<DOC>
[108th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:92613.wais]
FISCAL RESPONSIBILITY AND FEDERAL CONSOLIDATION LOANS: EXAMINING COST
IMPLICATIONS FOR TAXPAYERS, STUDENTS, AND BORROWERS
=======================================================================
HEARING
before the
COMMITTEE ON EDUCATION
AND THE WORKFORCE
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
March 17, 2004
__________
Serial No. 108-48
__________
Printed for the use of the Committee on Education and the Workforce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
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COMMITTEE ON EDUCATION AND THE WORKFORCE
JOHN A. BOEHNER, Ohio, Chairman
Thomas E. Petri, Wisconsin, Vice George Miller, California
Chairman Dale E. Kildee, Michigan
Cass Ballenger, North Carolina Major R. Owens, New York
Peter Hoekstra, Michigan Donald M. Payne, New Jersey
Howard P. ``Buck'' McKeon, Robert E. Andrews, New Jersey
California Lynn C. Woolsey, California
Michael N. Castle, Delaware Ruben Hinojosa, Texas
Sam Johnson, Texas Carolyn McCarthy, New York
James C. Greenwood, Pennsylvania John F. Tierney, Massachusetts
Charlie Norwood, Georgia Ron Kind, Wisconsin
Fred Upton, Michigan Dennis J. Kucinich, Ohio
Vernon J. Ehlers, Michigan David Wu, Oregon
Jim DeMint, South Carolina Rush D. Holt, New Jersey
Johnny Isakson, Georgia Susan A. Davis, California
Judy Biggert, Illinois Betty McCollum, Minnesota
Todd Russell Platts, Pennsylvania Danny K. Davis, Illinois
Patrick J. Tiberi, Ohio Ed Case, Hawaii
Ric Keller, Florida Raul M. Grijalva, Arizona
Tom Osborne, Nebraska Denise L. Majette, Georgia
Joe Wilson, South Carolina Chris Van Hollen, Maryland
Tom Cole, Oklahoma Tim Ryan, Ohio
Jon C. Porter, Nevada Timothy H. Bishop, New York
John Kline, Minnesota
John R. Carter, Texas
Marilyn N. Musgrave, Colorado
Marsha Blackburn, Tennessee
Phil Gingrey, Georgia
Max Burns, Georgia
Paula Nowakowski, Staff Director
John Lawrence, Minority Staff Director
------
C O N T E N T S
----------
Page
Hearing held on March 17, 2004................................... 1
Statement of Members:
Boehner, Hon. John A., Chairman, Committee on Education and
the Workforce.............................................. 2
Prepared statement of.................................... 4
Hoekstra, Hon. Pete, a Representative in Congress from the
State of Michigan, Prepared statement of................... 64
Kildee, Hon. Dale E., a Representative in Congress from the
State of Michigan.......................................... 6
Miller, Hon. George A., Ranking Member, Committee on
Education and the Workforce, Prepared statement of......... 5
Norwood, Hon. Charlie, a Representative in Congress from the
State of Georgia, Prepared statement of.................... 81
Wilson, Hon. Joe, a Representative in Congress from the State
of South Carolina, Prepared statement of................... 78
Statement of Witnesses:
Ashby, Cornelia M., Director, Education, Workforce and Income
Security, U.S. General Accounting Office................... 8
Prepared statement of.................................... 10
Hamlett, Titus, Student, University of Maryland.............. 18
Prepared statement of.................................... 19
Neubig, Dr. Tom S., National Director, Quantitative Economics
and Statistics, Ernst and Young LLP........................ 20
Prepared statement of.................................... 22
Shapiro, Dr. Robert, Chairman, Sonecon, LLP and Senior
Fellow, Brookings Institution and Progressive Policy
Institute.................................................. 48
Prepared statement of.................................... 51
FISCAL RESPONSIBILITY AND FEDERAL CONSOLIDATION LOANS: EXAMINING COST
IMPLICATIONS FOR TAXPAYERS, STUDENTS, AND BORROWERS
----------
Wednesday, March 17, 2004
U.S. House of Representatives
Committee on Education and the Workforce
Washington, DC
----------
The Committee met, pursuant to notice, at 10:35 a.m., in
room 2175, Rayburn House Office Building, Hon. John Boehner
(Chairman of the Committee) presiding.
Present: Representatives Boehner, Miller, Petri, Hoekstra,
McKeon, Castle, Johnson, Greenwood, Biggert, Tiberi, Keller,
Wilson, Porter, Kline, Carter, Burns, Kildee, Andrews, Woolsey,
Tierney, Wu, Holt, Davis, Grijalva, Van Hollen, and Bishop.
Staff present: Kevin Frank, Professional Staff Member;
Sally Lovejoy, Director of Education and Human Resources
Policy; Catharine Meyer, Legislative Assistant; Krisann Pearce,
Deputy Director of Education and Human Resources Policy; Alanna
Porter, Legislative Assistant; Alison Ream, Professional Staff
Member; Deborah Samantar, Committee Clerk/Intern Coordinator;
Kathleen Smith, Professional Staff Member; Jo-Marie St. Martin,
General Counsel; Ellynne Bannon, Minority Legislative
Associate; Tom Kiley, Minority Press Secretary; John Lawrence,
Minority Staff Director; Ricardo Martinez, Minority Legislative
Associate; Alex Nock, Minority Legislative Associate; Joe
Novotny, Minority Legislative Staff; Lynda Theil, Minority
Legislative Associate; and Mark Zuckerman, Minority General
Counsel.
Chairman Boehner. The Committee on Education and the
Workforce will come to order. A quorum being present, the
Committee meets today to hear testimony on ``Fiscal
Responsibility and Federal Consolidation Loans: Examining Cost
Implications for Taxpayers, Students, and Borrowers.''
Under the Committee rules, opening statements are limited
to the Chairman and Ranking Member. If other Members have
statements, we will keep the record open for 14 days to include
those statements and other extraneous material referred to
during today's hearing.
With that, I ask unanimous consent for the record to remain
open.
Without objection, so ordered.
STATEMENT OF HON. JOHN A. BOEHNER, CHAIRMAN, COMMITTEE ON
EDUCATION AND THE WORKFORCE
Good morning to our witnesses and to all of our guests that
are here today. Today's hearing is the latest in our ongoing
series of hearings on the reauthorization of the Higher
Education Act.
We are here today to examine the Federal Consolidation Loan
Program, and how student lending issues fit within our broader
goal of expanding access to higher education for low and middle
income students.
In particular, we have witnesses before us who will help us
understand the cost of consolidation loans--the cost to
taxpayers, the cost to graduates repaying their loans, and most
importantly, the cost to low and middle income students in
college today, or striving to attend college tomorrow.
For the past 2 years, our Committee has been holding these
hearings, meeting with members of the higher education
community, and moving ahead with legislation to meet one
central goal: expanding access to higher education for low-to-
middle-income students who strive to attend a university or
college of their choice.
Our proposals for reauthorization of the Higher Education
Act will reflect that goal, and today's hearing will help shed
light on the role of student loans, and particularly
consolidation loans, in our efforts to ensure that low and
middle income students have access to a higher education.
The Federal Consolidation Loan Program is different than
other student aid programs, because it doesn't provide
subsidies to people who are currently students. Rather, it
provides billions in subsidies to people who are former
students, most of whom I would imagine are graduates who have
realized their dream of a college education and who have
entered the workforce.
The program was created to help college graduates repay
their student debt. Consolidation loans allow borrowers with
multiple loans, held by multiple lenders, to combine their debt
into a single, often lower, monthly payment.
While the program has been largely successful in helping
college graduates repay their debt, changes in how the program
has been used in recent years raise a number of questions about
how the program should operate into the future.
A recent report by the General Accounting Office warned
that, as the program becomes more expensive, Congress needs to
consider alternatives. I believe the implication of this report
is that if we leave the Consolidation Loan Program on
autopilot, the cost could balloon, taking billions of dollars
away from the very low and middle income students that we are
seeking to help.
Chief among the topics we will examine today is the issue
of interest rates.
Unlike other Federal student loan programs, the
Consolidation Loan Program locks borrowers into a fixed
interest rate for the life of the loan. Because interest rates
today are the lowest in the history of the Federal student loan
programs--and I might add, the lowest interest rates we have
seen in this country for 50 years--many graduates are choosing
to consolidate their loans simply to lock in these low interest
rates. Can't say that I blame them.
