U.S. Government is Making a Huge Profit on Student Loans at the Expense of College Students

H.R. 1911: Bipartisan Student Loan Certainty Act of 2013

Full Title

To amend the Higher Education Act of 1965 to establish interest rates for new loans made on or after July 1, 2013, to direct the Secretary of Education to convene the Advisory Committee on Improving Postsecondary Education Data to conduct a study on improvements to postsecondary education transparency at the Federal level, and for other purposes.

Status

This bill was enacted after being signed by the President on August 9, 2013.

Introduced:

May 09, 2013 (113^th Congress, 2013–2015)

Slip Law:

This bill became Pub.L. 113-28.

Summary by GovTrack

In what could become an annual occurrence, Congress yet again faced a looming deadline to resolve the problem of student loan interest rates. Without Congressional action, the rate on federally backed Stafford loans was set to double from 3.4 percent to 6.8 percent on July 1, 2013.

The potential change in interest rates on subsidized student loans has its origins in a 2007 bill intended to boost college aid. In addition to increasing grant amounts to students and improving access to student loans, the College Cost Reduction and Access Act established a stepped reduction in interest rates. Beginning in July 2008, the rate was lowered over the course of four years from 6.8 percent to 3.4 percent, and was supposed to revert to 6.8 percent in July of 2013. 

Just two days before the July 1, 2012 deadline, Congress passed an extension of the 3.4 percent rate for another year. The temporary fix was adopted as part of a transportation spending bill that passed the House by a vote of 373 to 52 and the Senate 74 to 19. The $6 billion price tag associated with the extension was paid for by limiting students’ eligibility to subsidized loans to six years and changes in pension laws. A year has gone by, and now legislators are back at square one.

Student Loan Act Could Mean Higher Federal Profits

Market-based interest rates mean students could pay more and the government could end up making more. As part of the Affordable Care Act passed in 2010, Congress barred private banks from offering student loans. Three years ago, Congress passed a temporary reduction in rates from 6.8 percent to 3.4 percent, and extended the reduction again in 2012.

 
August 14, 2013  

 

US News & World Report - The Congressional Budget Office projects the new law will increase government profits on student loans through 2023 by $715 million.

The Bipartisan Student Loan Certainty Act of 2013, which President Barack Obama officially signed Aug. 9, is touted mostly as a retroactive fix for the July 1 doubling of the interest rates on subsidized federal direct loans. But the truth is that Congress has simply kicked the can down the road.

The new law offers a moderate amount of help to current students at the expense of future ones. And it does nothing to address what the Student Loan Ranger sees as a fundamental problem in the student loan system – the huge profit the federal government is making at the expense of students.

The legislation moves student loan interest rates to a new market-based fixed rate based each academic year on the rate on the 10-year Treasury note, plus a set amount that varies depending on the loan.

The amount added to subsidized and unsubsidized direct loans for undergraduates is 2.05 percentage points. Unsubsidized direct loans for graduate and professional students have 3.6 percentage points added to the 10-year Treasury note rate and 4.6 percentage points are added to PLUS loans for graduate and professional students.

By itself, this is not so bad. When interest rates are low, as they are now, students will by and large benefit.

This academic year, for example, undergraduate students will pay 3.86 percent, higher than the 3.4 percent they were paying for subsidized direct loans but lower than the 6.8 percent rate for unsubsidized direct loans. Graduate students will pay 5.41 percent interest for unsubsidized loans and 6.41 percent for PLUS loans, both of which are lower than current rates.

Unfortunately, the new law combines this market rate with different – and much higher – interest rate caps. Undergraduates can now pay a maximum interest rate of 8.25 percent – compared with the previous maximums of 6.8 and 3.4 percent for unsubsidized and subsidized direct loans.

The maximum rate for unsubsidized direct loans for graduate and professional students is now 9.5 percent and the rate for PLUS loans is a whopping 10.5 percent. Those are much higher than the previous rates of 6.8 percent for unsubsidized direct loans and 7.9 percent for PLUS loans. When interest rates go up – and they will in the near future – students will pay much higher rates.

