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A key motive for letting graduate students borrow unlimited amounts was to use the projected profits from such lending to reduce federal deficits, said two congressional aides who helped draft the legislation.
Each change was publicly justified as a way to help families pay for college or to save the taxpayer money, said Robert Shireman, who helped draft some of the laws in the 1990s as an aide to Sen. Paul Simon (D., Ill.) and later was deputy under secretary of education in the Obama administration.
But how agencies such as the Congressional Budget Office “score” such changes—determine their deficit impact—“is a key factor in deciding whether a policy is adopted or not,” Mr. Shireman said. “The fact that it saved money helps enact it.”
Some expectations came true. Households did borrow more, and borrowers were less able to escape repayment. By 2014, five million Americans owed at least $50,000 in student debt, according to a Brookings Institution study. A majority of the big-balance borrowers earned graduate degrees.
Borrowing by parents for their children also surged. In 2016, for the first time, most new federal student loans went to parents and graduate students rather than to undergraduates.
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Tuition at America’s public universities has nearly tripled since 1990. With President Biden looking to ease the burden for some students, experts explain how federal financial aid programs can actually contribute to rising costs. Photo: Storyblocks
The assumption that all this student lending would mean growing profits for the federal government and savings for taxpayers has been consistently off the mark.
The federal government extended $1.3 trillion in student loans from 2002 through 2017. On paper, these would earn it a $112 billion in profit.
But student repayment plummeted. In response, the government revised the projected profit down 36%, to $71.5 billion. The revision would have been bigger except for the fall in interest rates that let the U.S. borrow inexpensively to fund loans.
The phenomenon is worsening in recent years. For the fiscal year ended September 2013, the government projected it would earn 20 cents on each dollar of new student loans. For fiscal 2019, it projected it would lose 4 cents on each dollar of new loans, federal records show.
Congress approves the student loan program each year, doing so based on a profit assumption. Then, in subsequent years, it revises those profit estimates based on the repayments that actually arrive.
If repayments come in lower than expectations—as has happened successively in recent years—the Treasury Department fills the gap with cash infusions to the Education Department.
This process takes place outside of the budget review and outside of congressional oversight. Ever-larger cash infusions from the Treasury have been needed.
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<img src="https://parentsecurityonline.com/wp-content/uploads/2021/05/1620022593_457_Is-the-US-Student-Loan-Program-Facing-a-500-Billion.5.jpeg" data-enlarge="https://images.wsj.net/im-330819?width=1260&size=1.5" alt="" title="Former President Barack Obama signed a memorandum in June 2014 that enabled more student borrowers..."/></div>
<figcaption class="wsj-article-caption article__inset__image__caption" itemprop="caption"><h4 class="wsj-article-caption-content">Former President Barack Obama signed a memorandum in June 2014 that enabled more student borrowers to tie their monthly repayments to their incomes, effectively reducing how much they paid each month. </h4>
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Jacquelyn Martin/Associated Press
In 2018, more than a year after Mrs. DeVos became education secretary, she looked for someone to sort through this, and JPMorgan’s Mr. Dimon recommended Mr. Courtney, who had just retired from the bank after heading its private student-loan branch. He joined the administration and started going through documents.
According to his report a year later, students who took out federal loans in the 1990s had repaid, on average, 105% of the original balance a decade later, including interest. Since 2006, they had repaid an average of just 73% of their original balance after a decade.
He looked into why government projections seemed so far off. One thing he found was that Education Department budget officials didn’t look at basics such as borrowers’ credit scores to estimate the likelihood they would repay. Not checking credit would be unthinkable in the private sector.
With the help of a contractor that does statistical modeling, FI Consulting of Arlington, Va., he ran some numbers. The credit scores of four in 10 borrowers would qualify them as “distressed”—double the rate on all types of private consumer loans, his analysis found.
He also saw that when borrowers defaulted, the government continued to charge interest, allowing balances to keep rising, which also differs from private lenders’ practice.
Then, the government typically put those defaulting borrowers into new loans, and the accrued interest was wrapped into a new balance. The borrowers’ loans were no longer “nonperforming.”
A substantial number of borrowers go on to default on these new loans, according to Mr. Courtney’s report, which was part of why he estimated so much lower a recovery of defaulted amounts.
Another source of what he considered faulty projections: Borrowers unable to make regular monthly payments sometimes lowered them by switching to income-based repayment. President
made this move widely available, which his administration could do by itself on the understanding it wouldn’t widen the deficit.
The accrual of unpaid interest caused loan principals to rise instead of decline, making the loans appear more profitable to the government, even though the accrual stemmed from borrowers’ difficulty in repaying.
Mr. Courtney’s conclusions, outlined in a presentation to Mrs. DeVos in May 2019, also said Education Department budget officials overestimated how much borrowers would earn and thus be able to pay back. The department is blocked by law from reviewing individual borrowers’ tax records. Its estimates of how much borrowers’ incomes would rise were consistently wrong, he concluded.
All told, his analysis led to his estimate that taxpayers would be left with the bill for around a third of all outstanding loans when they reach the end of their repayment cycles.
Some OMB staffers voiced concern Mr. Courtney’s project would undermine the president’s budget proposals, potentially forcing the government to come up with hundreds of billions of dollars to balance the books, said Ms. Jones, the former deputy under secretary of education.
OMB takes data from the Education Department to project how much student loans will earn for taxpayers or cost them. The agency has final say on accounting procedures, and Ms. Jones said some staffers expressed concern that private-sector officials with no experience with the federal budget process were doing a task the law gives to OMB.
Mr. Courtney left shortly after giving Mrs. DeVos his report, which was based on an alternative student loan budget model developed with the help of FI Consulting and audited by the consulting firm Deloitte.
While the Biden administration has rejected his analysis, the status quo creates problems both for borrowers and for the government, according to Mr. Shireman, the former aide to Sen. Simon and President Obama. Mr. Shireman said the projected profits from student lending discourage making changes that would help borrowers, such as lowering interest rates.
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