Variable interest massive student debt problem

Jul 29, 2013 by

Future college students may need to monitor the bond market almost as closely as they watch their grade-point averages.

Under a bill passed by the Senate on Wednesday, future interest rates on student loans will rise and fall with the yield on 10-year Treasury notes. That yield is close to historic lows and is likely to move higher.

That doesn’t mean students got a raw deal. The rate on subsidized Stafford loans was due to jump from 3.4 percent to 6.8 percent without the bill. Now, assuming that the House goes along, the rate will drop to 3.86 percent for subsidized and unsubsidized undergraduate loans made this fall. That rate is good for the life of the loan, and future undergrad loans are capped at 8.25 percent.

Watching the bond market may actually be easier than trying to guess what Congress might do next. The old fixed rates had to be renewed periodically and were always an inviting target for deficit hawks.

“I think the philosophy behind the bill is a good one,” says Richard Vedder, an Ohio University economics professor who has written extensively about higher-education issues. “This is a way of aligning the government’s costs with the needs of students, and students should have to share in real-world economic realities.”

Opponents of the bill seized on a Congressional Budget Office projection that the measure would shrink the federal deficit by $710 million over 10 years. That amounts to balancing the budget on the backs of poor students, the critics said.

Predicting interest rates five to 10 years from now is a dicey business, though. The CBO’s projections for this year and next should be much more reliable — and the bill increases the deficit by $8.1 billion in 2013 and $12.7 billion in 2014. That’s more subsidy to students, not less.

In a sense, however, Congress did students a disservice by focusing so narrowly on interest rates. We should be more concerned about the size of the debt students are amassing than about the cost of servicing it.

According to the Project on Student Debt, two-thirds of the Class of 2011 graduated with loans, and the average debt was $26,600. The debt figure has climbed steadily along with tuition costs.

Vedder says the easy availability of federal loans — along with tax breaks and other forms of assistance — has been a major driver of tuition increases. When the government puts more money in students’ hands, colleges see a signal to raise prices.

“The student loan program has had disastrous unintended consequences that no one foresaw when we created the program,” he says. “I’d like to put less emphasis on the interest rate and more emphasis on the cost issue.”

In Warrensburg, Mo., last week, President Barack Obama also expressed concern about an “undisciplined system” that has let college costs spiral out of control. He vowed to “shake the trees” for ideas to lower tuition costs.

Vedder has a couple of suggestions: He would cut off loans at colleges that get too expensive, using the government’s clout to hold down tuition increases. And he would make colleges share in the default risk, which would penalize institutions with low graduation rates.

As Obama said in his Missouri speech, “there’s never going to be enough money” if college costs keep rising. The Senate may have passed a student-loan bill, but it hasn’t begun to deal with the real student debt problem.

Interest rate bill only scratches the surface of student debt problem : Business.

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