However, the fundamental premise of the program was
consolidation, not refinancing. This means consolidation loans
were never intended to be a tool to secure low interest rates--
low interest rates where the Federal Government, I might add,
over the next 30 years, will take all of the risk and absorb
all of the additional cost.
When the consolidation program began, interest rates were
considerably higher than they are today.
For example, consolidation loans made before July 1, 1994
had a fixed interest rate that was determined by the weighted
average of the loans being consolidated, rounded to the nearest
whole percent, or 9 percent, whichever was greater. That means
consolidation loans had an interest rate of at least 9 percent.
Compare that to today's 3.42 percent interest rate.
Clearly, when the program began it was never intended to be
a tool to secure low interest rates, yet today's historically
low rates have resulted in unprecedented growth in the number
of consolidation loans, and as a direct result, unprecedented
growth in the Federal subsidy that is not targeted to helping
today's students, as opposed to graduates.
Now, while we are all aware of the budget realities facing
the Congress, with the limited resources, we must establish
priorities, and I believe students should be our first
priority. For that reason, I question whether dramatically
expanding subsidies to non-students and/or graduates is
justified.
The Consolidation Loan Program fulfills an important
purpose as it exists today, and there are reasonable steps
Congress can and should consider to strengthen the program, but
any effort to expand it will likely mean reduced resources for
the low and middle income students whom we all hope to assist.
If we are targeting our limited resources toward a
particular group, I think that group should be students and
those who are attempting to enter a college or university of
their choice.
I am eager to hear from our witnesses and their different
perspectives on the cost of consolidation loans.
In particular, this hearing will help us better understand
how Federal subsidies are being used in the program, and how
the fixed interest rate structure is different from the
variable rate structure used for other Federal student loans,
and the overall impact these issues have on our ability to
assist current and future students.
I would also encourage the witnesses to help shed light on
proposals to change the Consolidation Loan Program. I think
everyone would agree the program has been successful in its
mission to help college graduates repay their loans.
I oppose weakening the Consolidation Loan Program, but I
also oppose isolating it from positive changes at the expense
of low and middle income students.
We should ask whether it would be best to maintain the
program as it exists today, or make changes to the program in
order to address questions about how the program itself has
changed in recent years.
We should ask whether it would be prudent to expand
subsidies to non-students, as some have proposed, bearing in
mind that a massive increase in this program could take
resources away from the very low and middle income students
that the Higher Education Act was created to serve.
I look forward to a detailed discussion on this issue, and
I am hopeful that this hearing will help us find the right
balance as we look to reform the Federal student aid programs
and strengthen the Higher Education Act on behalf of current
and future students.
I now yield to the gentleman from Michigan, our good
friend, Mr. Kildee.
[The prepared statement of Chairman Boehner follows:]
Statement of Hon. John A. Boehner, Chairman, Committee on Education and
the Workforce Committee
Good morning. Today's hearing is the latest in our ongoing series
of hearings on reauthorization of the Higher Education Act. We're here
today to examine the federal Consolidation Loan Program, and how
student lending issues fit within our broader goal of expanding access
to low and middle income students striving for college. In particular,
we have witnesses before us who will help us understand the cost of
consolidation loans-the cost to taxpayers, the cost to graduates
repaying their loans, and most importantly, the cost to low and middle
income students in college today or striving to attend college
tomorrow.
For the past two years, our committee has been holding hearings,
meeting with members of the higher education community, and moving
ahead with legislation to meet one central goal: expanding access to
higher education for low and middle income students who strive for it.
Our proposals for reauthorization of the Higher Education Act will
reflect that goal, and today's hearing will help shed light on the role
of student loans-and particularly consolidation loans-in our efforts to
ensure low and middle income students have access to a higher
education.
The federal Consolidation Loan Program is different than other
student aid programs, because it doesn't provide subsidies to people
who are currently students. Rather, it provides billions in subsidies
to people who are former students--graduates who have realized their
dream of a college education and have entered the workforce.
The program was created to help college graduates repay their
student debt. Consolidation loans allow borrowers with multiple loans-
held by multiple lenders-to combine their debt into a single, often
lower monthly payment. While the program has been largely successful in
helping college graduates repay their debt, changes in how the program
has been used in recent years raise a number of questions about how the
program should operate into the future. A recent report by the General
Accounting Office warned that as the program becomes more expensive,
Congress needs to consider alternatives. I believe the implication of
this report is that if we leave the Consolidation Loan Program on
autopilot, the cost could balloon, taking billions of dollars away from
the very low and middle income students we are seeking to help.
Chief among the topics we will examine today is the issue of
interest rates. Unlike other federal student loan programs, the
Consolidation Loan Program locks borrowers into a fixed interest rate
for the life of the loan. Because interest rates today are the lowest
in the history of the federal student loan programs, many graduates are
choosing to consolidate their loans simply to lock in these low
interest rates. However, the fundamental premise of the program was
consolidation, not refinancing. This means consolidation loans were
never intended to be a tool to secure low interest rates.
When the Consolidation Loan Program began, interest rates were
considerably higher than they are today. For example, consolidation
loans made before July 1, 1994 had a fixed interest rate that was
determined by the weighted average of the loans being consolidated,
rounded to the nearest whole percent, or 9 percent, which ever was
greater. That means consolidation loans had an interest rate of at
least 9 percent. Compare that to today's 3.42 percent interest rate.
Clearly when the program began it was not intended to be a tool to
secure low interest rates. Yet today's historically low interest rates
have resulted in unprecedented growth in the number of consolidation
loans, and as a direct result, unprecedented growth in the federal
subsidy that is not targeted to helping today's students.
We are all aware of the budget realities facing this Congress. With
limited resources, we must establish priorities and I believe students
should be priority number one. Not just one priority of many, but our
first priority. For that reason, I question whether dramatically
expanding subsidies to non-students is justified. The Consolidation
Loan Program fulfills an important purpose as it exists today, and
there are reasonable steps Congress can and should consider to
strengthen the program. But any effort to expand it will likely mean
reduced resources for the low and middle income students we all hope to
assist. If we are targeting our limited resources toward a particular
group, I think that group should be students first and foremost.
I am eager to hear from our witnesses and their different
perspectives on the cost of consolidation loans. In particular, this
hearing will help us better understand how federal subsidies are being
used in the Consolidation Loan Program, how the fixed interest rate
structure is different than the variable rate structure used for other
federal student loans, and the overall impact these issues have on our
ability to assist current and future students.
I would also encourage the witnesses to help shed light on
proposals to change the Consolidation Loan Program. I think everyone
would agree this program has been successful in its mission to help
college graduates repay their loans. I oppose weakening the
Consolidation Loan Program, but I also oppose isolating it from
positive change at the expense of low and middle income students. We
should ask whether it would be best to maintain the program as it
exists today, or make changes to the program in order to address
questions about how the program itself has changed in recent years. We
should ask whether it would be prudent to expand subsidies to non-
students as some have proposed, bearing in mind that a massive
expansion of this program could take resources away from the low and
middle income students the Higher Education Act was created to serve.
I look forward to a detailed discussion on this issue, and I am
hopeful that this hearing will help us find the right balance as we
look to reform the federal student aid programs and strengthen the
Higher Education Act on behalf of current and future students. With
that, I would yield to Mr. Miller for any opening statement he may
have.
______
Mr. Kildee. Thank you, Mr. Chairman, and happy St.
Patrick's Day to you.
Chairman Boehner. Thank you.
Mr. Kildee. I love your tie.
Chairman Boehner. Everyone, a happy St. Patrick's Day.
Mr. Kildee. Mr. Chairman, our colleague, Mr. Miller, has
been temporarily delayed, so I would ask that his opening
statement be submitted for the record.
Chairman Boehner. Without objection.
[The prepared statement of Mr. Miller follows:]
Statement of Hon. George Miller, Ranking Member, Committee on Education
and Workforce
Thank you Mr. Chairman. I am pleased to join you at today's hearing
on student loan consolidation.
I particularly want to welcome Titus Hamlett to the committee
today. I look forward to your testimony and the testimony of the other
witnesses, too.
