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In the mid-1990s, when the Department of Education launched its current direct student loan program, the program was expected to generate profits for the US Treasury. Initial estimates were that it would gross $114 billion over the next quarter century. Now that we’re here, that estimate turns out to be…
The best listening experience is on Chrome, Firefox or Safari. Subscribe to Federal Drive’s daily audio interviews at Apple podcast or Podcast One.
In the mid-1990s, when the Department of Education launched its current direct student loan program, the program was expected to generate profits for the US Treasury. Initial estimates were that it would gross $114 billion over the next quarter century. Now that we’re here, that estimate turns out to be wrong… well wrong. The Government Accountability Office found that the program actually cost the government $197 billion. The reasons for this giant difference are quite complex, so Federal Drive Associate Editor Jared Serbu spoke with the lead author of a GAO report that examined the direct lending program: Melissa Emrey- Arras, GAO’s director of education, labor and income security issues on the Federal Drive with Tom Temin.
Jared Serbu: Melissa, thank you for doing this. And I think the way I kind of want to set the stage before I go deeper into your findings is who exactly would that be a surprise to? I guess education re-estimated these numbers every year and had a good idea of where it was in any given year. But was it followed by Congress or publicly? Who will be surprised by these numbers?
Melissa Emrey-Arras: That’s a great question, Jared. I think this is going to surprise a lot of people in the student loan world. Until a few years ago, many people thought the student loan portfolio would make money for the federal government. So I think this report showing that the student loan portfolio is now expected to cost the government close to $200 billion is going to surprise them.
Jared Serbu: Can you explain a bit why the process of estimating the costs or income of these loans is so difficult to begin with? And I think it got harder over time, right?
Melissa Emrey-Arras: It is a very difficult process. And it is very difficult to do. One of the problems is that the Ministry of Education must estimate the cost of the loans before even granting these loans. He must therefore estimate in advance how many people will borrow, how much they will borrow and also what the income of these borrowers will be. And it is very difficult to predict.
Jared Serbu: And when you at GAO drilled down into your budget data here, what were the major drivers of the huge difference between the original 25-year cost estimate and what the current estimate is?
Melissa Emrey-Arras: We found that two factors were driving the cost evolution. One is what we call programmatic factors. So it’s changes in the program, the student loans program, so any new legislation affecting the program, any new administrative measure affecting the program, that would affect the cost. In this case, for example, we have the student loan payment break, which is currently set to expire at the end of the month. And we found that the cost for that alone through April of this year was about $100 billion. So that was a significant cost that was driven by the pandemic. In addition, we have also seen changes in costs due to improved data. As you mentioned, the Ministry of Education reassesses the cost of the student loan program every year. And with these re-estimates, it develops new data and new hypotheses. With better data and better assumptions about the student loan portfolio, he is able to have better cost estimates. And these changes in assumptions and data have also increased the cost of the portfolio.
Jared Serbu: With respect to the recent COVID payment pause once we kind of got past that phase, does that $100 billion and change and start to reset and come back into the program once people perform at payments again, is this just some kind of temporary blip?
Melissa Emrey-Arras: Thus, the cost of the student loan program would be reassessed each year. And we can see what happens in the coming years based on the status of the break and the status of other conditions.
Jared Serbu: Are there any real impacts on the resulting loan program? I guess, reject for lack of a better term? Is it just adding to the budget deficit? Or does it impact the program’s ability to generate new loans or does it have other consequences?
Melissa Emrey-Arras: I think it’s more about people understanding what the real cost is so they can factor that into policy decisions.
Jared Serbu: And also, going back to the complexity of making those estimates in the first place. I think one of the factors you found is income-based reimbursements, which can change over time. Can you tell us a bit more and why it was such a problem here?
Melissa Emrey-Arras: Glad to, thanks for the question, Jared. Income-based repayment occurs when people make their repayments based on their income and family size. So the amount they pay each month will vary depending on their current income and the size of their family. Currently, the number of income-contingent loans represents about half of the student loan portfolio. It has not always been so, the student loan portfolio has changed over time. But now about half of them have loans that are in these income-driven repayment plans. And what that means in terms of cost is that the Department of Education now has to estimate borrowers’ incomes over a long period of time, in order to estimate how much they will pay on their loans. This therefore means that the department must estimate the cost of student loans before even granting loans. And then he has to estimate the incomes and family sizes of those borrowers in the coming decades. Which is a very difficult task.
Jared Serbu: Yes, have you looked at some of the reasons why more of the program has been spent on income-driven repayments? Is it related to the rising cost of college education in the first place?
Melissa Emrey-Arras: Income-based repayment can help lower the monthly cost for borrowers, which can make it more affordable for many people. Additionally, individuals who work for the federal government or nonprofit organizations may qualify for income-based reimbursement when tied to a public service loan forgiveness. So people who participate in income-driven repayment plans can pay less each month and then, after 10 years of public service, have their balance fully forgiven.
Jared Serbu: I’m glad you mentioned this program. Because if I’m not mistaken, this is another one of those examples where this loan forgiveness program didn’t even exist when the federal student loan program was created. It would therefore have been impossible to estimate the costs.
Melissa Emrey-Arras: To correct. So that was one of the programmatic changes that happened when the Civil Service Loan Cancellation came into being. And there have been changes even within the civil service loan relief program, there is an expanded temporary civil service loan relief program, there is a public service. And all of that is newer and didn’t exist when some of these loans were originally made.
Jared Serbu: And what other kinds of economic factors come into play to change the cost of the program over those 25 years?
Melissa Emrey-Arras: Both income and inflation can affect costs. We did some modeling in our report and found that if there was higher inflation, it could lead to higher costs to the government in the student loan portfolio. Similarly, we found that if revenue growth is slower, if people are earning less, that could also drive up costs in the student loan portfolio. This tells us that several factors come into play when estimating the cost of student loans. And it is very difficult to predict the future on all these fronts before loans are granted.
Jared Serbu: And I think just one example of that, if I understood the report correctly, is that education has to set the interest rates on the loans they’re about to give out before the school even starts. ‘school year. But he doesn’t know what his costs of borrowing from the Treasury will be until much later, and those costs may have increased during that time. And I’ve often thought, haven’t I?
Melissa Emrey-Arras: It’s correct. So the borrower’s interest rates, what the borrower pays is fixed in advance. Yet the cost to the Ministry of Education, the cost to the government is not fixed until 18 months later. So there is up to a year and a half difference between the timing of the interest rate for the borrower and the timing of the interest rate for the government. And during that time, interest rates can change. And if the costs increase, it can increase the cost to the federal government.