January 28, 2008

Forbes analyzes the 2 different federal loan programs

Posted in Student Loan News at 3:15 PM by Joe From Boston


Let’s just say the government’s numbers are optimistic at best.  Forbes analyzes the 2 loan programs, FFELP and Direct, and also analyzes the government’s analysis.  Read the entire article here.  Here’s an excerpt:

“For more than a decade the federal government has played a game with student loans. The budget estimators pretend the loans cost taxpayers little or nothing as the money goes out the door, then make an “upward reestimate” to reflect the true cost. It’s sort of like budgeting nothing for a war and then throwing in an emergency appropriation later.

The government’s accountants define the cost of a student loan as the cash going out minus the projected repayments, the repayments being discounted using a complicated blend of rates on U.S. Treasury securities. In recent years direct federal loans, of which $100 billion are now outstanding, have been magically profitable on issuance. Interest charged is expected to more than cover interest costs plus losses from deadbeats. But watch those revisions, which since the
direct loan program was started in 1994 have increased the cost from a mere $400 million to $11 billion.

Brace for the mother of all revisions. A combination of congressional budget cuts and turmoil in the credit markets is driving many private lenders out of the indirect student loan business, where Uncle Sam protects lenders against defaults and pays them a subsidy to make up for below-market loan rates. This one-two punch will force millions of students into the government’s direct program. Indirect loans outstanding (via lenders like Citigroup and SLM Corp., alias Sallie Mae) come to $344 billion. New lending this year, direct and indirect combined, will be $110 billion.

Last year private lenders issued $79 billion in loans. Some of that traffic was tainted by underhanded tactics such as paying colleges for steering business. But many financial-aid administrators also say private lenders do a better job than the government at processing loan applications and handling collections. Wilma Hjellum of 20,000-student Illinois Central College in East Peoria says she’d have to add several people to her staff if she switched to the direct-loan
program.

Fans of direct lending like Senator Edward Kennedy have pointed to budget estimates that indirect loans were costing the government a lot, $13 per $100 lent. The direct-loan program, in contrast, appeared to make money with every new loan it issued.

Yet such numbers relied on accounting that would make an Enron executive blush. The government ignores administrative costs–around $708 million in the fiscal year ended Oct. 31, 2007–and makes unrealistic assumptions about interest rates, says Deborah Lucas, a finance professor at Northwestern University. (Even if market interest rates shoot up, today’s borrowers will owe only 6.8% and can stretch repayments out over 30 years.) Another little problem: The government assumes a 12.4% default rate over the life of a direct loan, which computes to an
annualized cost of 1.6%. That number looks sound now but will shoot up if there’s a recession, she says. “

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