CounterCurrent: Week of 8/7
Get ready, CounterCurrent readers—it’s time for Budgeting 101! We’re going back to the basics today, since it seems that principles such as “don’t spend more than you make” and “losing money is bad, actually,” are harder to grasp than they once were.
If you’re wondering what inspired this impromptu finance lesson, allow me to direct your attention to our old friend, the Department of Education (ED). For decades, the ED has been handing out nearly limitless amounts of student loan money based on flawed assumptions about the rate and nature of expected repayment. Last month, the Government Accountability Office (GAO) tallied the receipts and discovered that, over the past 25 years, the ED had underestimated the amount it would receive by a whopping $311 billion. That’s over three hundred billion taxpayer dollars that have been lost thanks to the federal government’s careless calculations.
But wait, it gets worse. According to research by Andrew Gillen, Senior Policy Analyst at the Texas Public Policy Foundation, the actual discrepancy is more than double that amount. The GAO report only included the discrepancy that resulted from the ED’s flawed projections about student repayment. When you add in the separate but related problems with the ED’s formula for determining the actual cost of loans, the number of lost taxpayer dollars rises to $645 billion.
About $100 billion of that amount is due to the 30-month pause in student loan payments, which began as part of President Trump’s response to COVID and has been repeatedly renewed by President Biden. The remaining discrepancy, however, is due to a whole host of calculation errors on the part of the ED, which Gillen outlines in this week’s featured article.
These errors fall into two main categories that, while not exhaustive, showcase the fatal flaws in the ED’s reasoning: 1) errors in the method of determining the lifetime cost of loans, and 2) errors in the method of forecasting repayment. (Trigger warning: The following paragraphs contain a large amount of technical language and alarming descriptions of government stupidity.)
Let’s start with the first type of error. To ensure that federal loan programs break even, the government assesses the cost of granting and extending loans based on what is known as a “discount rate,” which is used to determine the present value of future payments. For decades, the ED has determined the discount rate for student loans using a formula from the Federal Credit Reform Act (FCRA), which is based on federal interest rates, rather than following the fair-value discount rate, which is based on market projections. In other words, the ED relies on starry-eyed government forecasts to determine the cost of loans and ignores the realities of the market.
According to estimates from the Congressional Budget Office, fair-value calculations show 16% greater future costs for present expenditures than FCRA calculations. This is no small sum when working with billions, and it has led the ED to overlook $334 billion in the cost of student loans over 25 years.
The second type of error is a bit simpler. When calculating the overall cost of student loans, the ED guesses how many borrowers will choose each type of repayment plan and how much debt they will repay under those plans. Twenty-five years ago, the range of repayment plans was both more narrow and less generous; today, the options include debt forgiveness after as few as ten years of minimal payments. Unsurprisingly, these more generous plans have proven to be much more popular than the traditional repayment plans (another basic principle the ED has forgotten: everyone loves free money). This somehow came as a surprise to the ED, whose miscalculations about borrowers’ preferences cost taxpayers $138 billion.
Although the calculations are complicated, the takeaway is simple: a $645 billion loss is a big problem, and it’s time for the ED to do something about it. It doesn’t take a financial genius to figure that one out.
Until next week.
CounterCurrent is the National Association of Scholars’ weekly newsletter, written by Communications Associate Marina Ziemnick. To subscribe, update your email preferences here.