Next Move for Democrats on Student Loans

Senator Elizabeth Warren’s proposal to offer borrowers lower interest rates on their existing student loans died in the Senate yesterday after it failed to pick up enough Republican support.  The bill includes a tax increase on high-income households, ensuring that the Republican-controlled House would have ignored it even if it had passed the Senate.

The bill was little more than a “glorified talking point” and a poorly designed policy to boot.  Reducing rates on existing federal loans carried an estimated price tag of $63 billion, which would likely have gone disproportionately to more affluent households.  And borrowers of federal loans are already protected from unaffordable monthly payments by various programs that allow them to make payments based on their incomes.  The bill, despite being titled the “Bank on Students Emergency Loan Refinancing Act,” would have mostly covered non-emergencies.

Where do President Obama and Congressional Democrats go from here?  They could drop the legislative effort and make their case to voters, although it’s not clear that they would change the votes of enough borrowers to make a difference in the fall elections.  Alternatively, they could seize upon a piece of the Warren bill that actually might help struggling borrowers, and not require any tax increases to do so: allowing some borrowers to convert their private student loans into federal loans.

In addition to its provisions for federal loans, Warren’s proposal would also allow borrowers of private student loans to convert those loans into federal loans at lower interest rates, and gain access to the protections of the federal program, including income-based repayment.  This is critically important, as private loan borrowers struggling to make their payments have little recourse to prevent themselves from falling behind and defaulting on their loans.  They are not currently eligible for any of the several income-based repayment programs available to borrowers of federal loans.  Even declaring bankruptcy is unlikely to help them escape their education debt.

Among all borrowers, those with private debt are the most likely to face genuine emergencies due to the lack of safety nets.  Relief in the form of a lower interest rate would pale in comparison to the ability to choose affordable monthly payments.  But Warren’s proposal would only include private borrowers who are in good standing on their loans.  A truly progressive plan would include those who need help the most, many of whom may already have fallen behind on their payments.

Such legislation would have to be carefully designed to eliminate the problematic aspects of the Warren bill.  Many private loans are used to finance expensive degrees in fields such as business and law that lead to lucrative jobs.  A universal policy that included interest-rate reductions could be highly regressive, so it would be crucial to impose strict income limits on who can participate, with the goal of targeting struggling borrowers.  The current proposal is too vague in that it imposes limits in theory but does not specify what they will be.

Without a tax increase, how will this generous new benefit be paid for?  Miraculously, it will pay for itself due to the arcane accounting rules that Congress has imposed on federal credit programs.  By law, the Congressional Budget Office (CBO) cannot factor certain types of risk into the cost of these programs—risk that has a very real cost in the private market but magically vanishes in the government’s accounting.  For example, the CBO analysis of the Warren proposal estimates that the government can take on half of the existing balance of private student loan debt in the country, reduce interest rates, and still book a profit of $5 billion.

A method of accounting that could produce this result is ludicrous, but it is the law of the land until Congress says otherwise.  Democrats could take advantage of this loophole to present Republicans (and voters) with a choice: help struggling borrowers at no cost to taxpayers, or do nothing and let these borrowers default on their loans.  Republicans might argue that this is an accounting trick that obfuscates real costs to taxpayers.  That’s surely true, but if the Democrats got the details right they just might be able to pull off good policy and clever politics at the same time.