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The U.S. government may end up recovering only 51% to 63% of defaulted student loan amounts. This would mean that taxpayers could be on the hook to make up for a $500 billion shortfall. (The Wall Street Journal) |
NH: In December, we explained why so many Republicans and moderate Democrats are less than enthusiastic about a sweeping student-debt forgiveness program.
Among the arguments we summarized: Forgiveness would (a) be economically regressive and (b) worsen, not cure, America's higher-ed cost explosion. (See “A Student Debt Jubilee…Is It Coming?”)
This entire debate is predicated on the assumption that, on their current trajectory, existing federal student loans will eventually get paid back by borrowers. But let's back up a bit: Is this assumption reasonable? Maybe not. There's growing evidence that some sort of de facto forgiveness of student loans is already under way.
Last fall, when I described the rising delinquency rates for student-loan borrowers, I pointed out that the federal government offers borrowers so many options to limit their student loan repayments that millions of former borrowers actually accrue more debt than they pay off over time.
Ironically, such "negative amortization" arrangements are often considered illegal when practiced by private lenders.
On average, student borrowers are only paying back one percent of their debt every year. Two million Americans have been repaying their undergraduate student loans for at least twenty years or more. Many end up defaulting anyway.
What's going on? One possibility is that the federal government is trying to be humane and understanding with 30- and 40-somethings having a tough time. Another possibility is that the federal government, like a weak bank, is practicing "extend and pretend" with "zombie" student borrowers. If it did not offer forgiveness, many of these borrowers would default immediately. Better to defer the revenue--and simply to imagine that repayment will eventually happen.
Here's evidence in favor of the second possibility. The federal government currently assumes that it will recover 92 cents out of every dollar borrowers default on. This is pretty amazing, considering that private-sector issuers of unsecured debt, even after scrutinizing credit risk, typically assume an 80% payback on defaults.
Jeff Courtney, a former JPMorgan exec who conducted a close analysis of federal student lending programs, recently came to the conclusion that the fed's actual payback rate on defaults is somewhere between 51% to 63%.
During his investigation, Courtney queried government staffers how they were calculating such a high payback rate. Their answer: The government often issues new loans to defaulters, even after they pay nothing back, in order to keep the loans "on the books." Extend and pretend, indeed.
All told, based on historical recovery rates, Courtney expects that the government's total student loan portfolio of $1.6 trillion could ultimately experience losses of just over $500 billion. That's roughly a one dollar in three. In dollars, it's a bit more than the federal bailout to S&Ls back in the early 1990s. So who says some sort of slow-motion jubilee isn't already happening?
Needless to say, senior civil servants at the OMB and Education Department are challenging Courtney's analysis. They claim that Courtney doesn't understand how the programs work, that some early accounting errors "have since been corrected," and so on.
The politics are polarizing. Courtney was originally assigned to this task by President Trump's Secretary of Education Betsy de Vos, who gave him access to lending records. In-coming President Joe Biden swiftly terminated Courtney's access.
It might be helpful if both sides could discuss their differences and agree to better accounting methods. But I would hardly count on that ever happening. It's worth noting that the WSJ, in an earlier story last fall relying on other sources besides Courtney's, came to a similar conclusion--that the government would eventually lose $435 billion from the federal student loan program.
In any case, no one disputes that paybacks on ballooning student loans haven’t been anywhere near the levels originally anticipated when the lending programs were first authorized and budgeted.
For the fiscal year ending in September 2013, the government projected it would earn 20 cents on each dollar of new student loans. By FY 2019, that was revised to losing 4 cents for each dollar.
Behind this disappointment, there's a bitter if familiar story of accounting hubris. Back in the "bad old days" of paleolithic government accounting, the federal government ran pretty much everything on a cash-in, cash-out basis. At that time, the entire cost of a student loan was counted as an outlay.
If the government ever got the money back, well, that was great--at some future date, it would count as "negative outlays" and benefit younger generations.
Then, in 1990, some OMB budgeteers must have talked to some Wall Street bankers and realized they were overlooking a bonanza. They would up their game, practice accrual accounting, and thereby transform student lending from a money loser to a money maker.
The loss-adjusted return on each dollar lent could henceforth be booked right now as a negative outlay. Easing credit limits and unlimited grad-school borrowing were later on actually defended on the grounds that they would "help" the budget.
Alas, we should always beware of the innovations of public-sector accounting. Government seldom if ever argues in favor of accrual accounting when it results in bringing forward losses. (Want to talk about unfunded pension liabilities?) But bringing forward gains--well, that was an opportunity just too good to pass up.
As a result, it looks as though some sort of de facto forgiveness program is underway. In aggregate, it may be much larger than President Biden's relatively conservative proposal ($10K each for "economically distressed borrowers").
And, sooner or later, it will translate into higher taxes, reduced services, and extra zeroes tacked on to our already massive federal debt.
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ABOUT NEIL HOWE
Neil Howe is a renowned authority on generations and social change in America. An acclaimed bestselling author and speaker, he is the nation's leading thinker on today's generations—who they are, what motivates them, and how they will shape America's future.
A historian, economist, and demographer, Howe is also a recognized authority on global aging, long-term fiscal policy, and migration. He is a senior associate to the Center for Strategic and International Studies (CSIS) in Washington, D.C., where he helps direct the CSIS Global Aging Initiative.
Howe has written over a dozen books on generations, demographic change, and fiscal policy, many of them with William Strauss. Howe and Strauss' first book, Generations is a history of America told as a sequence of generational biographies. Vice President Al Gore called it "the most stimulating book on American history that I have ever read" and sent a copy to every member of Congress. Newt Gingrich called it "an intellectual tour de force." Of their book, The Fourth Turning, The Boston Globe wrote, "If Howe and Strauss are right, they will take their place among the great American prophets."
Howe and Strauss originally coined the term "Millennial Generation" in 1991, and wrote the pioneering book on this generation, Millennials Rising. His work has been featured frequently in the media, including USA Today, CNN, the New York Times, and CBS' 60 Minutes.
Previously, with Peter G. Peterson, Howe co-authored On Borrowed Time, a pioneering call for budgetary reform and The Graying of the Great Powers with Richard Jackson.
Howe received his B.A. at U.C. Berkeley and later earned graduate degrees in economics and history from Yale University.