Take a look at the Congressional Budget Office's estimate of the budgetary effects of the legislation to see how this may happen. Relative to a May 2013 baseline, the office projects increased costs to the government from 2013 through 2016. By 2017 though, the CBO projects interest rates will rise high enough so that the federal government will have increased profits that will last through 2023.

Overall, the office projects the new law will increase government profits on student loans through 2023 by $715 million.

It's true, as the New America Foundation points out, that $715 million over 11 years is not a lot. But this obscures the essential point that this is an additional $715 million over the baseline. And that baseline projects that the federal government will make about $174 billion in profits off student loans through 2023.

The CBO projections are not likely to be exact – the federal government may profit a bit less or a bit more off student loans over the next decade. But in kicking the can down the road, the Student Loan Ranger thinks Congress has ensured future students will be burdened by extremely high interest rates on what are likely to be large student loans. And, absent reform, it has ensured the federal government will make massive profits off of students for the foreseeable future.

Since Congress isn't helping, prospective students, current students or people repaying student loans should take a look at Equal Justice Works' free webinars and e-book "Take Control of Your Future," which offers advice on planning wisely and managing debt.

U.S. Government Subsidies to Higher Education are the Reason College Tuition Has Tripled Since the 1980s - Higher Tuition Means Massive Profits from Interest on Student Loans Collected by the Feds

May 2009

Chris Edwards and Neal McCluskey - The Department of Education spends about $30 billion a year on subsidies for higher education. The bulk of that funding goes toward student aid programs, with the balance going toward grants to educational institutions. In 2008, grants to institutions cost $2.3 billion and aid programs cost $27.6 billion, which included $17.4 billion for student grants, $9.6 billion for student loans, and $0.6 billion for administration.

In the next section, we explore the origins of federal subsidies for higher education and its rapid growth since the 1960s. Following that we focus on the harmful effects of higher education subsidies. Those effects include education cost inflation, increased regulatory control of colleges and universities, and huge fraud and waste in student aid programs.

Origins and Growth of Subsidies

Federal subsidies for higher education began in 1862 with the Morrill Act, which provided grants of federal land to the states. The states were supposed to use the proceeds of land sales to create colleges focused on agricultural and mechanical studies, but "many states squandered the revenue from this endowment." In 1890, a second Morrill Act began regular appropriations for the land-grant colleges.

In 1917, Congress passed the Smith-Hughes Act, which funded the salaries of vocational education teachers. The Act imposed a range of detailed rules on funded schools, which created an early precedent for today's huge burden of federal regulations on state and local education systems.

The first major subsidy for students in higher education was the Servicemen's Readjustment Act of 1944—the G.I. Bill—which allowed World War II veterans to attend college at no cost. The G.I. Bill is widely admired legislation, but like all subsidy programs it led to substantial wasteful spending and abuse. Some colleges and universities used federal funds for extraneous purposes, such as swimming pools and stadiums, while others increased tuition rates charged to veterans. There were also cases of outright fraud by schools aimed at garnering extra federal funds.

In 1958, the National Defense Education Act was approved in response to the Soviet Union's launch of Sputnik, which spread fear that the communists were getting ahead of Americans in technical skills. The Act authorized funding for higher education loans and fellowships, vocational teacher training, and programs in the K-12 schools, including math, science, and foreign language activities.

The year 1965 was a landmark for federal expansion into both the K-12 schools and higher education. The Higher Education Act of 1965 is the basis for many of today's postsecondary education subsidies, including student loan and grant programs, college library aid, teacher training programs, and other subsidies.

Since 1965, the federal government has provided increasing amounts of funding for higher education as grant and loan programs have been expanded, and new programs added. Federal aid for higher education soared from $10 billion in fiscal 2000 to $30 billion in fiscal 2008.

Of the total $30 billion in 2008, $2.3 billion went toward higher educational institutions, including large shares to Gallaudet College and Howard University. The remaining $27.6 billion went toward student aid: $5.5 billion for direct student loans made by the government, $4.9 billion for federally guaranteed loans made by private lenders, $15.7 billion for grants, and the rest for federal administration. Note that the figures for loans are the net amount of federal support, based on assumptions about loan repayments. The gross amount of loans is much larger—in fiscal 2008, the gross amount of loans was $110 billion.

