School Finance

Obama Budget Punts on Tough Choices for Pell Grants

April 10, 2012

Many student aid advocates and pundits have panned the House Budget Committee’s loosely outlined funding plan for Pell Grants. The plan was part of the fiscal year 2013 budget resolution (aka the “Ryan Budget”) that the House passed a few weeks back. Critics say it would make deep cuts to Pell Grants and kick a million students out of the aid program. Indeed, the House Republican proposal would make some changes to the program to permanently address a $7 billion funding cliff that the program will face in 2014. But where were these critics when President Obama outlined his Pell Grant funding proposal earlier this year?

The president’s proposal included only a one-year fix for the massive $7 billion Pell Grant funding cliff. After the one-year fix, the president’s budget simply assumes that an extra $7 billion will materialize in the annual appropriation for Pell Grants each year. But this extra funding must be offset by $7 billion in cuts to other programs funded with annual appropriations, which the president’s budget doesn’t specify.

Do student aid advocates really believe the president’s “let’s not make tough decisions now; we’ll find an extra $7 billion later” is the better proposal?

Sure, the president doesn’t propose any eligibility changes for Pell Grants or big cuts to other aid programs to address the funding cliff, so it might appear to be a better deal for students come 2015. But student aid advocates are taking a big gamble because the appropriations spending caps in place under the Budget Control Act require that any big increases in appropriations spending on one program must be offset by spending cuts to other programs (tax increases cannot be counted as an offset). It should be noted that the president’s budget would “turn off” the across-the-board (sequestration) cuts pending for 2013 and cancel the lower annual appropriations limits, both triggered by last year’s supercommittee failure.

The president does not call for a $7 billion increase in overall appropriations spending each year to accommodate Pell Grant costs. Instead, the president proposes to keep the annual appropriations limits set in the Budget Control Act of 2011. Those spending limits effectively locked in the 2011 Pell Grant appropriations funding levels for future years—about $22 billion annually. That means the president and lawmakers must offset his proposed $7 billion increase over that amount with $7 billion in cuts to other programs in 2015 and every year thereafter.

Those cuts could come from anywhere, including other education programs. Not even a Democratic Congress opted for that route when they had to address a similar Pell Grant funding cliff in 2010.

More importantly, the Congressional Budget Office won’t give the president’s budget credit for its Pell Grant funding plan past 2014. When the president or Congress promises to increase appropriations for one program in the future while promising to cut unspecified other programs by the same amount, the budget agency considers that to be more political posturing than a concrete proposal. In response, CBO will only measure total appropriations funding in a budget proposal. Since the president did not identify specific cuts in non-appropriations funding to offset the $7 billion increase past 2014, the official estimate from CBO shows that the president’s proposal, or lack thereof, cuts Pell Grant funding dramatically in 2015. The next year, total funding will be half what it was in 2012.

Why isn’t the press covering this like they are the House Pell Grant proposal? Why aren’t student aid advocates up in arms?  Where are the PreK-12 education advocates whose favorite programs might be called on to absorb the unspecified $7 billion in funding cuts the president’s budget envisions to support Pell Grants? Can President Obama fairly claim that the House-passed budget would cut Pell Grants by $1,000 per recipient when his lack of a proposal would, according to the Congressional Budget Office, cut them by much more?

That’s the most disappointing part of this whole story. The president punted on a long-term plan to shore up Pell Grants because he could be criticized for making tough choices. Then, when House Republicans put out a feasible, gimmick-free Pell Grant proposal that makes tough choices (i.e. cuts to other aid programs and eligibility changes) needed to fund the program for the long-term, the president didn’t attempt to work with them, but lambasted them instead.

Maybe the president doesn’t see the House proposal as a constructive, move-to-the-middle plan. In that case, he is free to propose his own long-term solution and show how he’d pay for it. The future of the Pell Grant program and the students who will rely on it would benefit from a more robust discussion.

