Federal Student Loan Rates Double Due To Lack Of Urgency In Congress

student loans

Due to the incompetence and lack of urgency in Congress the interest rate on subsidized Stafford Loans doubled on July 1st from 3.4 percent to 6.8 percent. Stafford Loans are given to students who lack the financial capacity to fund their own education. Starting in 2007 Senator Edward Kennedy and Senator George Miller wrote the Cost Reduction and Access Act which reduced subsidized loans from 6.8 percent to 3.4 percent over the course of four years. The rates were set to expire in 2011, but due to a compromise the limit was extended to 2012. Last year both Republicans and Democrats reached an agreement to extend the lowered rates into 2013. The rates were set to double unless Congress intervened to extend the lowered rates which it didn’t do.

Subsidized Stafford loans account for one-third of government aid to college students. The federal government pays for the interest of these loans while the student is still in school. Congress can retroactively lower the rates before the school year starts when they come back from their Independence Day vacation. If the interest rates stay at 6.8 percent the student borrower will end up paying 2,600 dollars more on their loans.

There are various plans swirling around Washington regarding how to deal with the interest rates for subsidized student loans. According to the Brookings Institute:

  1. Obama administration proposal: interest rate varies with market rates (10-year Treasury rate plus 0.93% for subsidized loans and 2.93% for unsubsidized loans) but is fixed for the life of the loan. There is no cap on interest rates.
  2. House Republican proposal: interest rate varies with market rates (10-year Treasury plus 2.5% for subsidized and unsubsidized loans) and varies over the life of the loan (as the Treasury rate increases or decreases). Interest rates are capped at 8.5%.
  3. Sens. Reed and Durbin proposal: same as House Republican proposal, except market rate is defined as the 91-day Treasury rate plus a percentage determined by the Education Secretary to cover administrative costs, and the cap is 6.8%.

There is a fourth proposal which hasn’t really gained any traction in Washington. Senator Elizabeth Warren’s proposal, Bank on Students Loan Fairness Act, has been widely dismissed by the Washington intelligentsia. Senator Warren proposed that the loans given to students should be pegged at the same interest rates the Federal Reserve distributes to banks. Brookings Institute said:

“Sen. Warren’s proposal should be quickly dismissed as a cheap political gimmick. It proposes only a one-year change to the rate on one kind of federal student loan, confuses market interest rates on long-term loans (such as the 10-year Treasury rate) with the Federal Reserve’s Discount Window (used to make short-term loans to banks), and does not reflect the administrative costs and default risk that increase the costs of the federal student loan program.”

However, Warren’s plan raises an interesting debate. The Federal Reserve has the ability to expand its balance sheet because it is regarded as the lender of last resort. The Quantitative Easing program purchased over 1 trillion dollars in “toxic” mortgages and allegedly reported a profit. The Federal Reserve could easily purchase student loan debt and refinance these loans at .75 percent. Introducing her bill Warren said:

“Right now, a big bank can get a loan through the Federal Reserve discount window at a rate of about three quarters of one percent. But this summer a student who is trying to get a loan to go to college will pay almost 7 percent. In other words, the federal government is going to charge students interest rates nine times higher than the rates they charge the biggest banks – the same banks that destroyed millions of jobs and nearly broke the economy. That isn’t right.”

The sole reason banks are able to receive loans from the federal reserve at such a low rate is because they are considered a good credit risk. Students are considered “riskier” investments because there are no assets against which the debt can be collected. However, it is important to understand that the reasons why the banks are considered better investments are because these banks are backed by the Federal Reserve and the federal government. The federal government doesn’t back students the same way they back the largest banks in the country. All of this ties into the notion of “too big to fail” and massive amounts of Wall Street money pouring into Washington. Corporate greed and corruption allows banks and large investment firms to be propped up by the federal government while “Main Street” students drown in debt and face ever increasing burdens on their financial life.

Default rates of student’s loans are exceeding 13 percent due to the lack of jobs or underemployment from recent graduates. 30 percent of student borrowers are delinquent on their loans missing payments for at least 30 days. Since 2008 students have been facing budgets cuts at state universities as the rate of tuition ballooned 27 percent. Students are being treated as second class priorities in Washington. Maintaining the interest rate at 3.4 percent is a good place to start, but Senator Warren’s proposal has a lot more to offer than being simply considered as “political demagoguery.”

Countries like Denmark, Sweden, France, Finland, New Zealand and Australia have considered education to be an investment in the future. Each of these countries places their students in a position to succeed after college. According to a report by the New York Federal Reserve, students graduating in American are less likely to purchase automobiles and houses due to the burden placed on them by student loans.

The student loan debate is considerably complicated. However, the plans proposed by President Obama, House Republicans and some Senate Democrats only exacerbate the problem. These proposals only cater to mainstream conventional thinking. Senator Warren’s proposal is out of the box and encourages investments in student without placing such a burden on the borrower. Warren’s proposal should be considered in its entirety with as much credibility as the aforementioned proposals. It is about time America reinvests in students higher education not only in rhetoric, but in practice.