In recent years, Congress has expanded subsidies for higher education. 

The College Cost Reduction and Access Act of 2007 cut interest rates on federally subsidized loans in half, thus encouraging more student borrowing.

The Ensuring Continued Access to Student Loans Act of 2008 increased the borrowing limits on certain student loans and gave the Department of Education new authority to fund student lending. In 2008, Congress increased Pell Grant maximums from $5,800 to $8,000 over time, authorized forgiveness of up to $10,000 in federal loans for people working in an area of "national need," and expanded other subsidies.

In 2009, President Obama proposed to eliminate all student loans through private financial firms guaranteed by the government, and thus make all federal loans "direct loans" from the Treasury. He also proposed to increase Pell grants and to budget for them as an "entitlement" program, thus putting spending on automatic pilot and not needed annual budgeting action from Congress.

Outside of the Department of Education, the federal government offers other aid programs for higher education, such as tuition assistance for military personnel in the Department of Defense. Also, the federal government funds more than $30 billion of research at the nation's universities through various departments.

Finally, a growing part of federal support for education comes through the tax code. In 1995, there were just 7 special breaks in the income tax code for K-12 and higher education. Today, there are 16 breaks, including the lifetime learning tax credit, Hope scholarship, education savings accounts, and education facility bonds. Politicians of both parties continue to offer more breaks, so the tax code will likely get more crowded with such giveaways.

Subsidies and Education Inflation

There are numerous problems with federal subsidies for higher education. For one thing, such subsidies benefit people who will earn higher than average incomes during their careers. Thus, the effect of subsidy programs, in part, is to impose taxes on blue collar workers, who have not attended college, to pay for the tuition of future white-collar professionals. Why should the government subsidize future high earners at the expense of average working people?

Supporters of student aid subsidies argue that higher education is a "public good" that would be underprovided in a free market. However, that is probably not the case. People have a strong incentive to invest in their own education because it will lead to higher earnings. Those with a college degree will earn, on average, 75 percent more during their lifetime than those with just high-school degrees. That is a big incentive for people to save or borrow in private markets to pay for their own college costs. There is no "market failure" here.

Interestingly, the main effect of federal student aid programs may not be to transfer wealth from taxpayers to students as mentioned, but from taxpayers to academic institutions. That's because the rise in student subsidies over the decades appears to have fueled inflation in education costs. Tuition and other college costs have soared as subsidies have risen.

It is matter of supply and demand. More and more Americans have sought a college education, which has pushed prices higher. Ordinarily, such upward pressure would be restrained by consumers' willingness and ability to pay, but as government subsidies have helped absorb tuition increases, the public's budget constraint has been lifted. Peter Wood, a professor at Boston University noted that federal subsidies "are seen by colleges and universities as money that is there for the taking . . . tuition is set high enough to capture those funds and whatever else we think can be extracted from parents."

One can look at average cost data to see the inflationary effect of rising student aid. From 1987 to 2007, there was a strong upward trend in average per-student costs of private and public universities (tuition, fees, and room and board). However, if you subtract from those costs federal grants, loans, and tax benefits, there has been only a modest increase over two decades.

Consider four-year private colleges and universities. The average real cost (in 2006 dollars) per student rose from $18,122 in 1986 to $30,497 in 2006, a 68 percent increase. But students didn't bear that large increase because of grants, loans, and tax benefits. After these benefits, the cost grew from $10,943 to $14,158, a much more modest 29 percent increase. A similar pattern holds for price increases and public institutions.

Nonetheless, even after taking inflated prices into account, federal aid has probably helped increase student enrollment. Total U.S. college and university enrollment increased about 48 percent between 1986 and 2006. But have those enrollment increases been an entirely good thing?

Many of those additional students may not have been ready, or suited, for college. As evidenced by the rising shares of college students who require remedial work. Further evidence of the problem is that institutions have lowered their standards to adapt to the rise in second-rate students. The American Academy of Arts and Sciences reported that from the mid-1960s to the mid-1990s, college grade point averages grew steadily but Scholastic Aptitude Test scores declined. The share of entering college students who complete degrees has also fallen over the decades. In addition, while college attendance is up, overall adult literacy has barely budged over the last 15 years. 

