Wednesday, June 10, 2009

Higher Ed Watch Misfire

by Andrew Gillen

Over at Higher Ed Watch, Jason Delisle accuses me of falling for loan industry propaganda “bait, hook, line, and sinker” in my op-ed at Inside Higher Ed. He highlights this NBER paper to make his point.

I was all set to write up a response, but Scott Fleming in the comments not only beat me to it, but did so more thoroughly and elegantly than I was going to (2nd comment – though the name is not verified, whatever that means). I’ve copied his comment below, with my additions in bold:
It seems we're still not talking about the same thing. There's a distinction made by NBER, Holtz-Eakin and Gillen regarding market risk, economic cost, and arbitrage rates. Switching terms as if they were interchangeable, as you have done here, does not clarify the debate at all.

The NBER paper is a convenient side bar, but an updated analysis of their conclusions would yield dramatically different results now that new FFELP loans don't qualify for SAP allowances. The artificially suppressed 3-month CP rate ensures that FFELP lenders receive no SAP on loans made after January 1, 2000.(AG: Presumably, as financial markets recover, the subsidy payments to FFEL lenders will return (I’m against these). But even when they do, relying on old estimates is dangerous – the College Cost Reduction and Access Act reduced these subsides. Table 8 of the NBER paper indicates that the 11.2% difference in subsidy rates is cut to 7.7% by a .5% cut in subsidies, and to 4.8% by a 1% cut. Since the bill cut subsidies by .7% for Stafford loans, and .65% for consolidation loans, the subsidy rate difference as calculated by NBER would probably be around 6.5%.) Eliminating that one factor from the cost analysis done in the NBER paper would show FFELP to be cheaper than direct lending by about 200 bps (18.1 for FFELP v. 20.1 for direct lending) (AG: 18.1 figure comes from table 6 – subtract 13.2 from 31.3). Accordingly, a student lending model that does away with SAP but continues to originate loans through the private sector would be more cost effective for the government than a switch to 100% direct lending (emphasis added).
(AG: This is a key point missed by many. If you've got a government subsidized program that is costing too much (surprise surprise), here's a radical idea - stop subsidizing it)

That's still a distraction however (AG: Right on. I devoted a couple of sentences to the issues above. It was one of 5 separate objections I raised, and a pretty minor one at that - see the third bullet below. Even supposing that I'm completely wrong on this one, I would think you'd have to maybe sort of address the other 4, but maybe that's just me), since the real issue, and where NBER, Holtz-Eakin and Gillen all appear to agree, is whether direct lending can actually achieve the arbitrage spread necessary to generate the savings CBO projects. The fact that 10-year Treasury notes are already higher than CBO estimates for 2010 and are closing in on the rate assumed for 2011 suggests that "savings" from direct lending for FY10 and FY11 will be substantially overstated. In fact, inflationary pressure may erase most of the arbitrage earnings assumed by CBO before the bill even becomes law, and that's assuming a one-day shift, rather than a phased in approach as has been described by some policymakers recently.

Coincidentally, CBO also assumes only 8.8 percent unemployment for 2009, a figure that would sound like good news if it ever came back to visit.

A quick look back over the past 8 fiscal years shows a $31 billion cash flow shortfall in the direct loan program account - something not taken into account at all in the NBER paper. Even the most ardent supporters of direct lending would be compelled to admit that the program has never lived up to its budget expectations.

All excuses aside, is the government really going to erase an entire industry over savings that everyone knows will never materialize? Policymakers deciding that real people should lose real jobs to capture make believe savings seems like a bad policy choice to me.
To this I would like to add a few points.

• The op-ed was responding to the continual flouting of the CBO figures. If you would like to discuss the NBER paper I’m all for it. I think it's a very good paper, but note that they often dealt with the issues rasied by taking educated guesses when it comes to assumptions about differences between the programs. In spite of this I think that their figures are a more accurate assessment of the cost of these programs, but their assumptions are a source of differences nonetheless.

• Moverover, the NBER paper also provides evidence for a key point mentioned above – if the motivation of dropping the FFEL is to save money, than that is the wrong policy. To save even more money, drop the SAPs (payments to lenders) for FFEL and abolish DL. The fact that the near opposite of this is being proposed leads me to believe that there is some other motivation or belief that is driving this proposal.

• Another area where the CBO, Holtz-Eakin, NBER and I are in agreement is what I referred to as the most important point in my op-ed. As the NBER paper summarizes
The biggest difference is that the direct program reports large interest income, whereas the guaranteed program reports large interest costs.
I can’t stress enough 1) the importance of this in the CBO and OMB figures, and 2) the folly of thinking it is a great idea for the government to take over lending just because they can borrow at a cheaper rate than they lend. As I stated in my op-ed:
This gain reflects the fact that the government expects to borrow the money for DL at low rates (0.76 percent in 2010) and charge students 6.8 percent.

This substantial gain would be reported for any program that borrows at the Treasury rate, and lends at a higher one. But that doesn’t mean it’s a good idea. To understand why, note that the exact same logic -- that the government can borrow more cheaply than it lends -- could be used to argue that the government should take over all lending in any market.

Consider an analogy to mortgage lending. Just as with FFEL, there are private lenders that have received subsidies from the government (we’ve already provided Fannie Mae and Freddie Mac $200 billion, and are on the hook for losses on their $5.2 trillion combined portfolio). By the logic of the pro-DL advocates, this subsidization is much more expensive than if the government provided the mortgages in the first place, so why not have the government take over all mortgage lending? I don’t know of anyone who thinks the government should be the only provider of mortgages, but there seem to be quite a few who think such a policy is a good idea for student loans.

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