Higher education has a long tradition of providing opportunities
towards a better life for millions of Americans. Today, the Higher
Education Act is more important than ever to succeeding in the global
marketplace, lifting millions of Americans out of poverty, and keeping
Americans safe in the post-9/11 society.
Despite the need to expand access to an affordable education,
college is fast becoming a pipe dream for too many students. States are
cutting support for higher education and pushing higher tuition prices
onto students and their families.
In addition to budget cuts and rising prices, millions of students
are taking on high debt levels that discourage college attendance and
encourage default--which costs taxpayers billions of dollars.
This year, almost 7 million students will borrow more than $50
billion in federal student loans--accounting for almost 70 percent of
all federal financial aid.
Over the past ten years, student loan debt has nearly doubled to
$17,000 and about one-fifth of full-time working students spend 35 or
more hours per week on the job to cover college costs. At the same
time, student aid is falling further and further behind the cost of a
college education. In fact, last year the maximum Pell Grant was worth
$500 less than the maximum grant in 1975-76.
It is imperative that we return to the original premise of the
Higher Education Act of 1965--that no college qualified student should
be denied a college education because he or she is lacks the financial
resources.
A key tool to ensuring that millions of students can access a
college education is the low-fixed rate benefit of consolidation loans,
which allows students to lock in a low rate and save thousands of
dollars. In addition, borrowers can eliminate the need for dealing with
multiple lenders, extend their repayment period, or enroll in payment
plans based on a percentage of their income when they consolidate their
loans.
As more and more students take on high debt levels it is important
to focus on the financial need of students both as they enter college
and when they leave. For student borrowers, the cost of college does
not impact them until they graduate and begin repayment. This is the
critical time when consolidation can, and does, make repayment
manageable for student borrowers.
The benefits of consolidation are particularly important today, as
graduates face a weakened economy and rising unemployment rates. A
recent study by the Economic Policy Institute (EPI) found that the
long-term unemployment among college-educated workers increased by
nearly 300 percent between 2000 and 2003--almost double the increase of
non-college graduates in the same time period.
In addition, the General Accounting Office (GAO) found that the
average annual income for consolidation borrowers is $47,000 and that
their debt to ratio income is 9.4 percent--just above the 8 percent
industry suggested standard for borrowers in repayment to maintain
financial stability.
A recent analysis by the State PIRGs' Higher Education Project
found that the average borrower with $20,000 in debt would be forced to
pay more than $7,000 in additional interest if the low-fixed
consolidation rate benefit is eliminated.
At a time of rising college costs, high unemployment and little job
growth, we should not be forcing students and their families to pay
more for a college education.
As we reauthorize the Higher Education Act, I look forward to
working with my colleagues on the committee to strengthen loan
consolidation program and to expand college access to low and middle-
income students.
Thank you Mr. Chairman.
______
STATEMENT OF HON. DALE E. KILDEE, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF MICHIGAN
Mr. Kildee. You mentioned that the students are attracted
to consolidating their loans at a fixed rate. Well, they aren't
the only ones in this market right now.
I, for the, I think, third time in 3 years, just refinanced
my home mortgage--at the solicitation of the lender, by the
way. They were afraid I might go someplace else. So I did
reduce it, at a fixed rate also. The economy right now does
attract people toward consolidation or refinancing.
Thank you, Mr. Chairman. I want to join you in welcoming
today's witnesses before this Committee. This is indeed an
important topic which deserves the attention of the Committee
today, and I appreciate the fact that you are having this
hearing.
Everyone in this room would agree that a higher education
is critical to future earning potential and the ability to
provide for your family and your children.
The reality facing most students, however, is high tuition,
and grant aid from the Federal Government and state government
that has lost much of its buying power. Also, student debt now
is at an all-time high.
Our economic policies have lost rather than created jobs,
and worse, outsourced many of our jobs overseas. Students
graduating from college and looking for employment simply can't
catch a break right now.
There are so many people out there who graduated from my
University of Michigan still looking for a job, even with all
the talents they have accrued there at the University of
Michigan.
On top of all this comes today's discussion about changing
the interest rate structure on consolidation loans from a fixed
rate to a variable rate.
Let us be clear. Once we cut through all of the arguments,
one fact is undeniable. This proposal will heap thousands of
dollars in increased interest costs on the backs of students
and recent college graduates.
You will hear a lot today about helping current students,
and that we should be investing in programs which provide
benefits to students who are entering college, and I couldn't
agree with that more. However, financing those up-front
benefits on the backs of those who have consolidated their
loans I do not think is the proper approach.
Cutting benefits from one part of the program to finance
another doesn't increase access. Rather, I believe it short-
changes those who are struggling to find employment in an
economy which isn't even producing enough jobs to keep pace.
If members want to reduce origination fees, and consider
whether we should increase loan limits, we should not be
robbing Peter to pay Paul. Instead, let us get the resources we
need to enact these changes.
The Senate budget resolution includes $5 billion in funding
to address these types of higher education priorities. Our goal
should be to expand our higher education programs, not move
resources around an already paltry pie.
In closing, I want to again stress what this proposal will
mean for students.
A variable rate structure for consolidation loans means
that the average student will face thousands of dollars in
increased interest rate cost. When the Bush administration
proposed this very change just 2 years ago, Mr. Chairman, it
was met with bipartisan opposition because of its impact on
students. I hope today's discussion keeps these points in mind.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Chairman Boehner. Thank you, Mr. Kildee.
It is my pleasure to introduce our witnesses today.
Our first witness will be Ms. Cornelia Ashby. Ms. Ashby has
served in numerous capacities since she joined the U.S. General
Accounting Office in 1973. That is a few years ago, Ms. Ashby.
Currently, Ms. Ashby serves as the Director of Education,
Workforce, and Income Security, directing studies in numerous
areas, including higher education. Prior to this position, Ms.
Ashby was GAO's Associate Director for Tax Policy and
Administrative Issues.
In addition to her job as Director, Ms. Ashby is presently
pursuing her Ph.D. in sociology at American University.
Then we will hear from Mr. Titus Hamlett. Mr. Hamlett is
currently a student at the University of Maryland, majoring in
government and politics. In addition to his studies, Mr.
Hamlett is also engaged in numerous extra-curricular
activities. He is an active member of the Student Government
Association and the Maryland Student Legislature, a non-profit
organization that organizes delegates from colleges and
universities across Maryland to research and debate issues of
local and national importance.
Then we will hear from Dr. Tom Neubig. Dr. Neubig is a
partner and also the National Director of Quantitative
Economics and Statistics in the national tax department of
Ernst & Young, LLP. He was a consultant to numerous public and
private clients from Federal and state tax policy issues before
joining Ernst & Young.
Dr. Neubig served as director and chief economist at the
U.S. Treasury Department's office of tax analysis and is the
top executive branch career economist in tax policy.
Lastly, we will hear from Dr. Robert Shapiro. Dr. Shapiro
is a founding partner and current Chairman of Sonecon, LLP, a
private economic advisory firm. In addition, Dr. Shapiro is a
non-resident senior fellow of the Brookings Institution and
also the Progressive Policy Institute. From 1997, Dr. Shapiro
served as the Under Secretary of Commerce for Economic Affairs,
providing economic policy oversight for the Commerce
Department.
Dr. Shapiro was the principal economic advisor to President
Bill Clinton in his 1991-1992 Presidential campaign, and also
served as legislative director and economic counsel to
Senator--former Senator and late Senator--Daniel Moynihan.
Let me explain the lights. You will have 5 minutes to give
your testimony. We are not real rough on people who want to
talk a little longer than that, unless you get too carried
away, and then I will gently remind you.
And with that, Ms. Ashby, you may begin.
STATEMENT OF CORNELIA M. ASHBY, DIRECTOR, EDUCATION, WORKFORCE,
AND INCOME SECURITY ISSUES, U.S. GENERAL ACCOUNTING OFFICE,
WASHINGTON, D.C.
Ms. Ashby. Mr. Chairman and members of the Committee, thank
you for inviting me here today to discuss issues related to
consolidation loans and cost implications for taxpayers and
borrowers. My testimony will focus on recent changes in
interest rates and consolidation loan volume, and how these
changes have affected Federal costs for FFELP and FDLP
consolidation loans.