With all this in mind, phasing out federal aid would probably not result in reduced accessibility for truly college-ready students. Indeed, college cost inflation induced by federal aid probably hurts low-income families—the people that federal aid was supposed to target—more than others. Further, many private philanthropists support promising, low-income college kids, and they would have greater interest in doing so if the federal government was not in the aid business.

The value of a college education is very real, so young people and their families have a strong incentive to invest in higher education themselves, and private lenders have an incentive to lend to them. By cutting federal subsidies, tuition and related costs would fall as students shopped around for the best deals, which in turn would force schools to reduce their bloated cost structures.   

There is plenty of evidence of bloat in academia. Consider congressional earmarks, which often fund dubious projects at colleges and universities. The number and value of educational earmarks has soared in recent years. In 2008, earmarks included $140,502 "to maintain healthful interscholastic youth-sports programs" at the University of Maine; $98,000 to build a "Student Wellness and Recreation Center" at Heidelberg College in Ohio; and $1,915,934 for the Charles Rangel Center for Public Service at the City University of New York.

Here are some other signs that both students and institutions could tighten their belts:

• College students devote 3.2 hours to education on an average weekday, versus 3.9 hours to "leisure and sports;"
• The six-year graduation rate for bachelor's students is only about 56 percent, indicating that many students are not very serious about education;
• Almost half of full-time college students binge drink or abuse drugs, and the incidence of such behaviors is rising.
• Between 1983 and 2007, energy consumption costs at America's colleges rose twice as fast as energy costs in the private business sector, indicating that colleges are not very cost-conscious.  

Rising Federal Regulatory Control

Even with its problems, the American postsecondary education system is considered to be the best in the world. Driven by freedom of choice by consumers and competition between independent institutions, it has an unmatched vibrancy.

However, increasing top-down control and subsidization from Washington is creating a threat to the strength of the American system. As we have seen in K-12 education, the growth in federal subsidies is usually accompanied by calls for more oversight, micromanagement, and rising levels of red tape imposed by Washington.

A classic case of top-down federal control coming as a package deal with federal money was Title IX of the education amendments law of 1972. It banned discrimination on the basis of sex for any education-related program receiving federal assistance. Title IX has created many dislocations in activities such as college athletics, and it has generated large bureaucracies of lawyers to administer, enforce, and litigate the complex rules. The law is enforced by the Office of Civil Rights in the Department of Education, which had 629 employees in 2008. Title IX is a regulatory octopus with arms in education programs, athletics, cheerleading, the Boy Scouts, fraternities, and many other activities. Whole books have been written about its broad-ranging and problematic effects.

Today, a growing regulatory threat to higher education are the calls for "national standards," similar to the top-down rules imposed on K-12 education. In 2005, then secretary of education Margaret Spellings created a commission to formulate a "comprehensive national strategy" for higher education. The Bush administration signaled that it wanted to tighten federal control over higher education as it had done over K-12 education under the No Child Left Behind Act. The commission's final report stopped short of advocating outright federal imposition of standards and tests, but it did call for the creation of "a national strategy for lifelong learning" and a federal database with information on every college student in the country.

Secretary Spellings also tried to impose outcome-measurement requirements on colleges through the regulation of accreditors, which are organizations whose stamp of approval is needed for the receipt of federal aid. In her plan, accreditors would be required to have schools report explicit outcome measures, which would probably mean standardized tests for incoming and outgoing students.

For the time being, Congress has rejected these proposed advances of federal intervention into higher education. However, Americans need to be aware that federal subsidies and regulations create a growing threat to academic independence, and would jeopardize the nation's outstanding system of autonomous and competing institutions of higher learning.

Waste, Fraud, and Abuse

Just about every federal program that hands out subsidies to individuals or businesses suffers from large waste, fraud, and abuse problems. Those problems are an ongoing issue in Medicare, Medicaid, housing subsidies, food stamps, farm aid, and other budget areas. When programs hand out billions of dollars of grants or loans, they attract cheaters and fraud artists. What makes it worse is that federal policymakers have shown themselves to be incapable of standing up for taxpayers and ending the waste.

