Ed Money Watch

While Congress has debated extending the 3.4 percent interest rate on Subsidized Stafford loans issued this year to undergraduates, advocacy groups are gearing up for a debate on longer-term reforms. They know the odds don’t favor Congress adopting a one-year extension of the lower rate again next year. Besides, spending $6 billion to save college graduates $9 a month isn’t a great deal for borrowers or taxpayers. So it’s good that student aid advocates want a better plan. But they aren’t off to a great start. They are gathering support for an outrageously expensive proposal that turns a blind eye to far more worthy aid, like Pell Grants.

The student loan interest rate proposal that is dominating discussions among advocates and other stakeholders would provide borrowers with variable interest rates that would be capped at the current fixed rates of 6.8 percent on Stafford loans and 7.9 percent on PLUS loans for parents and graduate students.

The rate on all newly-issued federal loans would be adjusted annually based on interest rates on short-term (three month) U.S. Treasury debt, plus a markup of two to three percentage points to partially offset costs. Today, that would translate into an interest rate of about 3 percent. If short-term U.S. Treasury rates rise, the rate borrowers pay would too, though it would never exceed 6.8 percent. Such a proposal would represent a return to the policy of the 1990s and early 2000s, except the cap on the variable rate then was 8.25 percent.

This variable-rate-with-a-cap proposal would give borrowers a “heads-I-win, tails-you-lose” arrangement. If short-term rates stay low, borrowers benefit. If short-term rates rise, the loans convert to low, fixed rates and the borrower wins again. When short-term rates decline, the fixed-rate loan converts back to a variable rate, and the borrower wins again.

The policy effectively shelters borrowers from the financial tradeoffs that they would normally face when they choose between fixed and variable interest rates on loans in the private market. Variable rates are lower at first, but can go higher. Fixed rates might be higher on average, but they provide certainty.

The variable-rate-with-a-cap proposal doesn’t, however, make that fundamental tradeoff disappear. It just shifts the cost entirely onto taxpayers.

How much would taxpayers have to pay to provide borrowers with this no-lose insurance policy? According to sources on Capitol Hill, the Congressional Budget Office says it would cost $200 billion over 10 years.

To put this price tag in perspective, Congress could fund an $8,000 maximum Pell Grant (up from $5,550 today) for the next 10 years if it allocated an additional $200 billion to the program over that time period.

Still, there are other options for policymakers to modify student loan interest rates that would make meaningful improvements for borrowers without breaking the bank. One even generates savings (read more here).

Students and aid advocates would be wise to rally around some version of a more feasible interest rate reform proposal in the coming months. But if they really want to get behind a proposal that costs $200 billion, please make it one that supports the Pell Grant program rather than college graduates’ monthly budgets.

Congress is now officially deadlocked over how to pay for a one-year extension of the 3.4 percent interest rate offered on newly-issued Subsidized Stafford student loans. The disagreement isn’t over extending the rate, but where to find the extra $6 billion needed to pay for it. In the midst of all the partisan bickering, wouldn’t it be great if Congress could magically lower interest rates for all borrowers without cutting other programs or raising taxes, while reducing budget deficits in the meantime? Take a look at the Congressional Budget Office’s “Reducing the Deficit: Spending and Revenue Options” publication from March 2011 (page 32).

The CBO has provided a cost estimate for a proposal that would link the interest rate on all newly-issued federal student loans—Subsidized and Unsubsidized Stafford, Graduate and Parent PLUS—to long-term U.S. Treasury borrowing rates.  (The CBO isn’t endorsing the proposal, just showing lawmakers how it would ‘score’.) Interest rates would still be fixed for the life of the loan, but the rate would change each year loans are offered based on market rates for Treasury notes. The proposal sets the rate for newly issued loans based on the interest rate on 10-year Treasury notes at the time the loan is issued, and adds a premium of 3 percentage points to it.

