusetts Sen. Elizabeth Warren during her campaign for the Democratic nomination for president two years ago.

The cost of Warren’s plan, which the Brookings Institution estimates is $1 trillion, is enough for many progressives to balk, given that much of the benefits would accrue to higher-earning Americans, but a new report in the Wall Street Journal could call this math into question.

The Journal reported that an analysis done by Jeff Courtney, a former JPMorgan executive in charge of its private student loan business hired by the Education Department estimated that federal government is overvaluing the $1.6 trillion portfolio by roughly one-third, meaning that the program would ultimately need a $500 billion “bailout” by U.S. taxpayers.

And while President Joe Biden’s Education Department disputes this characterization as “motivated by a political agenda by [former Trump Education Secretary Betsy DeVos] to kill the student loan program,” the debate underscores the unusual nature of the federal government’s accounting for student loan debt, how a desire to make the federal budget deficit appear smaller than it might otherwise be has helped drive the rapid rise of student loan debt in the United States, and why the Democratic Party’s embrace of student debt cancellation could make it more amenable to Courtney’s analysis.

Prior to the Federal Credit Reform Act of 1990, the federal government accounted for loans and loan guarantees it made to individuals and businesses using cash flow accounting: that is, when it issued a loan, it would count as a large expenditure, and loan repayments would show up as revenues over the course of the loan’s maturity. When making a loan guarantee, the opposite would happen: the fees would begin coming in immediately as revenue, but future defaults on those loans wouldn’t be recognized until the future.

Such a system is problematic when Congress typically budgets over a 10-year time frame, so the 1990 reform required the Congressional Budget Office to determine the impact of loans on the federal deficit using a net-present value calculation that sets aside the upfront expenditure and instead estimates what the cash-flow effects of the transaction will be over the life of the loan.

According to Donald Marron, director of Economic Policy Initiatives at the Urban Institute, that means that when the federal government issues student loans, it actually is logged as increasing revenue, per CBO analysis.

“The standard estimates are that in most years the interest people pay and the fees they will pay are more than enough to cover the federal borrowing costs plus whatever the defaults are,” he told MarketWatch.

Susan Weber, a Goldman Sachs veteran who has long blogged under the pseudonym Yves Smith at Naked Capitalism, called this accounting “dodgy” and compared it to how large financial institutions treated credit-default swaps and collateralized debt obligations — the complex financial instruments that helped lead to the 2008 financial crisis.

“Bad accounting regularly drives bad outcomes, and that looks [to be] the immediate cause for the expansion of student loans,” she wrote, noting that just as when banks last decade would buy questionable mortgage debt, package it and sell it to investors, they were able to book it as income rather than keep it as debt on their balance sheets.

Weber argued that it’s this accounting practice, and the desire to make budget deficits appear smaller, that has driven the explosion of student loan debt from nearly nothing in the early 1990s to more than $1.6 trillion today. In other words, budget politics, rather than sound education policy, has been guiding policy makers in this area for decades.

Courtney, the former JPMorgan banker, does not dispute that federal loans will ultimately make a profit, but that the portfolio will earn 37% less than the Education Department now maintains, and that therefore the entire value of the portfolio could be upward of $500 billion less than currently assumed.

The Journal article says that this means that “taxpayers could be on the hook for roughly a third of the $1.6 trillion student loan portfolio,” but what does that actual mean for taxpayers if, in fact, the program is still earning a profit?

“In the budget context, we’re not accustomed to think about the financial assets the federal government owns,” Marron said. “Writing down a loan doesn’t cost the government any money immediately, because it’s just an accounting exercise, but the budgetary impact is that all the money in principle and interest payments that was supposed to come in doesn’t.”

While the Biden administration characterized the attempt to revalue the Education Department’s student loan portfolio as an attack on the student loan program, which has long been a Democratic priority, the left’s embrace of student loan cancellation could this logic on its head.

President Biden has voiced his support for a scaled-back version of Warren’s plan — he’d like Congress to authorize him to forgive $10,000 of student loan debt for every American with federally backed student loans, versus Warren’s call for $50,000 by executive fiat — but regardless of one’s position on the amount of debt that should be canceled, the cost of that cancellation is reduced if the value of the federal government’s debt portfolio is less than anticipated.

Stephanie Kelton, professor of economics and public policy at Stony Brook University and former chief economist for the Democratic staff of the U.S. Senate Budget Committee, for instance, estimated in a 2018 study that canceling all student debt owned by the federal government would add just an average of $76.28 billion per year to the federal budget deficit, half as much as assumed when assuming the face value of the debt.

“When people like loan programs, they want them to appear as profitable as possible,” Marron said, but added this might not longer be the case for the Democratic Party, which now supports loan cancellation and some form of direct support for postsecondary education. “I’ve been wondering if the political valence might flip a bit when the discussion comes to forgiving loans, when you want forgiving them to look as cheap as possible.”

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