Friday News Roundup: Week of April 2-6

April 6, 2012

Montana settlement in funding lawsuit means $4.6 million more for public schools

$30 million ‘bullet’ targets New York aid gap

Penn State students, alumni rally against proposed 30 percent cut in state support

Dayton vetoes GOP bill on Minnesota school IOUs

Montana settlement in funding lawsuit means $4.6 million more for public schools
A lawsuit settled this week between the Montana Quality Education Coalition and the state of Montana yielded $4.6 million in additional funding for public K-12 schools for the 2013 school year.  Another lawsuit, filed in 2002 by the Coalition, successfully argued that the state’s financing system was unconstitutional because it did not adequately fund public schools. In 2011, the state legislature passed a bill to increase public K-12 school funding for the 2013 school year by 2.4 percent, or around $3 million. But a political gimmick tied the funding to another bill that would move earmarked funds to state general funds, and when Governor Brian Schweitzer (D) vetoed that bill, the increase for schools was automatically lowered to 1.6 percent. The Coalition filed a lawsuit last November, again challenging school finance in the state. The state Attorney General reached a settlement this week to increase school funding by the full 2.4%. More here…

$30 million ‘bullet’ targets New York aid gap
New York’s state budget plan for fiscal year 2013 includes about $30 million in funding for public K-12 education, to be divvied up by lawmakers over the next several weeks as a way to fill in school district funding gaps.  The funds, which some argue are equivalent to earmarks because legislators use the money as a slush fund to prioritize funds for some districts without any application process, will provide money to districts above and beyond the “foundation” formula.  Foundation funding for fiscal year 2013 will total more than $15 billion, a $415 million increase over fiscal year 2012 levels.  The bullet aid is distributed between the Assembly and the Senate for allocation; the Senate receives $20.1 million, while the Assembly gets $9.1 million.  This year, for the first time, lawmakers are required to specify in legislation the recipients of the funds, and the resolution will have to pass both chambers. More here…

Penn State students, alumni rally against proposed 30 percent cut in state support
Penn State Capital Day, a lobbying effort in Harrisburg for Penn State students and alumni, kicked off this week with a rally on the steps of the Capitol Rotunda.  Participants were protesting Governor Tom Corbett’s (R) proposed 30 percent cut to the Pennsylvania State University’s state budget appropriation in fiscal year 2013.  The cut would reduce state funding for the university by $64.2 million from fiscal year 2012 levels, leaving its total state appropriation at about $150 million.  In 2012, the university’s appropriation was cut by 20 percent from fiscal year 2011 levels.  Corbett’s fiscal year 2013 budget would cut funding for all 14 of the state’s universities by an overall average of 20 percent. More here…

Dayton vetoes GOP bill on Minnesota school IOUs
The state of Minnesota owes its public K-12 schools more than $2 billion because it slowed the pace of scheduled back payments to them in an effort to balance the budget.  The state is expected to pay $315 million of that total this year thanks to higher-than-anticipated state revenue projections.  Governor Mark Dayton this week vetoed a Republican proposal that would have sped up the payments, adding another $430 million for public schools this year out of the state’s reserves. Dayton argued that the bill would place the state back in financial peril and could force it in the future to balance the budget by borrowing from banks.  An alternative proposal from the governor’s Democratic-Farmer-Labor (DFL) political party would end some tax breaks for businesses and redirect the savings to schools. More here…

House Democrats’ Data on Student Loan Interest Rates Misrepresent the Problem

April 6, 2012

Democrats on the House Education and the Workforce Committee this week released a document detailing the increased costs to borrowers if interest rates on Subsidized Stafford loans increase from 3.4 to 6.8 percent, as they are scheduled to for loans issued as on or after July 1st, 2012. The post provides some big numbers, stating that “more than 7 million students will incur an additional $6.3 billion in repayment costs for the 2012-2013 academic school year if student loan interest rates double on July 1.” But the committee staff’s claim buries the real story: Whatever the vitriol surrounding the interest rate number in Congress, individual students are not likely to notice much difference in their monthly payments.

There wasn’t much detail accompanying the committee document, so Ed Money Watch has tried to recreate the Democrats’ calculations.

Click here to read the full post on Ed Money Watch...

House Democrats’ Data on Student Loan Interest Rates Misrepresent the Problem

April 5, 2012

Democrats on the House Education and the Workforce Committee this week released a document detailing the increased costs to borrowers if interest rates on Subsidized Stafford loans increase from 3.4 to 6.8 percent, as they are scheduled to for loans issued as on or after July 1st, 2012. The post provides some big numbers, stating that “more than 7 million students will incur an additional $6.3 billion in repayment costs for the 2012-2013 academic school year if student loan interest rates double on July 1.” But the committee staff’s claim buries the real story: Whatever the vitriol surrounding the interest rate number in Congress, individual students are not likely to notice much difference in their monthly payments.