My comments are based on our October 2003 loan
consolidation report done for this Committee. For this
testimony, we updated our numbers to reflect recent estimates
made by the Department of Education.
In recent years, there has been a drop in interest rates
for student loan borrowers, along with dramatic overall growth
in consolidation loan volume. From July of 2000 to June 2003,
the interest rate for consolidation loans dropped by more than
half, with consolidation loan borrowers obtaining rates as low
as 3.5 percent as of July 1, 2003.
From fiscal year 1998 through fiscal year 2003, the volume
of newly originated consolidation loans rose from $5.8 billion
to over $41 billion.
The dramatic growth in consolidation loan volume in recent
years is due in part to declining interest rates that have made
it attractive for many borrowers to consolidate their variable
rate loans at low fixed rates. The chart on the screen shows
this relationship. Note that the interest rates set on July 1
of each year corresponds to the loan volume for the following
fiscal year.
In addition, increased marketing effort has likely
contributed to the record level of consolidation loan volume.
Many lenders, including newer companies that are specializing
in consolidation loans, have aggressively marketed
consolidation loans to compete for consolidation loan business,
as well as to retain the loans of their current customers.
Recent transit interest rates in consolidation loan volume
have affected the cost of the FFELP and FDLP Consolidation Loan
Programs in different ways, but in the aggregate. Estimated
subsidy and administration costs have increased.
For FFELP consolidation loans, subsidy costs grew from
about $650 million for loans made in fiscal year 2002 to over
$2 billion for loans made in fiscal year 2003. Both higher loan
volumes and lower interest rates in fiscal year 2003 increased
these costs.
Education's estimate of over $2 billion in subsidy costs is
based on the assumption that the guaranteed lender yield will
rise over the next several years.
The effect of this rise is shown on the chart on the
screen, where the bottom line shows the fixed borrower rate for
an FFELP consolidation loan made in the first 9 months of
fiscal year 2003, and the top line shows Education's estimate
values for the guaranteed lender yield over time.
In fiscal year 2003, market interest rates were such that
the guaranteed lender yield was actually below the borrower
rate. Lenders, therefore, received only the rate paid by
borrowers. No special allowance payment, or SAP, was paid.
However, in future years, when the guaranteed lender yield
is expected to increase and be above the borrower rate,
Education would have to make up the difference with a SAP. As
the chart shows, Education's assumptions would call for lenders
to receive a SAP over most of the life of the consolidation
loans made in fiscal year 2003.
Changing interest rates and loan volumes affected costs in
the FDLP loan consolidation program, as well. In both fiscal
years 2002 and 2003, there was no subsidy cost to the
government because the interest rate paid by borrowers who
consolidated their loans was greater than the interest rate
education paid to the treasury to finance the lending.
However, the drop in loan volume and interest rates that
occurred in fiscal year 2003 contributed to cutting the
government's estimated gain from $570 million in fiscal year
2002 to $543 million for loans made in fiscal year 2003.
Administration cost is not specifically tracked for either
Consolidation Loan Program, but available evidence indicates
that these costs have risen, primarily reflecting increased
overall loan volume.
In our October 2003 report, we recommended that the
Secretary of Education assess the advantages of consolidation
loans for borrowers and the government in light of program
costs, and identify options for reducing Federal costs.
We suggested options that include targeting the program to
borrowers at risk of default: extending existing consolidation
alternatives to more borrowers and changing from a fixed to a
variable rate the interest charged to borrowers on
consolidation loans.
We noted that, in conducting such an assessment, Education
should also consider how best to distribute program costs among
borrowers, lenders, and taxpayers. Education agreed with our
recommendation.
Mr. Chairman, this concludes my statement. I would be
pleased to answer any questions.
[The prepared statement of Ms. Ashby follows:]
Statement of Cornelia M. Ashby, Director, Education, Workforce, and
Security Issues, U.S. General Accounting Office
Mr. Chairman and Members of the Committee:
Thank you for inviting me here today to discuss issues related to
consolidation loans and their cost implications for taxpayers and
borrowers. Consolidation loans, available under the Department of
Education's (Education) two major student loan programs--the Federal
Family Education Loan Program (FFELP) and the William D. Ford Direct
Loan Program (FDLP)--help borrowers manage their student loan debt. By
combining multiple loans into one loan and extending the repayment
period, a consolidation loan reduces monthly repayments, which may
lower default risk and, thereby, reduce federal costs of loan defaults.
Consolidation loans also allow borrowers to lock in a fixed interest
rate, an option not available for other student loans. Consolidation
loans under FFELP and FDLP accounted for about 48 percent of the $87.4
billion in total new student loan dollars that originated during fiscal
year 2003. FFELP consolidation loans comprised about 84 percent of the
fiscal year 2003 consolidation loan volume, while FDLP consolidation
loans accounted for the remaining 16 percent.
Two main types of federal cost pertain to consolidation loans. One
is ``subsidy''--the net present value of cash flows to and from the
government that result from providing these loans to borrowers. For
FFELP consolidation loans, cash flows include, for example, fees paid
by lenders to the government and a special allowance payment by the
government to lenders to provide them a guaranteed rate of return on
the student loans they make. For FDLP consolidation loans, cash flows
include borrowers' repayment of loan principal and payments of interest
to Education, and loan disbursements by the government to borrowers.
The subsidy costs of FDLP consolidation loans are also affected by the
interest Education must pay to the Department of Treasury (Treasury) to
finance its lending activities. The second type of cost is
administration, which includes such items as expenses related to
originating and servicing direct loans.
My testimony today will focus on two key issues: (1) recent changes
in interest rates and consolidation loan volume and (2) how these
changes have affected federal costs for FFELP and FDLP consolidation
loans. My comments are based on the findings from our October 2003
report for this Committee, Student Loan Programs: As Federal Costs of
Loan Consolidation Rise, Other Options Should Be Examined (GAO-04-101,
October 31, 2003). Those findings were based on review and analysis of
data from a variety of sources, including officials from Education's
Office of Federal Student Aid and Budget Service, and representatives
of FFELP lenders; a sample of student loan data extracted from
Education's National Student Loan Data System (NSLDS)--a comprehensive
national database of student loans, borrowers, and other information;
relevant cost analyses prepared by Education; and statutory, regulatory
and other published information. For this testimony, we updated our
numbers to reflect recent estimates made by the Department of
Education. Our work was conducted in accordance with generally accepted
government auditing standards.
In summary:
<bullet> Recent years have seen a drop in interest rates for
student loan borrowers along with dramatic overall growth in
consolidation loan volume. From July 2000 to June 2003, the interest
rate for consolidation loans dropped by more than half, with
consolidation loan borrowers obtaining rates as low as 3.50 percent as
of July 1, 2003. From fiscal year 1998 through fiscal year 2003, the
volume of consolidation loans made (or ``originated'') rose from $5.8
billion to over $41 billion. The dramatic growth in consolidation loan
volume in recent years is due in part to declining interest rates that
have made it attractive for many borrowers to consolidate their
variable rate student loans at a low, fixed rate.
<bullet> Recent trends in interest rates and consolidation loan
volume have affected the cost of the FFELP and FDLP Consolidation Loan
Programs in different ways, but in the aggregate, estimated subsidy and
administration costs have increased. For FFELP consolidation loans,
subsidy costs grew from $0.651 billion for loans made in fiscal year
2002 to $2.135 billion for loans made in fiscal year 2003. Both higher
loan volumes and lower interest rates available to borrowers in fiscal
year 2003 increased these costs. Lower interest rates increase these
costs because FFELP consolidation loans carry a government-guaranteed
rate of return to lenders that is projected to be higher than the fixed
interest rate paid by consolidation loan borrowers. When the interest
rate paid by borrowers does not provide the full guaranteed rate to
lenders, the federal government must pay lenders the difference. FDLP
consolidation loans are made by the government and thus carry no
interest rate guarantee to lenders, but changing interest rates and
loan volumes affected costs in this program as well. In both fiscal
years 2002 and 2003, there was no net subsidy cost to the government
because the interest rate paid by borrowers who consolidated their
loans was greater than the interest rate Education must pay to the
Treasury to finance its lending. However, the drop in loan volume and
interest rates that occurred in fiscal year 2003, contributed to
cutting the government's estimated net gain from $570 million in fiscal
year 2002 to $543 million for loans made in fiscal year 2003.
