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The student loan fiasco

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Last night the Senate passed a bill to re-set student loan rates. The House is expected to accept this “compromise” measure (compromise being a term of art meaning “a GOP-backed measure acceptable to the Obama administration”).

The new deal essentially jacks up student loan rates drastically going forward, but disguises this with what Elizabeth Warren analogizes to an initial credit card teaser rate.

Here’s how it works. Each year, student loan rates will be determined by the following formula:

Subsidized Staffords will be set at the previous year’s 10-year T-bill yield plus 2.05%. (These are the loans that undergraduates can get for the first few thousand of education costs in a particular year).

Unsubsidized Staffords will be at the 10-year rate plus 3.6%. Grad Plus and Parent Plus will be at the 10-year rate plus 4.6%.

Now because treasury yields were at a post-WWII low last year, this formula actually reduces student loan rates slightly for next year. But it raises them, drastically, going forward, assuming (as the CBO projects they will) interest rates will rise toward anything even remotely close to their historical averages.

For example, graduate and professional students would see their loan rates increase above the current 6.8% (Stafford) and 7.9% (Grad PLUS) rates if the yield on the T-bill were to be at the lowest annual rate it hit in any year between 1962 and 2011. If interest rates climb anywhere close to historical averages, the Stafford and Grad PLUS rates will climb to 9.5% and 10.5% respectively, where they’re capped by the bill.

For undergraduates, subsidized Staffords are capped by the bill at a mere 8.25%, but they would hit this astonishing rate even before interest rates got to their 50-year historical average.

In effect, this bill treats federal student lending, even more than it is now, as a multi-billion dollar per year arbitrage opportunity for the government (unlike almost all other debt, student loans aren’t dischargeable in bankruptcy). This is especially true for graduate and professional students, who by 2015 are projected by the CBO to be paying even higher rates than they currently pay. (How does $200,000 in debt at 10% paid back over 25 years sound? If CBO projections regarding interest rates prove correct, that’s what the average law graduate who matriculates four years from now will be taking on).

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