There wasn’t much detail accompanying the committee document, so Ed Money Watch has tried to recreate the Democrats’ calculations.

Because we don’t have access to student loan recipients and loan volume data for 2013 (the data the committee used) we relied on the Department of Education data on Subsidized Stafford loans for the 2011 award year, the most recent year for which data are available. This means that our numbers are slightly different than the committee’s numbers.  We collapsed the data to get the total number of loan recipients and total loan volume originated by state (not for the state in which the borrower lives, but for the state in which the institution is located) and calculated the average loan per recipient in each state.

Next we used the Department of Education’s standard loan repayment calculator to determine the repayment period for each state, given its average loan size. Based on that repayment period, which ranged from 77 to 120 months, and accounting for the minimum $50 payment requirement set by the Department, we used an amortization calculator to measure the total interest paid on the average size loan in each state under both the 6.8 and 3.4 percent interest rates and calculated the difference between the two. It is important to note, that in most states, loans at the 6.8 percent interest rate had  longer repayment periods than loans at the 3.4 percent interest rate.

We found that the difference in student interest payments varied by state depending on the average size of the loans.  In Indiana, where the average loan size for 2011 was relatively low at $3,924, students would see an average increase in interest costs of about $772 over the life of the loan.  In Pennsylvania, where students had an average loan size of about $4,509, interest payments would increase by just over $1,000.

These numbers may sound large, but there is a bit of an illusion because the figures condense 10 years of future repayments into one number. The impact on individual borrowers is far less significant when measured on a monthly basis.

In fact, according to our calculations, students’ minimum monthly payments would increase by, at most, about $9. To calculate this figure, we calculated the monthly payment on an average loan at 3.4 percent interest over the repayment period specified by the Department of Education to reach a $50 payment. Then we calculated the monthly payment for the same loan at 6.8 percent within the same repayment period. In states with high average loan sizes, like Illinois ($5,113), the $50 monthly payments would jump to $59 when the interest rate doubles but the term length is kept the same. States with smaller average loans (for example, South Carolina at $4,103) would see monthly payments increase from the minimum $50 to about $56. The national average would see students pay about $7 more a month over the same repayment period.

Another caveat: The 3.4 percent interest rate applies only to undergraduates, but we are unable to determine the total loan volume only for undergraduate students. It appears the House Committee did not break out the undergraduate data either, which would significantly overstate both the numbers of borrowers and the total loan volume – and therefore the combined increase in costs to borrowers of the interest rate change.

And there’s another factor that we don’t think the minority staff on the Committee took into consideration (though without their original data, it’s hard to say for sure): the time-value of money. The Committee has collapsed 10 years of future interest payments into one amount, but they have not discounted the future payments for the time-value of money. This exaggerates the real cost of the payments today. Put another way, the 1st and 120th monthly payments on a 10-year loan are not of equal value to the borrower today, even though the payment is fixed at $56.

To more fairly represent the additional cost of the 6.8 percent interest rate over the life of the loan in today’s dollars, Democratic committee staff should discount the future payments for the time-value of money.  Of course, had the Committee chosen to simply show the increase in the monthly payments (a smaller number) rather than the value of all future payments combined, the discounting issue would have been moot.  But the Committee can’t have it both ways.

We originally calculated that an average student at a school in Maine (a mid-range state in terms of loan size) would owe an additional $939 dollars in interest as a result of the increase to interest rates. After discounting the payments for the time-value of money, the net present value of those payments is just over $895. In California, where the average loan size was relatively high, students would pay an additional $965 discounting for the time-value of money, as opposed to $1,012 without accounting for the time-value of money.

The numbers the House Education and the Workforce Democrats released appear to be rooted in legitimate calculations. And there’s no denying that borrowers will pay more on their loans when rates go up. But the House Education and the Workforce Democrats probably overstate the story. Given that the state average increased cost of doubling the interest rate tops off at $9 a month per borrower, Congress and the President may not be taking on an issue as big as it first seems.

To see our calculations for all 50 states and the District of Columbia, click here.

Unpacking Pell Grant Reforms in the House-Passed (“Ryan”) Budget

April 4, 2012

As we wrote last week, congressional budget resolutions are always light on details. At best, lawmakers include vague descriptions of policies that Congress could enact to meet spending goals. That’s exactly what House Republicans did for Pell Grant reforms in the fiscal year 2013 budget resolution that passed the House of Representatives last week. The document offers only a few hints about how lawmakers might fund Pell Grants as the program nears a major funding cliff in fiscal year 2014.