Administration costs are not specifically tracked for either
Consolidation Loan Program, but available evidence indicates that these
costs have risen, primarily reflecting increased overall loan volumes.
In our prior report, we recommended that the Secretary of Education
assess the advantages of consolidation loans for borrowers and the
government in light of program costs and identify options for reducing
federal costs. Education agreed with our recommendation.
Background
Consolidation loans differ from other loans in the FFELP and FDLP
programs in that they enable borrowers who have multiple loans--
possibly from different lenders, different guarantors, \1\ and even
from different loan programs--to combine their loans into a single loan
and make one monthly payment. By obtaining a consolidation loan,
borrowers can lower their monthly payments by extending the repayment
period longer than the maximum 10 years generally available on the
underlying loans. Maximum repayment periods allowed vary by the amount
of the consolidation loan (see table 1). Consolidation loans also
provide borrowers with the opportunity to lock in a fixed interest rate
on their student loans, based on the weighted average of the interest
rates in effect on the loans being consolidated rounded up to the
nearest one-eighth of 1 percent, capped at 8.25 percent. Borrowers can
qualify for consolidation loans regardless of financial need. Loans
eligible for inclusion in a consolidation loan must be comprised of at
least one eligible FFELP or FDLP loan, including subsidized and
unsubsidized Stafford loans, PLUS loans, \2\ and, in some instances,
consolidation loans. Both subsidized and unsubsidized Stafford loans,
and PLUS loans are variable rate loans. Other types of federal student
loans made outside of FFELP and FDLP, which may carry a variable or
fixed borrower interest rate, are also eligible for inclusion in a
consolidation loan, including Perkins loans, Health Professions Student
loans, Nursing Student Loans, and Health Education Assistance loans
(HEAL).\3\
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\1\ State and nonprofit guaranty agencies receive federal funds to
play the lead role in administering many aspects of the FFELP program,
including reimbursing lenders when loans are placed in default and
initiating collection work.
\2\ Both subsidized and unsubsidized Stafford loans are available
to undergraduate and graduate students. The interest rates borrowers
pay on these loans adjust annually, based on a statutorily established
market-indexed rate setting formula, and may not exceed 8.25 percent.
To qualify for a subsidized Stafford loan, a student must establish
financial need. The federal government pays the interest on behalf of
subsidized loan borrowers while the student is in school. Students can
qualify for unsubsidized Stafford loans regardless of financial need.
Unsubsidized loan borrowers are responsible for all interest costs.
PLUS loans are variable rate loans that are available to parents of
dependent undergraduate students. The interest rates on these loans
adjust annually, based on a statutorily established market-indexed rate
setting formula, and may not exceed 9 percent. Parents can qualify for
PLUS loans regardless of financial need.
\3\ Perkins Loans are fixed rate loans for both undergraduate and
graduate students with exceptional financial need. Perkins loans are
made directly by schools using funds contributed by the federal
government and schools; borrowers must repay these loans to their
school. The Health Professions Student Loans and Nursing Student Loans
are fixed rate loans for borrowers who pursue a course of study in
specified health professions. The HEAL program provided loans to
eligible graduate students in specified health professions. HEAL was
discontinued on September 30, 1998.
[GRAPHIC] [TIFF OMITTED] 92613.032
The Federal Credit Reform Act (FCRA) of 1990 helps define federal
costs associated with consolidation loans and was enacted to require
agencies, including Education, to more accurately measure federal loan
program costs. Under FCRA, Education is required to estimate the long-
term cost to the government of a direct loan or a loan guarantee--
generally referred to as the subsidy cost. Subsidy cost estimates are
calculated based on the present value of estimated net cash flows to
and from the government that result from providing loans to
borrowers.\4\ For FFELP consolidation loans, cash flows include, for
example, fees paid by lenders to the government \5\ and a special
allowance payment by the government to lenders to provide them a
guaranteed rate of return on the student loans they make. For FDLP
consolidation loans, cash flows include borrowers' repayment of loan
principal and payments of interest to Education, and loan disbursements
by the government to borrowers. Unlike FFELP, FDLP involves no
guaranteed yields or special allowance payments to lenders because the
program is a direct loan program. The subsidy costs of FDLP
consolidation loans are also affected by the interest Education must
pay to Treasury to finance its lending activities. Another type of cost
pertaining to consolidation loans is administration, which includes
such items as expenses related to originating and servicing direct
loans.\6\
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\4\ Present value is the value today of the future stream of
benefits and costs, discounted using an appropriate interest rate
(generally the average annual interest rate for marketable zero-coupon
U.S. Treasury securities with the same maturity from the date of
disbursement as the cash flow being discounted).
\5\ For consolidation loans, FFELP loan holders must pay, on a
monthly basis, a fee calculated on an annual basis equal to 1.05
percent of the unpaid principal and accrued interest on the loans in
their portfolio.
\6\ Under FFELP, a large portion of the administration cost is
borne by the private lender. The federal government pays many of these
costs in its subsidy payment to lenders--specifically, in the 2.64
percent add on paid over and above the 3-month rate on commercial
paper.
---------------------------------------------------------------------------
In estimating loan subsidy costs, Education first estimates the
future economic performance (net cash flows to and from the government)
of direct and guaranteed loans when preparing its annual budgets. These
first estimates establish the subsidy estimates for the current-year
originated loans. The data used for the first estimates are reestimated
in later years to reflect any changes in actual loan performance and
expected changes in future performance. Reestimates are necessary
because projections about interest and default rates and other
variables that affect loan program costs change over time. Any increase
or decrease in the estimated subsidy cost results in a corresponding
increase or decrease in the estimated cost of the loan program for both
budgetary and financial statement purposes.
Borrowers' Rates Have Dropped, and Loan Volume Has Risen
Recent years have seen a drop in interest rates for student loan
borrowers along with dramatic overall growth in consolidation loan
volume. From July 2000 to June 2003, the interest rate for
consolidation loans dropped by more than half, with consolidation loan
borrowers obtaining rates as low as 3.50 percent as of July 1, 2003.
From fiscal year 1998 through fiscal year 2003, the volume of
consolidation loans made (or originated) rose from $5.8 billion to over
$41 billion. Over four-fifths of the fiscal year 2003 loan volume is in
FFELP. While overall volume rose in 2003, the trends differed by
program. FDLP consolidation loan volume for fiscal year 2003 decreased,
but loan volume in the larger FFELP increased, resulting in total
consolidation loan volume of well over $41 billion.
The dramatic growth in consolidation loan volume in recent years is
due in part to declining interest rates that have made it attractive
for many borrowers to consolidate their variable rate student loans at
a low, fixed rate. Figure 1 shows the relationship between these two
factors. When interest rates are low, some borrowers may find it in
their economic self-interest to consolidate their loans so that they
can lock in a low fixed interest rate for the life of the loan, as
opposed to paying variable rates on their existing loans, regardless of
whether they need a consolidation loan to avoid difficulty in making
loan repayments and avert default.
[GRAPHIC] [TIFF OMITTED] 92613.033
Underscoring the potential attractiveness of these loans to
potential borrowers, many lenders, including newer loan companies that
are specializing in consolidation loans, have aggressively marketed
consolidation loans to compete for consolidation loan business as well
as to retain the loans of their current customers. Their marketing
techniques have included mass mailings, telemarketing, and Internet
pop-ups to encourage borrowers to consolidate their loans. This
increased marketing effort has likely contributed to the record level
of consolidation loan volume.
Changes in Interest Rates and Loan Volume Affect FFELP and FDLP Costs
in Different Ways but in the Aggregate, Estimated Costs
Increased
While the estimated future costs for consolidation loans can vary
greatly from year to year, low interest rates and recent loan volume
changes have resulted in substantial increases in overall costs to the
federal government. However, in light of the differences between how
FFELP and FDLP operate, the subsidy costs within these two programs
were affected in very different ways. For FFELP, the result was a
substantial increase. For FDLP, the result was a narrowing of the net
difference between the estimated interest payments paid by consolidated
loan borrowers to Education and the costs paid by Education to Treasury
to finance direct loans.
