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About the Student Loan Forgiveness Price Tag...

posted by Adam Levitin

Senator Warren's student loan forgiveness proposal has a lot of scolds moaning about the immorality of debt forgiveness, the unfairness to those who paid their debts, and complaining about the price tag. It's pretty obvious that none of those folks know anything about how the federal student loan system works. If they did, they'd know the we crossed the debt forgiveness Rubicon long, long ago. There is already enormous debt forgiveness baked into the federal student loan program.

The only real difference between Senator Warren's proposal and the existing forgiveness feature in the student loan program is whether the forgiveness comes in a fell swoop or is dribbled out over time. Given the federal government's infinite time horizon, the difference is really just an accounting matter. It's not a matter of principle in any way, shape, or form.  

Most student loans are federal student loans and are under existing law eligible for substantial loan forgiveness.  My Georgetown colleague Jake Brooks has explained in a terrific paper about why education costs keep rising:

By 2018, 90% of all student lending is directly from the federal government, and all of those loans (and most earlier loans) can, using one of the [Income-Driven Repayment] programs, be paid back on an income-contingent basis, typically as 10% of discretionary income for 20 years, followed by forgiveness of the remaining loan balance.

Put another way, instead of having a front-end ability-to-repay requirement for student loans, we have it on the back-end with income-driven repayment and debt forgiveness. Debt forgiveness is already a fundamental feature of the federal student loan system. The real question is why all federal student loan borrowers aren't in Income-Driven Repayment programs and benefitting from loan forgiveness. Borrowers ought to be placed in IDR by default, but that would require ED having automatic access to their tax returns, which it doesn't. This strikes me as a very easy fix --make tax return sharing a condition of obtaining a student loan and then have IDR be the default setting.

Now you might ask what's the benefit from an immediate debt forgiveness, rather than a delayed one.  The answer, I think, is psychological. Consumers feel weighed down by the stock of their debt, even if they won't actually have to repay a large chunk of it.  Immediate debt forgiveness removes this notional stone from consumers' necks.  

In any case, I don't know an easy way to calculate the total potential forgiveness amount under the current system if everyone did take advantage of IDR.  Maybe it's as simple as considering all federal student loan debt potentially forgivable.  In any case, even adjusting it to reflect the 20 years of IDR payments, I suspect it isn't so different from the price tag of Senator Warren's proposal.  If all we're quibbling about is the size and the timing of debt forgiveness, however, that seems a very different debate than the uninformed sanctimoniousness of critics who aren't aware that we're already in a world with a lot of potential debt forgiveness.  

Comments

Under the various income-based repayment plans, aren't a lot of borrowers making payments that result in negative or at best minimal amortization? If so, from ED's standpoint, the difference between forgiveness now and forgiveness later is obvious. It's the extraction of a couple decades of interest on loan balances that the borrowers have no hope of repaying. Indeed, with enough deferments and forbearances, and worse yet a reinstatement after back fees and interest are capitalized, many borrowers end up paying more in interest, even under IDR, than the original loan balance. Focusing on whether there is a difference in the amount forgiven, if by that you mean the principal forgiven, seems to miss the point.

FJP is right that there can be a sweatbox like quality to Direct Loans if there isn't positive amortization. But I think my basic point still stands--ED is already going to be forgiving a lot of debt in many cases. Interest collections offset some of that, but principal vs. interest is again an accounting matter. The only question here seems to be how much more forgiveness.

I still have student loan debt and would qualify under Elizabeth Warren's plan. And while I wouldn't mind not paying back that debt, I have no issue (financial or otherwise) doing so.

Isn't an important difference between IDR and Warren's plan is that Warren's plan is more expansive and that it would grant relief to people who, like myself, don't particularly need it?

There shouldn't be any justification in this era for what is ostensibly a mortgage at 18 years old for an education.

Colleges and banks have zero skin in education, all risk is assumed by borrowers. Colleges have no duty about outcomes, let alone whether a student graduates. We also know Congress won't add it to bankruptcy outright, so they're siding with school (no surprise).

It is a scam, and the employment rates with a degree point this out glaringly (FRED LNS11327662).

If amortization is sufficiently negative, DoEd is the one who bears most of the burden.

For a debtor whose repayment rate is less than the interest rate minus the rate of inflation, the DoEd absorbs a future economic loss that is greater from the standpoint of financial accounting than an immediate discharge. For my calculations I assumed 2% inflation rate.

I did a time value adjusted analysis and found that on a $250k debt with $0 monthly rate of repayment, the DoEd loses $650k in 2019 dollars in the future discharge in 25 years (GradPlus consolidation repayment term). Whereas they only lose $250k in 2019 dollars with immediate discharge.

$0 a month repayment is an extreme hardship case. I think that’s someone stick under 150% of the federal poverty line.

So the question becomes, assuming minimum payments under IBR, what income does a debtor of $250k need to be expected to make for recognition of the debt not to impose an economic loss. The answer is around $60k.

Basically, with sufficient negative amortization, DoEd is the one losing money because they’ll eat the growing debt. Eventually these automatic end of repayment period discharged will choke up their whole budget.

Therefore in high negative amortization cases (debts where repayment rate is never expected to surpass interest minus inflation), it’s critical to the survival of DoEd that they discharge these ASAP.

I also want to add that I believe Mr. Bruckner is right.

