THE BLOG

Forgiven Loans Are Hidden Grants

03/11/2015 03:09 pm ET | Updated May 11, 2015

The Department of Education hosted a rule-making session last week, which will reconvene on March 31 for three days. The goal is to evaluate whether the generous student loan repayment plan known as Pay As You Earn (PAYE) should be extended to borrowers who are currently ineligible. This investigation comes on the heels of a recent Politico report that raised concerns about the increasing cost of the student loan program.

The Politico report revealed a $21.8 billion budget shortfall in student loan revenue, sparking a range of reactions. Some argued that adjustments to profit estimates are to be expected and that, regardless of the shortfall, the program is still profitable. Others argued that $21.8 billion is a significant cost to the taxpayers that cannot be swept under the rug. Still others say that this adjustment is a one-time occurrence due to Obama's recent policy changes regarding the terms of PAYE and loan forgiveness. If the DOE recommends further extensions to repayment plan eligibility, this profit shortfall certainly won't be one-time thing.

Of course, this debate re-opened the tired discussions about which accounting method should be used to determine the "real" cost of the PAYE program. Some, like Senator Deb Fischer of Nebraska, argue that using the fair value accounting method would better reflect the cost of the program. This method makes the program look more expensive because it factors in the cost of the market risk. Others argue that the current accounting method is best since the lender is the government and the associated risks are different from those in the private market.

While these discussions are important, I think we are missing a crucial point. Further expanding the PAYE plan forgiveness clauses will ultimately come at the expense of Pell Grant funding. One of the rationales behind reforming the loan program in 2010 was to provide more funding for the Pell Grant. Now Obama envisions directing $14.6 billion from the loan program toward Pell in the next 10 years. But money is needed to cover forgiven loans. If further expansion of the generous forgiveness clauses leads to another unanticipated shortfall, will this transfer of fund still be possible?

President Obama needs to carefully consider the long-term financial implications. We can all agree that as financial aid goes, Pell Grants are relatively well-targeted. In contrast, the loans that are being forgiven are essentially hidden grants: it is unclear who will most benefit from them. While increased funding for Pell Grants is part of the government's annual budget (which has to be approved and often fought over), these new repayment plans and forgiveness benefits are a matter of regulatory policy. Thus, we are unaccountably doling out hidden grants to some students who receive debt forgiveness at the expense of those who qualify for the Pell. In some cases the forgiven loan can amount to much more than the maximum Pell. If we need to offer such great bailouts so that students do not default on their debts, then the government must be enabling the lending of bad loans.