FFELP Subsidy Costs Affected by Increased Special Allowance Payments to
Lenders and Increased Loan Volume
Estimated subsidy costs for FFELP consolidation loans rose from
$0.651 billion for loans made in fiscal year 2002 to $2.135 billion for
loans made in fiscal year 2003. The increase is largely due to the
higher interest subsidies the government is expected to pay to lenders
to ensure they receive a guaranteed rate of return on student loans and
the result of greater loan volume. The interest subsidy, which is
called a special allowance payment (SAP), is based on a formula
specified in law and paid by Education to lenders on a quarterly basis
when the ``guaranteed lender yield'' exceeds the borrower rate. This
guaranteed lender yield is currently based on the average 3-month
commercial paper \7\ interest rate plus an additional 2.64 percent.
When this guaranteed yield is higher than the amount of interest being
paid by borrowers, Education makes up the difference. If the borrower's
interest rate exceeds the guaranteed lender yield, Education does not
pay a SAP, and the lender receives the borrower rate.
---------------------------------------------------------------------------
\7\ Commercial paper is short-term, unsecured debt with maturities
up to 270 days. It is issued in the form of promissory notes, primarily
by corporations. Many companies use commercial paper to raise cash for
current transactions and many find it to be a lower-cost alternative to
bank loans.
---------------------------------------------------------------------------
Education's estimate of $2.135 billion in subsidy costs for FFELP
consolidation loans made in fiscal year 2003 is based on the assumption
that the guaranteed lender yield will rise over the next several years,
reflecting Education's assumption that market interest rates are likely
to rise from the historically low levels experienced in fiscal year
2003. The effect of this rise is shown in figure 2, where the bottom
line shows the fixed borrower rate for a FFELP consolidation loan made
in the first 9 months of fiscal year 2003, and the top line shows
Education's estimated values for the guaranteed lender yield over time.
In fiscal year 2003, market interest rates were such that the
guaranteed lender yield established under the SAP formula was actually
below the borrower rate. Lenders, therefore, received only the rate
paid by borrowers; no SAP was paid. However, in future years, when the
guaranteed lender yield is expected to increase and be above the
borrower rate, Education would have to make up the difference in the
form of a SAP. As figure 2 shows, Education's assumptions would call
for lenders to receive a SAP over most of the life of the consolidation
loans made in fiscal year 2003.
[GRAPHIC] [TIFF OMITTED] 92613.034
An increase in loan volume also played a role in the subsidy cost
increase from fiscal years 2002 to 2003. However, the effect of the
increased loan volume was not as large as that of the higher interest
subsidies the government is expected to pay to lenders in the future.
FDLP Loans also Affected by Changing Interest Rates
Subsidy costs can occur within FDLP as well, but in a different
way. FDLP's consolidation program is a direct loan program and,
therefore, involves no guaranteed yields to private lenders. Still, the
program has potential subsidy costs if the government's cost of
borrowing is higher than the interest rate borrowers are paying. The
government's cost of borrowing is determined by the interest rate
Education pays Treasury to finance direct student loans, which is
equivalent to the discount rate.\8\ The difference between borrowers'
rates and the discount rate--called the interest rate spread--is a key
driver of subsidy estimates for FDLP loans. When the borrower rate is
greater than the discount rate, Education will receive more interest
from borrowers than it will pay in interest to Treasury to finance its
loans, resulting in a positive interest rate spread--or a gain
(excluding administrative costs) to the government. Conversely, when
the borrower rate is less than the discount rate, Education will pay
more in interest to Treasury than it will receive from borrowers, which
will result in a negative interest rate spread--or a cost to the
government.
---------------------------------------------------------------------------
\8\ While the discount rate is the interest rate used to calculate
the present value of the estimated future cash flows to determine
subsidy cost estimates, it is also generally the same rate at which
interest is paid by Education on the amounts borrowed from Treasury to
finance the direct loan program.
---------------------------------------------------------------------------
For FDLP consolidation loans made in fiscal years 2002 and 2003, no
such negative interest rate spreads were incurred in either year, based
on the methodology Education uses to determine these costs. In both
years, borrower interest rates for FDLP consolidation loans were
somewhat higher than the discount rate, resulting in a net gain to the
government. However, while Education continued to benefit from lending
at interest rates higher than its cost of borrowing for FDLP
consolidation loans made in fiscal year 2003, the size of this benefit
declines from $571 million in fiscal year 2002 to $543 million in
fiscal year 2003.
The smaller net gain that occurred in fiscal year 2003 reflects
both a decrease in the loan volume and a narrowed difference between
the discount rate and the borrower rate. Loan volume in fiscal year
2003 was $6.7 billion, a decrease from $8.8 billion in fiscal year
2002. In fiscal year 2003, this difference narrowed in part because
borrower rates dropped more than the discount rate. The borrower rates
for FDLP consolidation loans dropped 1.2 percentage points, from 6.3
percent in fiscal year 2002 to 5.1 percent in fiscal year 2003. The
discount rate, on the other hand, dropped by only 0.88 percentage
points, from 4.72 percent in fiscal year 2002 to 3.84 percent in fiscal
year 2003. The resulting interest rate spread decreased from 1.59
percent to 1.22 percent (see table 2). In other words, each $100 of
consolidated FDLP loans made in fiscal year 2002, will result in $1.59
more in interest received by Education than it will pay out in interest
to the Treasury. A similar loan originated in fiscal year 2003,
however, will generate only $1.22 more in interest for the government.
[GRAPHIC] [TIFF OMITTED] 92613.035
Administration Costs also Increase, Mainly because of Loan Volume
Loan volume affects administrative costs, in that cost is in part a
function of the number of loans originated and serviced during the
year. As a result, when loan volume increases, administration costs
also increase. Education's current cost accounting system does not
specifically track administration costs incurred by each of the student
loan programs. Consequently, we were unable to determine the total
administration costs incurred by Consolidation Loan Programs or any
off-setting administrative cost reductions associated with the
prepayment of loans underlying consolidation loans. However, based on
available Education data, we were able to determine some of the direct
costs associated with the origination, servicing, and collection of
FDLP consolidation loans. For fiscal year 2002, these costs totaled
roughly $52.3 million. This does not include overhead costs, which
include costs incurred for personnel, rent, travel, training, and other
activities related to maintaining program operations. For fiscal year
2003, the estimated costs for the origination, servicing, and
collection of FDLP consolidation loans is projected to increase to
$59.5 million. While we similarly were unable to determine Education's
administration costs directly related to FFELP consolidation loans,
they are likely to be smaller than for FDLP consolidation loans. This
is because a large portion of FFELP administration cost is borne
directly by lenders, who make and service the loans. The special
allowance payments to lenders, which rise and fall as interest rates
change, are designed to ensure that lenders are compensated for
administration and other costs and provided with a reasonable return on
their investment so that they will continue to participate in the
program.
Concluding Observations
As the discussion of both FFELP and FDLP loans shows, interest
rates have a strong effect on whether subsidy costs occur and how large
they are. The movement of subsidy costs for consolidation loans made in
future years will depend heavily on what happens to interest rates. As
we have shown, subsidy cost estimates for FFELP consolidation loans can
increase substantially, depending on how much the guaranteed lender
yield rises above the fixed rate paid by borrowers, which, in turn,
requires the federal government to pay subsidies to lenders.
Conversely, if borrowers obtained consolidation loans with a fixed
interest rate at a time when rates were expected to decrease in the
future, federal subsidy costs could be lower, than is currently the
case, because the borrower rate could exceed the rate guaranteed to
lenders, and the federal government might not be required to pay lender
subsidies. For FDLP consolidation loans, allowing borrowers to lock in
a low fixed rate might result in decreased federal revenues if the
variable interest rates on those loans borrowers converted to a
consolidation loan would have otherwise increased in the future. The
exact effects of FDLP consolidation loans, however, depend on a number
of factors, including the length of loan repayment periods, borrower
interest rates, and discount rates.