Using those hints, we’ve done some detective work to put together what we think the House Republicans might be after with respect to Pell Grant funding levels. The results suggest that House Republicans do in fact have a long-term plan for Pell Grants that would stave off a big cut to the maximum grant and/or avoid radical eligibility changes come 2014 – but their plan includes a few key tradeoffs.

Click here to read the full post on Ed Money Watch...

Unpacking Pell Grant Reforms in the House-Passed (“Ryan”) Budget

April 3, 2012

As we wrote last week, congressional budget resolutions are always light on details. At best, lawmakers include vague descriptions of policies that Congress could enact to meet spending goals. That’s exactly what House Republicans did for Pell Grant reforms in the fiscal year 2013 budget resolution that passed the House of Representatives last week. The document offers only a few hints about how lawmakers might fund Pell Grants as the program nears a major funding cliff in fiscal year 2014.

Using those hints, we’ve done some detective work to put together what we think the House Republicans might be after with respect to Pell Grant funding levels. The results suggest that House Republicans do in fact have a long-term plan for Pell Grants that would stave off a big cut to the maximum grant and/or avoid radical eligibility changes come 2014 – but their plan includes a few key tradeoffs. 

The report accompanying the House-passed budget resolution says it will make Pell Grants sustainable, referring to the funding cliff Congress must address for the fiscal year 2014 appropriation and each year thereafter. The funding cliff is the $30.7 billion annual appropriation needed to maintain the maximum grant under current law. (Keep in mind that the upcoming fiscal year 2013 appropriation isn’t problematic due to a current surplus of $2.1 billion and funding provided through other sources like the Budget Control Act of 2011. More information on funding history and the cliff is here.) To address the upcoming funding cliff, House lawmakers propose several policy and eligibility changes.

As part of their sustainability plan, House Republicans would set the maximum grant at $5,550 indefinitely – the same level as in fiscal years 2010 through 2012. That is a major concession over past proposals. House Republicans last year vowed to return the program to its “pre-stimulus” levels (a maximum grant of $4,731 at a cost of $16.2 billion). Congress first set the $5,550 maximum grant level using funds from the 2009 America Recovery and Reinvestment Act. Republican lawmakers have now proposed to fix that “post-stimulus” grant level in perpetuity.

Under current law, the maximum grant is scheduled to rise with inflation for five years starting in fiscal year 2013. The change proposed by the House budget – forgoing the five years of inflationary increases – reduces the cost of the program by about $1.5 billion in 2014 and a bit more each year thereafter based on figures from the Congressional Budget Office’s March 2012 baseline. It’s important to understand that House lawmakers would end the portion of the grant funded as an entitlement (not the portion funded through the appropriations process) to achieve the cost savings.

The entitlement funding source provided $5.0 billion in 2012 when the maximum grant was $5,550. Therefore, we assume that even though the House proposal would end entitlement funding currently in law for Pell Grants, lawmakers would move $5.0 billion each year from that funding source to support the annual appropriation in future years. Therefore, the portion of the entitlement funding that is eliminated by capping the maximum grant is the only actual reduction in program costs ($1.5 billion in 2014) that stems from eliminating the entitlement funding.

Other savings stem from changes House lawmakers would make to eligibility rules for Pell Grants (see this side-by-side). These include eliminating Pell Grants for students attending school less than half time, reducing the individual income threshold that automatically qualifies a student for the maximum grant from $23,000 to $20,000, and limiting grant eligibility to students below an absolute income threshold, though the proposal doesn’t specify what that income level would be. The first two proposals result in minor savings according to previous Congressional Budget Office estimates.

The latter proposal, however, could be the source of major savings depending on where lawmakers set the income ceiling. Current rules don’t set an absolute income limit for Pell Grant recipients. Eligibility is instead determined by a formula that takes income and other factors into account. Data from the U.S. Department of Education show that more than $7 billion in Pell Grants went to families earning incomes of $30,000 and above. For our estimate, we assume the House budget envisions an income cap of $45,000, which we approximate would lower the cost of providing a maximum grant of $5,550 by about $2.5 billion per year.  

Finally, we assume that savings generated by the House resolution’s proposal to end the interest-free benefits on Subsidized Stafford loans for undergraduate students would be used to fund Pell Grants. Ending the interest benefit produces large savings according to a Congressional Budget Office estimate released in 2010. It would free up about $4.8 billion annually to be reallocated to Pell Grants indefinitely.

