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The New America Foundation (Jason Delisle), The Heritage Foundation, and others are expending significant efforts to claim that the cost of the federal student lending system will ultimately cost the taxpayers a significant amount, rather than make a profit as Elizabeth Warren has said. These opposing claims arise from two separate analyses performed by the Congressional Budget Office- one using standard accounting methods, and the other using so-called "fair value" accounting.

In view of these two studies and the large contrast in results, the CBO has essentially concluded that we just don't know what future costs are likely to look like.

While valid questions have been raised about the appropriateness of FVA for valuing assets on government books, most agree that FVA, which discounts the value of a lending instrument based on future risk projections, is a worthwhile approach generally- and should yield better results than assuming no future risk.

Upon cursory examination, however, it becomes obvious that the fair-value analysis used by the CBO violates fundamental fair value accounting principles grossly. The costs that the analysis predicts are, consequently, baseless.  They should, in fact, be thrown out, and the analysis re-done correctly if there is to be any meaningful discussion on the question at hand. Consider the following to see why this is so.

 
 
 In evaluating the value of a lending asset, Fair Value Accounting principles require, first, that actual, historical market data on sales of similar assets be used as a benchmark for determining the fair value of the assets if such data exists.  For federal student loans, such data exists, since federal loans have been securitized and traded for years, and except for a brief period following the financial crisis in 2008, the market has been active, healthy, and relatively stable.  Therefore, any competent fair value accountant tasked with evaluating federal student loan assets would, of course, use this data as the primary benchmark, and look no further. It is, in fact, the best data one could hope for by FVA standards.

This is where the CBO analysis goes horribly wrong. Rather than using historical federal loan sales data, CBO chooses to ignore it, and instead chooses to use private student loans as their relevant benchmark. These loans have much higher interest     rates, are far riskier, come with none of the guarantees or collection powers attached to federal loans, and the private student loan market is far smaller (less than a fifth the size of the federal market), more volatile, and far more difficult to find reliable historical sales data on generally. Even assuming there was no federal loan sales data available, to use private student loans as a second choice would be a dicey proposition, at best,

What is worse, however:  The private loan market has always been highly dependent upon the federal loan system in many ways. One example:  many if not most borrowers turn to private loans only as a last resort because they could not get federal loans.  The lenders know this well, and raise their interest rates accordingly.

No credible fair value analyst, given all this, would choose to use private student loans for the purposes of valuing federal loans.  But this is what CBO does. As such, the large difference in interest rates between private and federal loans is used to calculate a "loss" for the federal lending portfolio.  This explains in large part how a profit estimate of $180 billion becomes a loss of $100 billion under this particular FVA methodology.

The best analogy I can think of for this type of accounting is a Big Oil company pointing to a guy selling biodiesel out of his garage for $8/gallon (compared to the Big Oil company's price of $4), and using this to justify writing off $4 for every gallon the corporation sells. Is Big Oil actually losing money?  If this guy's brother came up with his own batch that he could sell for $12/gallon, would Big Oil then be able to claim an $8 loss for every gallon it sold? 

Of course not!   The “costs” are not only completely fictitious, there is ZERO chance that they will ever occur based on all available data.  Also:  years of presidential budget data show that for defaulted FFELP loans, the government’s recovery rate is 122%, a rate far higher than any loan, public or private could ever claim (this is directly attributable to unprecedented collection powers, and the removal of bankruptcy and other protections). For Direct loans, this rate has been about 110%, but I estimate that with FFELP ended, this rate is about 115% .  Even discounting generously for collection costs (using cost data for generalized bank loans which typically involve seizure of property, significant court costs, etc.), and factoring in the government’s cost of money leaves a hefty profit on defaults, and in fact shows that the government makes more money on defaults than loans which remain in good stead (a defining hallmark of a predatory lending system).

This analysis should be repeated using the correct benchmark, and also the historical data available for the "cost" of defaults.  This important issue, the larger policy debate it informs, and the large number of affected citizens warrant at least this much from the CBO.
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For Questions, Please Contact:

Alan Collinge
, Flawed Analysis used to Dispute Student Loan Profitability
justice@studentloanjustice.org
(253) 617-3407
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