Federal student loan and grant programs have been subject to waste and fraud for decades, and have taken many forms. One problem with needs-based student aid, for example, is that it creates incentives for families to misreport their income to garner excess federal cash. With the Pell grant program, this fraud problem costs taxpayers hundreds of millions of dollars per year. Another ongoing problem is the high default rate on student loan programs. In 2001, the Government Accountability Office found that there were about $22 billion of student loans in default.

Students aren't the only culprits in education aid abuse. Under most student loan and grant programs, the aid is sent directly to thousands of educational institutions, which are supposed to distribute it to the eligible students. However, that distribution system has attracted swarms of shady school operators, who have lined their own pockets with funds meant for students. A related type of waste that has grabbed news headlines recently regards the large returns earned by the financial institutions that are subsidized to service student loans.

The magnitude of waste and fraud in federal student aid programs became clear in the early 1990s. One scandal at the time regarded the trade school American Career Training Corporation in Florida. The school recruited new "students" at food stamp offices and housing projects, and helped them take out loans. The school owners received tens of millions of dollars in federally guaranteed student loans, and simply pocketed much of it.

Many similar rip off schemes came to light. In 1991, a year long Senate investigation found that the federal student loan program is "plagued with fraud and abuse at every level," robbing taxpayers of billions of dollars. The investigation accused the Department of Education of "gross mismanagement, ineptitude and neglect" and found that it had a "dismal record" of dealing with loan abuses. The report found that losses from the student loan program totaled an enormous $13 billion between 1983 and 1990.

Another fraud scheme at the time involved 21 Jewish schools in New York State, which received millions of dollars in federal Pell grant money. The schools spent hardly any of the money on education. For example, one of the schools pocketed $3.2 million in Pell grants in a year and spent just $21,000 on education. Another scandal involved employees of Advanced Business College in Puerto Rico, who used Pell grant monies to buy high-end sports cars and real estate, wasting more than $3 million of taxpayer funds. Once again, auditors fingered the Department of Education for its poor management and oversight of loan programs.

In 1994, the department admitted that it was losing a staggering $3 billion or more annually to waste, fraud, and loan defaults, accounting for more than 10 percent of its entire budget. Education Secretary Richard Riley called the department's oversight "worse than lax." For years the department had been wiring billions of dollars of loans and Pell grant funds to obscure trade schools based on unproven claims about how many enrolled students were qualified. Students and schools had to fill out paperwork to get the aid, but the Department of Education never verified it.

Some program changes have reduced the extraordinarily high fraud rates of the 1990s, but large amounts of funding are still wasted. One 2002 investigation revealed how easy it is to scam student loan programs: the GAO created a fake university in London with three fake students, and then applied for, and was awarded, $55,000 in federal student loans. And a 2005 investigation revealed that owners of a company called the CSC Institute stole $4.3 million of the $13 million it received in Pell grants.

Student aid scandals have continued in recent years. In 2007, Secretary Spellings testified to Congress, "federal student aid is crying out for reform. The system is redundant, it's Byzantine, and it's broken. In fact, it's often more difficult for students to get aid than it is for bad actors to game the system." One issue is the very large return earned by some financial institutions using a loan program loophole. Under the Federal Family Education Loan Program, dozens of loan originators figured out how to earn a 9.5 percent guaranteed return from the government, even though market interest rates were much lower. The 9.5 percent rate was supposed to have been eliminated in the 1990s, but lenders figured out how to revive it, which caused subsidies on guaranteed loans to explode and lenders to earn billions of dollars at taxpayer expense.

The Democrats have used this latest scandal to try to reduce or eliminate private student loans in favor of direct loans from the government. The Republicans have reflexively supported private lenders over government-sourced loans. Our view is that the Department of Education has been a terrible financial manager of all its aid programs, including Pell grants, direct loan programs, and loan guarantees to private lenders. All of those programs should be scrapped, and students ought to rely on grants and loans from private financial institutions and philanthropic sources.