When you add up the reallocated funding and the cost reductions that stem from the proposed eligibility changes, the House proposal would require Congress to appropriate annually about $21 billion. (See table below.) That’s about $9 billion less than what would be needed under current law starting in 2014 and each year thereafter. Furthermore, a $21 billion annual appropriation is in line with what Congress has provided through the regular appropriations process in recent years, bolstering the House Republican’s claim that their plan makes the Pell Grant program “sustainable.”

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Of course, it is possible that House Republicans would not reallocate savings achieved by the various proposals into Pell Grants. Still, House Republicans state in their budget resolution that they want to support a maximum Pell Grant of $5,550 indefinitely. That concrete proposal gives us a good sense of how much funding Congress will need to provide each year for the program (after the proposed eligibility changes are made). Our calculations suggest that to eliminate the 2014 funding cliff and support a maximum grant of $5,550, most of the savings associated with the proposed spending cuts would have to be reallocated to Pell Grants.

If our assumptions are right, we think the House Republicans have a feasible proposal that trades cuts to other aid programs, a freeze to the maximum Pell Grant, and a few eligibility changes to fund maximum Pell Grants at $5,550 for the long-term. Now the question is: Will House Republicans provide all the details behind their proposal?

Friday News Roundup: Week of March 26-30

March 30, 2012

Connecticut governor’s education plans take hit in revised budget

Idaho House passes public schools budget for 2013

Concerns hover over California illegal school fee legislation

Senate panel considers New Jersey education budget

Connecticut governor’s education plans take hit in revised budget
Connecticut lawmakers scaled back Governor Dannel Malloy’s education reform proposals for fiscal year 2013 this week as the Democratically-controlled joint House-Senate budget committee issued a recommendation for a more constrained budget proposal. For example, Malloy recommended $22.9 million for efforts to turn around the state’s lowest-performing schools, but the committee recommended only $10.8 million. Appropriations Committee members also proposed less funding than Malloy had requested for charter school students and implementation of a new statewide teacher evaluation system. They also proposed more funding for science education than Malloy had included. The Governor said that the committee would have to produce a recommendation with many more reforms and a higher funding level before he would sign it. More here…

Idaho House passes public schools budget for 2013
The Idaho House passed a budget proposal this week that would fund state programs for fiscal year 2013. The budget includes $1.27 billion in general funds, $56 million more than in fiscal year 2012. Though this represents a 4.6 percent increase in state funding, slow growth in federal support means that this will represent on 0.4 percent growth in overall state revenue. Still, one lawmaker says the increase in funding will permit more funding for schools next year. Other legislators have said that the funds won’t be sufficient to cover increased costs for teacher salaries, promised to faculty once the economy recovered. The plan also includes numerous education reforms; among them, increasing minimum teacher salaries and implementing merit pay bonuses. More here…

Concerns hover over California illegal school fee legislation
The California state legislature is working on a bill that would enforce existing laws against schools implementing student fees, but the bill’s future may be in jeopardy. The bill was passed out of the Assembly Education Committee and is currently before its Appropriations Committee. However, special interest groups have argued that the bill would only further hurt schools struggling with spending cuts. The director of education advocacy for the ACLU of Southern California, Brooks Allen, said that a UCLA survey last year found that one-fifth of public school principals reported instituting fees at their schools for instructional materials. The fees run counter to a 1984 state Supreme Court decision that found charges for children for extracurricular activities and participation in courses to be unconstitutional. The legislation before lawmakers now would require districts to review school finances annually and report to the local school board any improper fees, as well as establish a reporting system for parents to submit complaints. More here…

Senate panel considers New Jersey education budget
The New Jersey Senate Budget Committee is currently reviewing Governor Chris Christie’s proposed education budget and reforms. Education Commissioner Christopher Cerf testified before the committee this week, pushing for the reforms included in the budget. Christie’s 2013 budget, which would include an additional $135 million over fiscal year 2012 levels for public K-12 schools, also reforms the school aid formula. It would provide less funding for economically disadvantaged students and English language learners, but would increase overall per-pupil funding. State Senator Paul Sarlo, chairman of the Senate Budget Committee, says that schools would receive less under Christie’s proposed budget in fiscal year 2013 than they did in 2010. In all, the proposal provides $7.82 billion for education in fiscal year 2013, roughly $100 million below 2010 levels. More here…

Ryan Budget Seeks to Limit Education Spending, but Includes Few Details

March 30, 2012

On Thursday, the House voted to approve a fiscal year 2013 budget resolution drafted by Budget Committee Chairman Paul Ryan (R-WI). The resolution is a long way from a final budget, and includes no agency or programmatic funding plans, but it kicks off the 2013 budget debate, at least on the House side.