We noted in our prior report \9\ that borrowers' choices between
obtaining a fixed rate consolidation loan or retaining their variable
rate loans can significantly affect federal costs. While consolidation
loans may be an important tool to help borrowers manage their
educational debt and thus reduce the cost of student loan defaults, the
surge in the number of borrowers consolidating their loans suggests
that many borrowers who face little risk of default are choosing
consolidation as a way of obtaining low fixed interest rates--an
economically rational choice on the part of borrowers. If borrowers
continue to consolidate their loans in the current low interest rate
environment, and interest rates rise, the government assumes the cost
of larger interest subsidies. Providing for these larger interest
subsidies on behalf of a broad spectrum of borrowers may outweigh any
government savings associated with the reduced costs of loan defaults
for the smaller number of borrowers who might default in the absence of
the repayment flexibility offered by consolidation loans.
---------------------------------------------------------------------------
\9\ GAO-04-101.
---------------------------------------------------------------------------
In our October 2003 report, we also discussed the extent to which
repayment options other than consolidation loans allow borrowers to
simplify loan repayment and reduce repayment amounts. We found that
other repayment options that allow borrowers to make a single payment
to cover multiple loans and smaller monthly payments are now available
for some borrowers under both FFELP and FDLP, but these alternatives
are not available to all borrowers. In that report, we concluded that
restructuring the Consolidation Loan Program to specifically target
borrowers who are experiencing difficulty in managing their student
loan debt and at risk of default, and/or who are unable to simplify and
reduce repayment amounts by using existing alternatives, might reduce
overall federal costs by reducing the volume of consolidation loans
made. In addition, making the other nonconsolidation options more
readily available to borrowers might be a more cost-effective way for
the federal government to provide borrowers with repayment flexibility
while reducing federal costs. An assessment of the advantages of
consolidation loans for borrowers and the government, taking into
account program costs and the availability of, and potential change to,
existing alternatives to consolidation, and how consolidation loan
costs could be distributed among borrowers, lenders, and the taxpayers,
would be useful in making decisions about how best to manage the
Consolidation Loan Program and whether any changes are warranted.
In our October 2003 report, we recommended that the Secretary of
Education assess the advantages of consolidation loans for borrowers
and the government in light of program costs and identify options for
reducing federal costs. We suggested options that could include
targeting the program to borrowers at risk of default, extending
existing consolidation alternatives to more borrowers, and changing
from a fixed to a variable rate the interest charged to borrowers on
consolidation loans. We also noted that, in conducting such an
assessment, Education should also consider how best to distribute
program costs among borrowers, lenders, and the taxpayers and any
tradeoffs involved in the distribution of these costs. Furthermore, if
Education determines that statutory changes are needed to implement
more cost-effective repayment options, we believe it should seek such
changes from Congress. Education agreed with our recommendation.
Mr. Chairman, this concludes my prepared statement. I would be
pleased to respond to any questions that you or other members of the
Committee may have.
GAO Contact and Acknowledgments
For further contacts regarding this testimony, please call Cornelia
M. Ashby at (202) 512-8403. Individuals making key contributions to
this testimony include Jeff Appel, Susan Chin, Cindy Decker, and
Julianne Hartman-Cutts.
[Attachments to Ms. Ashby's statement follow:]
------
[GRAPHIC] [TIFF OMITTED] 92613.023
Chairman Boehner. Thank you, Ms. Ashby.
Mr. Hamlett, you may begin.
STATEMENT OF TITUS M. HAMLETT, STUDENT, UNIVERSITY OF MARYLAND
Mr. Hamlett. Thank you, Chairman Boehner and distinguished
Committee members, for inviting me here today to speak on
consolidation loans and financing a college education.
I just wanted to mention that this is my first time
testifying. I am a little nervous and I am also feeling a
little under the weather today, so please bear with me.
My name is Titus Hamlett. I am a senior at the University
of Maryland, College Park. I will graduate this May with a
degree in government and politics, and I plan to pursue a
career in public service. I will be the first person in my
family to graduate from college, which is a major
accomplishment, and I am very proud of that.
I currently work at the U.S. Department of Justice as a
student paralegal. I am actually in the Civil Division and I do
work with the U.S. attorneys. I do a lot of research and
different things for them.
Basically what I want to talk about is the effects of
student loans on students, and the effects of tuition increases
on students.
As you all know, many students like myself struggle to pay
for higher education today. In the University of Maryland
system, tuition prices have risen by 20 percent in the last
year alone. Despite rising prices, growing student loan debt,
and more students working to pay for college, the Governor in
Maryland has continued to cut funding for higher education,
unfortunately.
The real impact has been that, along with thousands of
other University of Maryland students, I have had to take out
more loans and work longer hours for these unexpected, and they
are unexpected, tuition increases. I am currently working 20-
plus hours a week while balancing an 18-credit course load,
which is tough, but it's what I have to do, because I have to
graduate, and I have to pay for my college education.
My mother, who is a single parent, works two full-time
jobs, but even with her two jobs, she cannot afford to pay a
significant amount toward my college education, so I rely on
some help from my mother--financial help, that is.
I work during the summer; as I mentioned, I work throughout
the school year; and I have also received Pell Grants, which
have helped a lot. However, I primarily rely on student loans
to pay for my college education.
When I graduate this May, unfortunately, I will have about
$41,000 in Federal education loan debt. I have taken out
$22,000 in subsidized Stafford loans, and $19,540 in
unsubsidized Stafford loans.
When I graduate, I plan to consolidate my loans in a locked
low interest rate, hopefully, to save thousands of dollars, and
to make repaying my college loans manageable.
In addition to my loans, working through school and
receiving scholarships and grants have made it possible for me
to attend college. However, as I near graduation, I worry that
I am not going to be able to manage the $41,000-plus that I am
going to have in undergraduate loan debt.
I would like to pursue a career in public service, because
I feel that it's important for me to give back to my community
and my country, but if my monthly student payments are too high
once I graduate, I may have to reconsider whether or not I want
to go into the public sphere or into the private sector.
I really, really like--my heart is into public service.
It's what I want to do. But I may have, you know, more debt
than I would make in my first year as a graduate, and I have to
take that into consideration when I apply for a job once I
graduate.
I believe the grants and the loans that I received while I
have been in college have been key to making my education
possible.
As I mentioned before, given that both tuition prices and
student debt has been constantly rising, I was shocked to learn
that Congress may consider eliminating the low fixed rate
benefit for student borrowers.
Eliminating this benefit will push higher prices on
thousands of students like myself, and increase the numbers of
student borrowers who simply won't be able to manage repaying
their student loans.
When I graduate this spring, I plan to continue working at
the Department of Justice because, like I mentioned before, I
really want to work in public service and give back to my
country. I know that this is possible for me, because
consolidation will allow me to save thousands of dollars on my
loans overall and make my monthly payments a lot lower.
I strongly support making college more affordable by
allowing student borrowers to consolidate their loans to a low,
fixed interest rate.
Chairman Boehner and Ranking Members of the Committee, I
urge you to retain the low fixed interest rate for student
borrowers, and I oppose any efforts to raise costs on student
loans.
Thank you for allowing me to testify today.
[The prepared statement of Mr. Hamlett follows:]
Statement of Titus M. Hamlett, Student, University of Maryland
Thank you Chairman Boehner, Ranking Member Miller and distinguished
committee members for inviting me here to speak today on the issue of
student loan consolidation and financing a college education.
My name is Titus Hamlett and I am a senior at University of
Maryland College Park. I will graduate this May with a degree in
Government and Politics and I plan to pursue a career in public
service. I will be the first person in my family to graduate from
college. I currently work at the U.S. Department of Justice in the
Civil Division as a part-time paralegal.
As you know, many students like myself struggle to pay for higher
education today. In the University of Maryland system tuition prices
have risen by 20 percent, or over $1000 (for in-state students), in the
last year alone. Despite rising prices, growing student loan debt and
more students working to pay for college, The Governor of Maryland has
continued to cut funding for higher education. The real impact has been
that along with thousands of other University of Maryland students, I
have had to take out more loans and work longer hours to pay for these
unexpected tuition increases. I am currently working 20 plus hours a
week while balancing an 18-credit course load.
My mother, who is a single parent, works two full-time jobs, but
even with her two jobs she cannot afford to pay for my college
education. I rely on some financial help from my mother; I work during
the summer and throughout the school year, and I also received a
$4050.00 Pell Grant this year. However, I have primarily relied on
student loans to pay for my college education.
When I graduate this May I will have $41,540.00 in federal
education loan debt. I have taken out $22,000.00 in subsidized Stafford
loans and $19,540.00 in unsubsidized Stafford loans. When I graduate I
plan to consolidate my loans and lock in a low interest rate to save
thousands of dollars and to make repaying my college loans manageable.
