By John Stang
Reihan Salam at National Review explains why student loans are not profitable for the federal government to start out with:
To see why the government’s cost of borrowing doesn’t capture the full cost of making a student loan, consider an example similar to one that Debbie Lucas at the MIT Sloan School of Management uses. Let’s say the government issues $100 million in 10-year U.S. Treasury notes to finance $100 million in student loans with 10-year repayment terms. Assume that after the 10 years is up, the student loan portfolio has suffered losses such that the U.S. Treasury bonds cannot be fully repaid with the loan repayments alone.
Does the government then default on its debts? Of course not. It taps taxpayers to make up the losses and repays bondholders in full. Note that this makes taxpayers equity investors in the student loan program – it is their money that will be used to absorb 100% of any losses on the loans to ensure U.S. Treasury bond holders are always repaid.
That highlights a key point: the interest rate on U.S. Treasury securities tells us what investors want to be paid to lend with zero risk of default. Federal student loans are not, however, free of default risk. The U.S. Department of Education expects thatabout 19 percent of loans made to students in 2013 will default at some point. Yes, cost estimates can build those default rates in, and Congress can charge an interest rate on student loans that more than fully offset such expected losses. But any unexpected losses, those that might occur if the economy weakens, wouldn’t be covered, placing the default costs squarely on taxpayers.
For a solution, Mike Konczal advocates for a public option for public universities:
Beyond ensuring equality of opportunity, another advantage of this approach is that it would help stop cost inflation. Free public universities would function like the proposed “public option” of healthcare reform. If increased demand for higher education is causing cost inflation, then spending money to reduce tuition at public universities will reduce tuition at private universities by causing them to hold down tuition to compete. This public option would reduce informational problems by creating a baseline of quality that new institutions have to compete with, allowing for a smoother transition to new competitors. And it allows for democratic control over one of the basic elements of human existence—how we gather information and share it among ourselves.