Friday News Roundup: Week of March 19-23

March 23, 2012

Georgia State Senate adopts $19.2B state budget plan

Missouri House budget proposal comes with no higher education costs

More funding proposed for Mississippi public schools in separate plans

New Mexico estimates 2 percent increase in key funding factor for public schools next year

Georgia State Senate adopts $19.2B state budget plan
A fiscal year 2013 budget proposal passed unanimously by the Georgia State Senate this week allocates $19.2 billion for state programs, a slight increase over fiscal year 2012. According to State Senator Jack Hill (R), legislators had $80 million in discretionary spending to allocate, an increase over last year forced by increasing education and health care program costs. In the new budget, more students would be eligible for low-interest loans. The loans are meant to replace a statewide scholarship–the HOPE scholarship–that was cut in the 2012 budget. While the HOPE scholarship once provided full in-state tuition to students, it now provides a lower amount. The low-interest loans are intended to cover the difference in full tuition costs for awardees. The budget already passed the House earlier this month. More here…

Missouri House budget proposal comes with no higher education costs
Legislators in the Missouri House this week approved a $24 billion state budget for fiscal year 2013 – a $1 billion increase over fiscal year 2012. Most of that “additional money” came from budgeting changes that more accurately reflect expenditures. State revenue decreased by $500 million, primarily because of the loss of federal stimulus funds and Medicare reimbursements. To avoid raising taxes, lawmakers made cuts to other programs, including health care spending. However, the budget maintained the same level of funding for higher education. Governor Nixon’s proposal initially included a 15 percent decrease to the state’s public universities, but he later amended the plan by using revenue from a national settlement with mortgage companies to avoid the cuts. The House also cut welfare benefits to avoid any reductions in higher education funds from fiscal year 2012 levels. More here…

More funding proposed for Mississippi public schools in separate plans
The Mississippi House and Senate have not yet come together on a fiscal year 2013 budget proposal, but each chamber’s plan includes an increase in public K-12 schools funding over current year levels. The Senate bill prioritizes debt payments, whereas the House bill prioritizes additional funding for mental health programs.  Some House members unsuccessfully attempted to insert an additional $29 million for K-12 education. The chambers are expected to be in negotiations for a final version of the budget by late April  The final budget will likely total about $5.6 billion (excluding federal funding). The state fiscal year begins July 1. More here…

New Mexico estimates 2 percent increase in key funding factor for public schools next year
New Mexico’s Public Education Department said that one aspect of the state’s school funding formula will increase this year for the first time in three years, providing additional per-pupil state aid. The state determines funding for schools by multiplying a set dollar amount, called the unit value, by the number of students per school. The funding formula allocates a percentage of the unit value to each student depending on his grade level. The dollar amount will be increased by 2 percent to $3,668 for the 2013 school year. Most districts will benefit from this change, although districts with high rates of growth in student enrollment will benefit more than other districts. In all, the school funding budget will total about $2 billion. More here…

Fair-Value Accounting Shows Switch to Guaranteed Student Loans Costs $102 Billion

March 23, 2012

This week the Republican majority on the House Budget Committee released a fiscal year 2013 budget resolution. For the second year in a row, the document includes a so-called “fair value” rule that applies to cost estimates for federal loan programs—including student loans. While the rule went largely unnoticed last year (except by us here at Ed Money Watch), this year it has attracted a bit more attention. And with any budget rule, added attention begets added confusion.

Many have mischaracterized fair-value accounting as a Republican gambit to reinstate some version of a guaranteed student loan program and replace the 100 percent direct lending model in place since 2010. If that is in fact the intent, Republican lawmakers are terribly confused because reinstating the guaranteed loan program in place of direct lending would cost $102 billion over a ten-year budget window according to fair-value estimates.