The base $50k forgiveness Warren proposes would probably be a steroid shot into the economy. Moreover, I think it would free graduates up to pursue their core competencies rather than the biggest paychecks (which may be at low utility jobs). It would probably free up urban rent and revitalize suburbs and rural America as I think young people are partly overcrowded in cities because cities are the only place to find wages that repay student loans.

But in terms of addressing the “bad debt” problem, it would make more sense to forgive on a sliding scale: 90% of the top 10% of debts, 60% of the top 40%, 40% of the top 60%, and so on or whatever model realistically accounts for which debts are non-collectible. There’s not NECESSARILY a problem if that favors lawyers. Only half of people with law degrees practice law. Surpluses of people in overpaid professions will bring salaries down and therefore the loan forgiveness becomes a consumer cost-savingsubsidy on law, medicine, and STEM.

The big thing you’d need with such a system is a return to sensible borrowing caps. I’d set borrowing caps at something like 25% greater than the 10 year inflation adjusted average for degree holders of the type of degree sought. Maybe offer reduced interest rate and per semester incentive stipend (roughly set at the cost of textbooks) for debtors who maintain a lower than average rate. In general that would mean that programs would attempt to constrain themselves to closer to the average.

Beyond that, I think a cost driver at universities is the rivalry in marketing, recruiting, admissions, and amenities expenses. To the greatest extent possible, I think states should eliminate separate admissions, marketing, sports, and amenities budgets and programs. A centralized admissions and marketing department for all public universities would combat recruitment arms races. In turn, sports and amenities budgets could be apportioned by an index of academic performance, graduation rates, and graduate incomes.

> I did a time value adjusted analysis and found that on a $250k debt with $0 monthly rate of repayment, the DoEd loses $650k in 2019 dollars in the future discharge in 25 years (GradPlus consolidation repayment term). Whereas they only lose $250k in 2019 dollars with immediate discharge.

I think you've confused yourself with the math. The most you can lose on a $250k loan is $250k (in present dollars), regardless of when you get paid back zero. If you let the loan amortize for 25 years before admitting it's bad, then the balance will be much higher, but that's not an economic loss. You recognize a gain every year from the above-market interest, and then at the end you give it all back, netting to zero.

Also, inflation shouldn't matter, assuming the government (mostly) funds itself with nominal debt, and the student loan is nominal debt too. The calculation should be loan rate minus Treasury rate, not loan rate minus inflation. That doesn't change the result much in practice.

There's certainly an argument for writing off bad debt sooner rather than later, to avoid the wasted effort and human misery trying pointlessly to collect it. I agree that Warren's proposal doesn't seem terribly specific to that, though. Extended income-based repayment seems fairer and more efficient to me.

@LTK, if by "extended income-based repayment" you mean continuing the negative (or minimal) amortization sweatbox over a longer period of time, how is that fairer? Patrick's zero payment case is an extreme one. Most borrowers with above-poverty, but modest, incomes will pay something. Most retirees who have income beyond Social Security will have to pay something. But at higher debt levels, many IBR borrowers are just on a treadmill. Their hope of paying off the principal in their natural lives, or at least paying very much of it, are minimal. It only takes a few forbearances (due to job loss or whatever) or one episode of default and reinstatement (with back interest and 15% collection fees capitalized), for a borrower to owe lots more than they originally borrowed. Add in negative am under IBR and many borrowers will never catch up.

At some point, "extended income based repayment" starts to look like we're basically just saying that the cost of an education is a pledge of a percentage of your future income to the government. Yes, I know there are people who are advocating exactly that, calling it an "income share agreement." Great, if you like the idea of reintroducing indentured servitude.

@FJP By "extended", I mean "benefiting more people" (enrolling a greater share of eligible borrowers, defining discretionary income more favorably to the borrower, etc.), not "over a longer time".

The problems that you note seem like problems of framing to me. For a borrower who expects payments to conclude after 20/25 years vs. when the balance reaches zero, the balance of the loan is irrelevant. I agree with Adam that automatic enrollment in an income-based repayment plan would be a positive step, perhaps coupled with loan statements that showed the "balance to zero" and "income-based period expires" payment schedules with equal prominence.

The loan then becomes an income-share agreement with option to pay early, which seems fine to me--I don't see what's more "indentured" about paying back in proportion to your ability and (arguably) what you gained financially from the education than paying back a fixed dollar amount. The interest rate and balance are relevant only to the extent they determine whether you choose to pay early vs. letting the income-based period expire.

That's a nontrivial change to the current system. For example, the income-based payment amount or term would have to vary with the amount initially borrowed, to reward income-based repayers for not borrowing the absolute maximum they can. That difference in framing--of income-based repayment as an option that you should choose according to your self-interest vs. as a failure--seems like a big improvement to me, though.

Testing

There is a fundamental craziness in the idea that the Department of Education should not lose money. Any monies that the DOE collects in principal or interest come right out of our citizens' pockets.
In accounting terms, the assets of government are liabilities of individuals.

College should be funded by grants. No grants would be repaid. Taxes would go up to pay for the grants.
The whole process would be on-budget.

This is essentially what Germany and Norway do.

Of course no one ever got rich from servicing a grant. This would take out some Republican cronies.

If a grant recipient drops out of college before finishing -- and this will always happen for some -- then society will have lost money. So what?

Finally, debt forgiveness tends to pay for itself in the long run. The increase in prosperity brings in more taxes than draconian collections ever would. Compare Germany after World War II versus Germany after World War I.

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