Student Debt Intro

There’s been a lot written  about student loan debt recently and it’s being driven by a number of factors; the most important item bringing student debt onto the issue agenda seems to be the impending doubling of the subsidized Stafford student loan interest rate from 3.4 to 6.8% in July. There are a number of proposals out to address the issue, but real differences remain between Congress and the administration.

I think there are a number of different issues to tease out here. First, are current student loan rates abnormally high? Second, does the government profit off of student loans? If so, how much, and where do the profits go? Last, is there something unique about our current macroeconomic climate that impacts this debate in any way?

I’m not intimately familiar with the history of lending to students, so I think it would be helpful to quickly go over the recent history of federal student loan policies, because it looks like federal student aid policies have undergone a number of changes over the past several decades. You can find a good summary here (page 2).

“Congress enacted variable rates in 1992…The new variable rates reset once a year based on the interest rates on short-term U.S. Treasury securities plus 3.1 percentage points (a “markup”), capped at 9.0 percent… in 1993 Congress passed the Student Loan Reform Act to establish the Direct Loan program…the 1993 law pegged borrower rates to longer-term U.S. Treasury securities that were similar in duration to the student loans, plus a smaller markup of 1.0 percentage point would be calculated for loans issued after July 1, 1998.”

It looks like there were some issues in the attempt to transition to a direct loan program by 1998, so Congress postponed the shift until 2003 (before, the federal government subsidized private banks, and the banks, in turn, lent students money for tuition and fees). Before the change in 2003, Congress came together to enact a different proposal; the one that set the stage for today’s policies:

The new law, negotiated in 2001, “established fixed interest rates at 6.8 percent for Subsidized and Unsubsidized Stafford loans made after July 1, 2006…Lawmakers, higher education associations, and student advocate organizations championed the bill because the fixed 6.8 percent interest rate that would start in 2006 was lower than estimates of what borrowers would pay if Congress had maintained the variable formula…Congress…decided on 6.8 percent because it was approximately the average of the projected interest rates set to take effect in 2003 based on longer-term U.S. Treasury bills.”

In the 2006 election, Congressional Democrats campaigned to cut student interest rates in half—when they got into office, they realized doing so was considerably more costly than they had anticipated, so they slashed student interest rates to 3.4% from 6.8% with accounting caveats. These included: the rate cut from 6.8 to 3.4% was only for subsidized Stafford loans (going to middle and lower-income families), and only for undergraduates receiving those loans. Additionally, the law cut rates incrementally, ending w/ a 3.4% rate for loans issued in 2011-12, and then the rate cut expired, meaning that all loans after that point in time would revert to the standard 6.8% fixed rate.

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