The math on this is simple. A 2010 Congressional Budget Office (CBO) study compared the two loan programs under fair-value accounting and found that the typical direct loan costs the government about $12 for every $100 lent, but the same loan made through the guaranteed program (under the Federal Family Education Loan [FFEL] program that existed in 2010) costs $20 for every $100 lent. Multiply the higher cost for guaranteed loans by the $128 billion in loans that will be issued annually over the next 10 years and you get an added cost of $102 billion. That means if Congress adopted fair-value accounting and then proposed a bill to reinstate guaranteed student loans, they would need to find $102 billion in spending cuts or tax hikes to make the switch budget neutral.

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Guaranteed lending costs more than direct lending even under fair-value accounting because guaranteed lending subsidized both borrowers and private lenders. Direct lending subsidizes just the borrower because the government does not need to guarantee interest payments to private lenders or pay a complicated array of fees to guarantee agencies.

Is the fair-value movement really just about better, more honest accounting then? Mostly, yes. But it would also remove the budgetary incentive that Congress has under the current rules to expand subsidized loan programs. Under current rules, loans appear profitable even when they provide valuable subsidies to borrowers (and lenders). As a result, when lawmakers expand loan programs, it looks like they have simultaneously reduced spending. Generally, fair-value accounting reveals that government loan programs impose a cost on taxpayers when they subsidize borrowers (and lenders).

The difference arises because official rules value government loans as if the estimated performance of the loan (repayment rate, defaults, recovery rates, delinquencies, deferments, etc.) is certain to occur as projected. In contrast, fair-value accounting uses the exact same estimates of loan performance as the current rules (repayment rate, defaults, recovery rates, delinquencies, deferments, etc.), but it assumes that the estimated performance is not certain and that taxpayers bear a cost for assuming the risk that the loans will cost more than expected. The CBO explains that this is “market risk,” which is the risk that defaults will be higher and more costly in times of economic stress and that the federal government bears it when making loans just as any private lender would.

The Obama Administration’s proposal to revamp and expand the Perkins Loan program is a good example of the policymaking and political implications of fair-value accounting. The president’s proposal would turn the existing Perkins Loan program into one that allows some students to take out additional Unsubsidized Stafford loans—the most widely available federal student loans. Current accounting rules show that the proposal would generate a profit for the government—more lending at profitable terms means more profits. Fair-value accounting, on the other hand, shows the proposal would increase federal spending—more lending at subsidized terms means additional spending.

The table below, based on a 2011 CBO estimate of the Perkins Loan proposal included in the president’s fiscal year 2012 budget, compares the costs of the proposal under current rules and fair-value accounting.

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Private companies that used to be the primary lenders under the old guaranteed loan program (Sallie Mae, et al) do not favor fair-value accounting because it gives them a shot at returning to the days of politically negotiated subsidies and rent seeking under the old guaranteed loan program. They support it because it shows that if Congress expands the federal student loan program or creates an entirely new one—such as the president’s Perkins Loan proposal—it imposes a cost on taxpayers. That makes such proposals unlikely to pass given today’s record budget deficits. Private student loan companies have a better chance, then, of preserving the small slice of the student loan market they currently occupy.

Lastly, there is the matter of loan sales. For years, student loan companies lobbied Congress to sell off the direct loan portfolio. Even last year, investment banks were pitching a similar (albeit nonsensical) idea to Congress as a phony way to reduce government debt. Current accounting rules show that selling the loans, even at market prices, would present a cost to the government, making a loan sale proposal a nonstarter. Fair-value accounting, on the other hand, would theoretically show that a loan sale is budget neutral. That is, the loans are worth what someone is willing to pay for them so selling them leaves the government in the exact same financial position had it kept them.

It’s possible that student loan companies see a move to fair-value accounting as a way to convince lawmakers to sell the government’s direct student loan portfolio. But it’s hard to imagine something like this coming to fruition. Even so, many ill-informed members of Congress think that selling the direct loan portfolio somehow reduces the government’s costs. Again, such a transaction, at fair-value prices, offers no financial gain to taxpayers.

There is no doubt that fair-value accounting would make it harder for Congress to expand student loan programs, be they guaranteed or direct lending programs. And that may well be the primary motive of some who support the accounting rule, just as those who oppose fair-value accounting tend to do so only because it ends the “free lunch” of providing subsidies while earning apparent profits. But setting political motivations aside, fair-value accounting is the most comprehensive and meaningful way to measure what taxpayers are being asked to give up when the government uses their money to make student loans. Whatever policy outcome it favors shouldn’t be a factor in whether to adopt it.

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