That formula would make the rate on loans issued this fall fixed at 4.9 percent, a big drop from the current 6.8 percent rates. What’s more, that rate would be available to all undergraduate and graduate borrowers, unlike the proposal pending in Congress to provide lower rates for only some undergraduates. Of course, next year the rate could be higher or lower depending on what happens to interest rates in the market. The CBO assumes it will be higher. That’s where the deficit reduction (i.e. cost savings) comes in.

If and when the interest rates on 10-year U.S. Treasury notes rise, the fixed interest rate on newly-issued student loans will also increase. Once rates on those securities rise above 3.8 percent – the rates are currently 1.9 percent – the interest rate on newly issued student loans will exceed 6.8 percent, the current fixed interest rate. Because CBO assumed that interest rates will rise in the future, it assumed that borrowers will pay higher rates in the future than under current law, reducing spending and the deficit. According to the estimate, this new rate structure would reduce the deficit by $52 billion over ten years.

Keep in mind that CBO calculated this estimate in early 2011 when long-term interest rates were higher. That means the savings that would be ‘scored’ under the same proposal today are likely less. At the same time, the proposal CBO used for its estimate would charge the same interest rate on PLUS loans to graduates and parents of undergraduates as the rates on Stafford loans, a break from historical policy. If lawmakers opted to charge a higher interest rate for PLUS loans like they do currently, the total savings would be more in line with CBO’s 2011 estimate. 

Some student aid advocates and policymakers will likely dismiss this proposal because it could mean that future borrowers take out loans at rates higher than 6.8 percent. Still, that seems like a better policy than what we have today – fixed 6.8 percent rates on loans issued every year no matter what happens in the market. Furthermore, it will make rates on newly-issued loans more closely resemble the interest rates private lenders charge on home mortgages, something many student aid advocates seem to want.

The market-based, fixed-rate proposal like the one CBO scored in its 2011 publication is also better than a variable rate structure where rates are reset on all outstanding loans once a year. Too many advocates and policymakers seem to be falling for the allure of low variable rates as a way out of the current interest rate debates. But variable rates are a shortsighted solution. In fact, the drawbacks of variable rates – uncertainty and the risk that rates remain higher for years – are why Congress adopted fixed rates in the first place.

The lesson here is that fixed rates are an important benefit for borrowers as they provide a measure of certainty – but the rates on newly-issued loans do need to adjust when interest rates in the market change. The proposal outlined in a 2011 CBO cost estimate shows that Congress can adopt exactly that policy and save money at the same time.

Ever since the Department of Education (ED) released guidance on the Elementary and Secondary Education Act (ESEA) waivers, policymakers have debated the merits and problems surrounding the new accountability systems that states proposed. The waivers, if ED approves them, allow states to replace the accountability system Congress put in place under No Child Left Behind (NCLB) – Adequate Yearly Progress – with their own rules.  ED just released letters from their peer reviewers to each of the 27 states that submitted waiver applications in the second round. After comparing these letters to the first round of approved waivers, it looks like ED is not holding states to the reviewers’ recommendations.

Thanks to EdWeek, 13 of these letters are publicly available. Among the many shortcomings the reviewers identified, states’ treatment of student subgroups (students with disabilities, English language learners, minority students, and students living in poverty) in their school accountability grades featured prominently in the letters. It is not surprising that the reviewers were concerned about the treatment of subgroups in the waivers – many stakeholders have expressed similar concerns. Indeed, even the Department of Education’s guidance on how it will evaluate ESEA waiver applications explicitly requires states to address subgroup achievement. Has ED changed its tune after recognizing the challenges this created for the majority of schools?

For example, reviewers dinged Kansas’ waiver application for proposing to measure the achievement gap by comparing the performance of the top- and bottom-performing 30 percent of students instead of separating out student subgroups. Kansas also proposed using alternative assessments for subgroups and failed to demonstrate how they would collect data on individual subgroups over time to identify trends. The reviewers concluded that as it stands, the state’s new accountability framework could potentially mask the performance of struggling subgroups.

This is not the first time that reviewers have been concerned about subgroups. We recently examined three state waivers—from Colorado, Florida, and New Mexico—approved in the first round of waiver applications. ED approved Florida’s and New Mexico’s applications even though their school grade frameworks did not include the achievement of individual subgroups.

