Will the New Plan to Cut Your Student Loan Payments Work?

Big news on the student loan front: Sen. Elizabeth Warren (D-Mass.) and a cast of thousands — well, 23 of her Democratic Senate colleagues, anyway — introduced the Bank on Students Emergency Loan Refinancing Act.

The bill proposes to significantly expand the Federal Direct Student-Loan program by allowing those who financed their higher education in different ways — including under the FFEL and PLUS programs, and with private lenders — to refinance their loan balances at prevailing rates through the direct program.

The prospective legislation doesn’t do everything it could or should. There are no provisions that permit borrowers who are not current with their payments to refinance their debts at rates that could very well help them to overcome their difficulties. Nor does it offer to restructure the existing repayment terms of loans that often rival many home mortgages in size.

As currently drafted, the legislation faces stiff odds, not least because there are those who steadfastly oppose the notion of increasing the size and/or scope of any government program for any reason.

Add to that the so-called fair-share tax on high-income earners — which the Senate bill’s proponents intend as an offset to the added cost of an expanded direct loan program — and you have legislation that’s not likely to go anywhere in a Congress that has, to date, been unwilling to take the serious steps it must to address what’s become a desperate predicament for many.

Then there’s the matter of those who stand to lose — big time — when borrowers exercise their legal right to prepay the loans they have in place. You can bet your boots that the mother of all lobbying efforts was well underway before lawmakers on both sides of the proposed bill had learned their soundbites by heart.

The political value of recording yea and nay votes on a populist issue during an election year notwithstanding, it would have been better if this well-intentioned legislation actually had a chance of passing.

Could There Be a Win-Win?

BOSELRA (I really hope they can come up with a catchier acronym) is a blend of winners and losers. On the winning side are student borrowers who stand to benefit from lower rates and the government’s superior relief programs (should they encounter financial difficulties later on). Private lenders and high-earning taxpayers, however, are on the losing end of the deal.

The question is: Why involve taxpayers at all — and all the noise that always follows discussions about taxation — when the government has the ability to zero-out the losing side? Here’s how.

If the Department of Education were to act as principal by directly securitizing some or all of the loans that currently populate its balance sheet, not only would it be better able to control the costs of its programs, favorably influence transaction structures (repayment terms could be extended and the process for loan modifications streamlined) and pay off its debts, but this action would also counterbalance the lending side of the financial services industry’s losses with the investment banking side’s gains, as interest income is swapped for fee income.

There’s also the sticky matter of the DOE’s profitability.

The Bipartisan Student Loan Certainty Act of 2013 pegged loan-interest rates to the 10-year Treasury note plus varying rate surcharges for the different loan programs. If the government were to securitize these loans, its own rate would be pegged to a five-year financial instrument (likely to be LIBOR) rather than to a 10-year instrument. That’s because fixed-rate, full payout loans such as these are routinely funded at the half-life of its contracted duration.

A quick check of the rates for five- and 10-year LIBOR indicate a roughly 1% differential, which translates into an approximately 5% funding profit on every loan the government makes under this program — that is, if the DOE were actually borrowing five-year money. In fact, it’s currently funding its activity with less expensive borrowings at the low-rate, short-end of the yield curve. Moreover, these profits are before the value of the various program surcharges, and the fees that the feds assess upfront are taken into account.

It’s no wonder the department’s record-breaking profits are making headlines.

How to Make This Work

The best deal for student-loan borrowers — and for the taxpayers who will be on the hook should those debtors fail to honor their obligations — would be as follows:

Invite all education loans into the program without regard for origination channel or current payment status. It makes no sense to exclude those who are most in need of an opportunity to refinance their way out of hardship.
Establish a longer financing term as the new standard for the program so the monthly payments are more affordable, particularly for those just starting out.
Reform last year’s pricing legislation so borrowing rates are indexed to the same financial instrument that governs the DOE’s own financings.
Reconsider the rate surcharges for the different programs. This is not to say that the government shouldn’t cover its costs or be paid for the loan guarantees it provides. Rather, the profit it makes should be able to withstand public scrutiny.

Finally, whether or not this or any other plan that comprehensively deals with the student-loan problem succeeds, the DOE must establish more competent and thorough oversight of the loan-servicing activities it subcontracts to the private sector. Otherwise, self-interest will continue to trump even the best of intentions.