Making Government “Profits” Appear and Disappear: Student Loans vs. Fannie and Freddie
Official Congressional Budget Office estimates show that the federal student loan program will earn $184 billion for taxpayers in the next 11 years—about 13 cents for every dollar lent out. Those projected profits have student advocates and lawmakers such as Sen. Elizabeth Warren (D-Mass.) up in arms. They say Congress must drastically cut the interest rate on student loans to eliminate those profits.
Yet the Congressional Budget Office has repeatedly warned lawmakers that the profits are an accounting illusion, but it is forced to report them anyway because of an accounting law, the Federal Credit Reform Act. That law implicitly requires that the budget office exclude a premium in its estimates for part of the risk inherent in government loans, what financial economist call “market risk.” As a result, the CBO explains, “some large credit programs… appear in some years to make money for taxpayers.” And it further states that its official estimates, “do not provide a comprehensive measure of what federal credit programs actually cost the government and, by extension, taxpayers.” Those warnings have fallen on deaf ears, as lawmakers, advocates, and the media routinely cite them as correct.
No such accounting flaw exists, however, in the government’s largest loan program, the $1.2 trillion in new mortgages (nearly all of the market) the government guarantees annually through its ownership of Fannie Mae and Freddie Mac. After the government took over the entities in 2008, the CBO had the legal wiggle room, and the blessing of Congress, to override the official accounting rules for government loan programs. It opted to add a market risk premium to the costs taxpayers would bear for Fannie and Freddie’s future mortgage guarantees. In other words, the CBO was able to fix what it believes is a major flaw in its official cost estimates for government loan programs—but only for taxpayer-backed mortgage guarantees made by Fannie and Freddie.
With the correction in place (called a “fair-value” estimate), the Congressional Budget Office estimates that newly issued mortgage guarantees will cost taxpayers about $7 billion in 2014 and $28 billion over the next 11 years. And that is the official number. Without the market risk correction (i.e. using official rules that apply to all other loan programs) the Fannie and Freddie mortgage guarantees appear to generate a profit, approximately $46 billion over 11 years. In short, including the risk premium all but determines whether a federal loan program costs or makes money over the long term.
So what happens when the CBO adjusts its estimates for student loan programs in the same way it does for mortgage guarantees? The projected $184 billion profit completely disappears, and the program swings to a $96 billion cost—a whopping $280 billion net difference over 11 years.
Those dramatic differences are why groups like President Obama’s fiscal commission, the Peterson-Pew Commission on Budget Process Reform, economists at the Federal Reserve, and the Financial Economists Roundtable argue that Congress must fix the accounting rules for all loan programs. Indeed, a $96 billion cost versus a $184 billion profit in the student loan program is a game-changer in the debate over what interest rate students ought to be charged.
That is not to say that the federal government should raise interest rates to reduce the costs that the program imposes on taxpayers, or end it altogether. The loans are meant to subsidize higher education, a perfectly acceptable public policy, and one that by definition must entail budgetary costs. But how much and for whom are key questions. Congress cannot debate the answers accurately until it changes the accounting law that prevents the CBO from providing it with the most comprehensive measure of the program’s costs.
Congress and the CBO have already made that change for the federal government’s largest loan program, Fannie Mae and Freddie Mac. It’s time to do the same for student loans.
Jason Delisle is the director of the Federal Education Budget Project at the New America Foundation.