From our read of Florida’s original waiver application and the reviewer feedback on the proposal, reviewers criticized Florida’s application because, like Kansas, the state did not include individual subgroup achievement in school grades. Specifically, Florida’s plan ditches traditional ESEA subgroups and instead accounts for the performance of the 25 percent of students with the least test score growth from year to year, assuming that this 25 percent captures most of the students in these subgroups.

Florida’s response to the comments? Not much. Florida did concede by adding that they would use school improvement plans to intervene in schools in which any subgroup of students failed to meet the state’s achievement goals for two years in a row. But as far as we can tell, Florida made no changes to its school grade system in its approved waiver plan. Instead, Florida justified its use of the lowest-performing 25 percent of students by claiming that many schools did not have enough students in each subgroup to be properly measured under NCLB’s accountability system.

So the real question is—is ED taking the reviewers’ feedback about subgroups seriously? In the case of Florida, the Department approved the waiver even though the state made no substantive changes to its inclusion of subgroups in school grades. Will ED take a firmer hand with this second round of waivers? Or will states be allowed to obscure the performance of their neediest students in their school accountability grades? 

Every year the Department of Veterans Affairs (VA) directs a huge chunk of federal spending to higher education for veterans education benefits — more than $1.7 billion in the 2009-10 school year alone. But VA education benefits are often overlooked in education policy discussions. This is largely because of a lack of transparency in the VA budget. The agency doesn’t make good accounting information readily available. On top of these opaque budgeting practices, little information is available on the effectiveness of the current iteration of the GI Bill, how schools spend that money, or the degree to which veterans actually benefit from these programs. That’s starting to change. But policymakers can do more.

President Obama issued an executive order last week to crack down on how schools use VA and Department of Defense (DoD) funds. (Benefits for veterans are provided through a slew of VA programs, most notably the Post-9/11 GI Bill. Active duty servicemembers receive funding through the Department of Defense’s Tuition Assistance Program, rather than through the G.I. Bill.)

Under the president’s order, all schools enrolled in VA’s Post-9/11 GI Bill program (approximately 6,000 institutions) will be encouraged—and all DoD Tuition Assistance participating institutions mandated—to improve transparency and provide documentation of tuition and fees, financial aid information, and details of student outcomes at the school – much like the Consumer Financial Protection Bureau’s (CFPB) proposed “Know Before You Owe” sheet. The order also restricts the recruiting practices of Institutions participating in veterans education benefit programs.

The president’s executive order seeks to improve the quality of services the DoD and VA provide students by developing a complaint system whereby the agency quickly responds to concerns about funding or support services. Media reports earlier this year revealed disturbing figures concerning VA administrative failures. Tens of thousands of veterans education benefits were stalled in processing – as many as 62,000 applicants in one branch alone. As a result, tuition payments hadn’t reached many schools and housing stipends were delayed for months in many cases.  The VA argued that during peak enrollment periods, it often experiences backlog. 

Separately, a new report from the Center for American Progress (CAP), “Easing the Transition from Combat to Classroom,” provides some previously unavailable information on veterans education benefits that also helps to illuminate some of the delays in processing mentioned above. Largely thanks to the passage of the Post-9/11 GI Bill, VA has seen a dramatic increase in federal education funding in recent years commensurate with increasing numbers of veterans and major enrollment growth – 37 percent from 2009 to 2010.

But the administrative concerns that the president seeks to address in his executive order beg a larger question: What is the quality of VA oversight?

Though lawmakers funnel a significant amount of education benefits to veterans through the VA, limited access to information about those funds and programs mean veterans—and taxpayers—are often left in the dark. Public funds are spent with minimal information as to the success of federal efforts. The president’s order may shine a light on certain aspects of VA Post-9/11 GI Bill, but it may not go far enough to provide veterans what they were promised – access to equitable and high-quality education.  That’s going to require more oversight and regulation from the White House and Congress.