THE BLOG
11/21/2013 03:02 pm ET Updated Jan 25, 2014

Student Loans Are a Good Deal for Students and the Government

Shahien Nasiripour's November 18 piece stated that reported profits from the federal student loan program offset a large part of the U.S. Department of Education's budget, while noting that some experts disagree that the program actually generates a profit. We'd like to add three points: 1) the federal budget's accounting for student loans is correct -- the government does make a profit on the program; 2) this doesn't mean that the program is a bad deal for students; and 3) before making the program more generous, we should evaluate whether that's the best use of new federal dollars, which are very hard to find these days.

Explaining why the student loan program is running a profit is complicated so we'll save it for the end. But the government's profit does not mean that the program is necessarily a bad deal for students. More than 10 million undergraduates per year borrow from the government precisely because it helps them pay for college and comes with favorable repayment options and consumer protections not offered by private lenders.

How can the government both run a profit and charge lower interest rates and provide better terms than the banks? The key is that the Treasury borrows at lower cost than banks. It also doesn't pay dividends to stockholders, and it has more effective mechanisms for collecting overdue loans.

Advocates for students worry, understandably, that student indebtedness is growing too rapidly. Why not reduce or eliminate the federal profit by, say, cutting the interest rates that students pay for federal loans or forgiving a slice of outstanding debt? But making the student loan program more generous to students overall would raise total federal spending and deficits, since the program is part of the federal budget. And it may not be the best use of additional budget dollars, which are scarce.

Policymakers would need to weigh the range of alternatives across the budget, such as expanding Pell Grants for low- and moderate-income students, reducing the deficit, or making other investments with a future pay-off, such as repairing and expanding public infrastructure. If reducing the burden of student loans has merit, it is not simply because the federal program is running a profit but because many students need the relief and making college a bit cheaper is good for the nation's future.

Now for the accounting. Those who claim that the federal budget shouldn't show the student loan program as running a profit assert that the government's portfolio of student loans is worth less than the average amount the government will actually collect on those loans. They believe this is the case because they give more weight to the possibility that the government will collect less than expected in a given year (due to unexpectedly high defaults) than to the equally likely possibility that the government will collect more than expected in a given year. Therefore, they argue, the budget should add an extra amount to the program's actual cost to reflect what loss-averse private lenders would charge if they, rather than the federal government, issued the loans.

We strongly disagree (see here and here), as does former Congressional Budget Office Director Robert Reischauer. Under the government's accounting conventions, the risk of default on loans and loan guarantees is already factored in. There is no need to also add in costs to reflect the loss-averse nature of private lenders. Government accounting has always reflected -- and should always reflect -- how much cash the government spends and receives, not how the private sector would value the same transactions.

Many have proposed improving the federal student loan program to make it simpler, more targeted, and more effective, and it no doubt could be. Nevertheless, the student loan program as it stands is a good deal for both students and the government.