In theory, it is possible to improve federal management of higher education subsidies, but programs that hand out billions of dollars to a vast array of recipients will always be vulnerable to major rip-offs. As the Inspector General of the Department of Education noted, "the department's student loan programs are large, complex, and inherently risky … the loan programs rely upon over 6,000 postsecondary institutions [and] more than 3,000 lenders." There is no reason for taxpayers to support such a large, complex, and risky scheme, especially when private alternatives are available.

Conclusions

Federal aid to students and higher educational institutions is harmful on many fronts. It drives up tuition costs, encourages bloat and inefficiency, and is an unfair burden on taxpayers. It also poses a threat to the core strengths of American higher education, including institutional autonomy, competition, and innovation. All efforts to impose top-down federal regulations on colleges and universities should be rejected, and federal subsidies to students and institutions should be phased out and eliminated.

SOURCE:U.S. Department of Education, National Center for Education Statistics. (2012). Digest of Education Statistics, 2011 (NCES 2012-001)

Total tuition, room and board rates charged for full-time undergraduate students in degree-granting institutions, by type and control of institution: Selected years, 1980–81 to 2010–11
Year and control of institution	Constant 2009–10 dollars1			Current dollars
	All institutions	4-year institutions	2-year institutions	All institutions	4-year institutions	2-year institutions
All institutions
1980–81	$7,759	$8,756	$5,580	$3,101	$3,499	$2,230
1990–91	10,620	12,303	6,361	6,562	7,602	3,930
2000–01	13,393	15,996	6,766	10,820	12,922	5,466
2001–02	13,842	16,589	6,955	11,380	13,639	5,718
2002–03	14,298	17,185	7,441	12,014	14,439	6,252
2003–04	15,086	18,059	7,809	12,953	15,505	6,705
2004–05	15,595	18,666	8,022	13,793	16,510	7,095
2005–06	15,939	19,007	7,881	14,634	17,451	7,236
2006–07	16,438	19,611	7,926	15,483	18,471	7,466
2007–08	16,617	19,823	7,819	16,231	19,363	7,637
2008–09	17,257	20,606	8,318	17,092	20,409	8,238
2009–10	17,649	21,093	8,533	17,649	21,093	8,533
2010–11	18,133	21,657	8,734	18,497	22,092	8,909
Public institutions
1980–81	$5,938	$6,381	$5,072	$2,373	$2,550	$2,027
1990–91	7,699	8,485	5,612	4,757	5,243	3,467
2000–01	9,390	10,711	5,990	7,586	8,653	4,839
2001–02	9,757	11,185	6,249	8,022	9,196	5,137
2002–03	10,118	11,648	6,666	8,502	9,787	5,601
2003–04	10,769	12,432	7,002	9,247	10,674	6,012
2004–05	11,153	12,918	7,208	9,864	11,426	6,375
2005–06	11,386	13,188	7,071	10,454	12,108	6,492
2006–07	11,731	13,587	7,235	11,049	12,797	6,815
2007–08	11,848	13,748	7,141	11,573	13,429	6,975
2008–09	12,375	14,400	7,641	12,256	14,262	7,568
2009–10	12,804	15,014	7,703	12,804	15,014	7,703
2010–11	13,297	15,605	7,925	13,564	15,918	8,085
Private not-for-profit and for-profit institutions
1980–81	$13,686	$13,995	$10,766	$5,470	$5,594	$4,303
1990–91	20,894	21,423	15,055	12,910	13,237	9,302
2000–01	26,456	27,054	18,453	21,373	21,856	14,907
2001–02	27,261	27, 848	19,248	22,413	22,896	15,825
2002–03	22,778	28,310	21,129	23,340	23,787	17,753
2003–04	28,679	29,198	22,779	24,624	25,070	19,558
2004–05	29,189	29,690	22,949	25,817	26,260	20,297
2005–06	29,307	29,770	23,312	26,908	27,333	21,404
2006–07	30,194	30,703	21,535	28,439	28,919	20,284
2007–08	30,475	30,945	22,200	29,767	30,226	21,685
2008–09	31,102	31,576	22,946	30,804	31,273	22,726
2009–10	31,023	31,488	24,483	31,023	31,488	24,483
2010–11	31,395	31,975	23,401	32,026	32,617	23,871

Source