The smart way to lift the student-debt burden

Many Americans are struggling with student debt and need a lifeline – but not from the government, which caused much of the mess in the first place. The answer is a new private-sector plan that would slash the outrageously high federal interest rates.

Students and their parents owe $1.44 trillion, borrowed to finance college and university costs, according to the Federal Reserve. That’s an increase of one-third in just four years. By comparison, Americans owe $1.2 trillion in auto loans and $800 billion in credit-card debt.

{mosads}What makes the figures all the more troubling is that the vast majority of debt is issued by the federal government itself. The U.S. Department of Education has, in effect, become one of the largest banks in the world. Judging from the results of the last election, I would say that role just doesn’t fit the values of most Americans. 

Most student debt is held in what are called William D. Ford Federal Direct Loans, and, according to the U.S. Government Accountability Office, “Almost 20 percent of Direct Loan borrowers were delinquent on their loan payments at the end of 2015, and more than a million borrowers defaulted on their loans over the 2015 fiscal year.”

One big reason is that students and their families are being crushed by interest rates that far exceed market levels. At a time when most rates are close to all-time lows and a 10-year U.S. Treasury bond is yielding just 2.2 percent, the rates on Direct loans for the upcoming school year issued currently range from 4.45 percent for undergraduates, 6 percent for graduates, and 7 percent for parents, according to the Department of Education.

But those rates are mild compared with interest being paid by students and families who have already borrowed. The types of federal loan programs are bewildering, but, let me cite a few examples from the Education Department. The Stafford loans issued to most of the undergraduate and graduates students between 2006 and 2013 are charging 6.8 percent interest, and the PLUS loans to parents and graduate students at higher-cost schools issued during this same period are charging either 7.9 percent or 8.5 percent.

Most borrowers in the federal student-loan program are locked into high fixed interest rates. The only practical alternative currently is something called the Federal Direct Consolidation Loan program. But borrowers can lose many of the benefits of standard federal loans. An even bigger deficiency is that the program does not reduce interest rates – and can actually raise them. According to an Education Department primer: “A Direct Consolidation Loan has a fixed interest rate for the life of the loan. The fixed rate is the weighted average of the interest rates on the loans being consolidated, rounded up to the nearest one-eighth of one percent.” 

Under consolidation, a loan’s payoff date can be extended, lowering the monthly payment, but having a debt burden for longer won’t make most students or families feel better.

There is another way. Under a plan that’s the subject of legislation recently introduced in the U.S. House of Representatives by Reps. Todd Rokita (R-Ind.) and Alcee Hastings (D-Fla.), parents and students could consolidate their loans with private debt at a rate that cannot exceed one-month LIBOR (currently 1 percent) plus 3.5 percent. The rate would float, but if it ever exceeded 6.875 percent, then the borrower would have the option to refinance back into a Federal Direct Consolidation loan at that fixed rate. Borrowers would benefit from the rate competition between private lenders who want their business.

The new loans would also offer benefits borrowers currently have, such as special repayment plans, deferment, and forbearance. They would also provide public-service loan forgiveness and an interest-accrual benefit for active-duty service members.

The loans would be protected with a federal guarantee covering the principal on a sliding scale: 97 percent for the first five years, 87 percent for the next five, and 77 percent after that. Private lenders would pay a fee to cover that insurance: an initial 0.5 percent when the loan is disbursed and then an annual 1.05 percent.

Americans simply cannot shoulder the current burden of student debt. The only alternative on the horizon is a bill co-introduced by Sen. Elizabeth Warren (D-Mass) in the Senate and Rep. Joe Courtney (D-Conn.) in the House. That legislation calls for the government to refinance high-interest student loans, but has been consistently blocked in the Senate because of its price tag, estimated at $58 billion.

The last thing America needs is an additional government program to make up for the deficiencies of the current one. There’s a private-sector, bipartisan, and free-market solution out there. Yes, it requires a partial government guarantee, but taxpayers already own 100 percent of the student-loan risk. Under this plan, private lenders would assume an increasing amount of default risk and pay for the insurance on the rest. Society has an appropriate interest in encouraging Americans to complete college, but, innovative solution reduces it instead of enhancing the federal role, we should reduce it.

James K. Glassman, a former Under Secretary of State, recently ended a three-year term as a member of the U.S. Securities and Exchange Commission’s Investor Advisory Committee.

The views expressed by this author are their own and are not the views of The Hill.