In addition to my loans, working through school and receiving
scholarships/grants have made it possible for me to attend college.
However, as I near graduation I am worried that I will not be able to
manage the $41,000.00 that I have in undergraduate loan debt. I would
like to pursue a career serving my community and country. I am counting
on the benefit of a low-fixed rate consolidation loan, which would save
me thousands of dollars, to help make my career in public service
possible. Otherwise, I may have no other choice but to go into the
private sector.
I believe that the grants and loans that I received while I was in
college were key to making my college education possible. However, the
impact of my loans won't really hit me until I graduate and have to
make monthly payments. It's important to have financial assistance at
both points for students with need.
If I were not able to consolidate my loans under a fixed rate, I
would have to pay thousands more for my education. Higher total and
monthly payments would dictate where I work, when or if I am able to
purchase a home, and various other important life choices.
Given that both tuition prices and student loan debt have been
rising rapidly, I was shocked to learn that Congress may consider
eliminating the low-fixed rate benefit for student borrowers.
Eliminating this benefit would push higher prices on thousands of
students and increase the number of student borrowers who cannot afford
to repay their loans.
When I graduate this spring, I plan to continuing working at the
Department of Justice, because I believe that it is important to give
back to the community and my country. I know that this is possible for
me because consolidation will allow me to save thousands of dollars on
my loans overall and lower my monthly payments.
I strongly support making college more affordable by allowing
student borrowers to consolidate their loans and lock in a low-fixed
interest rate. Chairman Boehner, Ranking Member Miller and all of the
distinguished members here today I urge you to retain the low-fixed
rate benefit for student borrowers and oppose any efforts to raise the
cost of student loans. Thank you for allowing me to testify here today.
______
Chairman Boehner. Thank you, Mr. Hamlett.
Dr. Neubig.
STATEMENT OF THOMAS S. NEUBIG, NATIONAL DIRECTOR, QUANTITATIVE
ECONOMICS AND STATISTICS, ERNST & YOUNG, LLP, WASHINGTON, D.C.
Dr. Neubig. Mr. Chairman and members of the Committee,
thank you for inviting me to testify on the results of two
recent studies I prepared on the costs and benefits of the
consolidation student loan program. The results of both reports
rely heavily on Congressional Budget Office interest rate
projections, and I have included some updated estimates based
on CBO's most recent projections.
In today's hearing, you are going to see large differences
in the cost estimates of the Consolidation Loan Program, and if
I can leave you with two takeaways, I would like you to
understand why the cost of the program has changed over time,
and also why different cost methodologies show vastly different
results.
When I trained to be an economist, I did not want to be a
crystal ball gazer, forecasting GDP, employment, interest
rates. At the U.S. Treasury Department, we estimated tax
revenue and tax policy changes, taking the macroeconomic
forecasts of CBO and OMB as a given.
Economists rarely agree on future projections, especially
interest rates. Even OMB and CBO disagree on the magnitude and
timing of the interest rate changes. One advantage of using CBO
interest rate projections is that they underlie all
congressional budget estimates.
Since accurate forecasting of the future is impossible,
budget numbers should at least be consistent across programs.
The principal reason for the varying costs of the Consolidation
Loan Program is that the cost is tied to the direction of
interest rate movements. As interest rates change over time,
the cost of each year's loans also changes.
I like to think of the consolidation loans as falling into
three buckets.
The first bucket includes loans consolidated before 2003.
That's when interest rates were high, but then fell sharply.
Due to that pattern of interest rate changes, lender-paid
fees on these loans will exceed the cost of the interest
subsidy to the tune of almost $4 billion over the entire life
of those loans.
The second bucket includes loans consolidated between 2003
and 2006, and those loans have low interest rates for the
students, and interest rates are projected to increase.
Based on the CBO projections of increasing interest rates,
I estimate that those loans consolidated in those 4 years will
cost Federal taxpayers $6 billion over the life of the loans.
That is a 180-degree cost change, but it is due to the shift
from stable, or falling interest rates, to a rapidly rising
interest rate environment.
The third bucket includes loans consolidated after 2006,
when future interest rates stabilize. In this stable interest
rate period--you know, again, based upon the CBO interest rate
forecast--consolidation loan fees will again exceed the
interest subsidy for a positive $2 billion benefit to the U.S.
Treasury between 2007 and 2010.
When you look at the cost of the Consolidation Loan Program
over the 16-year period between 1995 and 2010, and you combine
all three buckets of loans, the program is positive in the
initial years. It's quite costly for today's loans, and then it
is positive again once interest rates stabilize. If you look at
the program over 16 years, it is essentially cost-neutral.
Lender-paid fees roughly match the interest subsidy.
Now, if you are uncomfortable with people forecasting
future interest rates, you can look at the actual budget cash-
flow experience of the program to date.
From 1995 to 2003, the government collected $2.6 billion in
fees and only spent $400 million in special allowance payments.
That's a net positive of $2.2 billion. You can see those actual
budget numbers on Page 3 of my testimony.
The cost estimates I have provided the Committee follow the
Federal Credit Reform Act requirement to discount future cash-
flows from Federal loan guarantee programs to current dollars.
This recognizes that a dollar in 2024 is worth much less than a
dollar today. If future cash-flows are not discounted, the
estimates will be inflated and also inconsistent with other
loan guarantee program cost estimates.
Up to this point, I've focused on the cost side, but let me
briefly describe one of the benefits of the current program.
That is the one-time ability to lock in a fixed interest rate.
Similar to mortgage refinancing, consolidation loans have
become very popular at the current low interest rate. Changing
the consolidation loan interest rate formula from a fixed rate
to a variable rate would roughly double the interest cost paid
by students taking out a consolidation loan today, based on the
CBO interest rate forecast.
Whether student borrowers or the Federal taxpayer should
bear the risk of future interest rate increases is a key public
policy question.
I hope my testimony is helpful in the Committee's
deliberations.
Thank you.
[The prepared statement of Dr. Neubig follows:]
Statement of Dr. Thomas S. Neubig, National Director, Quantitative
Economics and Statistics, Ernst & Young LLP
I am the National Director of Ernst & Young LLP's Quantitative
Economics and Statistics practice. I was previously the Director and
Chief Economist of the U.S. Treasury Department's Office of Tax
Analysis.
I appreciate the invitation to testify before the Committee to
discuss the results of two studies on the costs and benefits of the
Federal Family Education Loan (FFEL) consolidation student loan
program. The two reports, ``The Net Incremental Cash Flow and Budget
Effects of the FFEL Consolidation Loan Program, fiscal year 2005-
FY2010'' and ``The Effect on Student Borrowing Costs if Consolidation
Loans Were Variable Rate Loans Rather Than Fixed Rate Loans,'' are also
submitted for the record. Both reports were prepared at the request of
Collegiate Funding Services LLC. My testimony summarizes the key
findings from the reports, with estimates updated for the most recent
loan volume and interest rate projections.
Two Key Considerations
Two key considerations for policymakers considering the cost
implications of consolidation loans during the coming Higher Education
Act reauthorization are:
1. Consolidation student loans are not all alike from a cost
perspective. The cost of future consolidation loans will be much less
than the estimated cost of the current 3.5% loans.
Depending on the interest rate environment, a year's issuance of
consolidation loans could bring in significant fee revenue to the U.S.
government or could require significant expenditures. Three groups of
consolidation loans should be distinguished:
<bullet> Loans made before fiscal year 03 have already generated
$1.7 billion of consolidation loan fees from lenders to date with only
$0.3 billion of government payments to lenders. The estimated net cost
of the Consolidation Loan Program for loans originated in fiscal year
1995-2002 is a positive $3.7 billion over the life of the loans.
<bullet> Loans made between fiscal year 03 and fiscal year 06 are
expected to have significant future subsidy costs if the predicted
sharp increase in interest rates occurs. Consolidation loans made at
historically low interest rates during this four-year period are
estimated to cost $6.1 billion over the life of the loans in net
present value.
<bullet> Loans made after fiscal year 06, when the interest rate
forecast is relatively stable, are estimated to have fees that will
exceed expenditures. The estimated net cost of loans made in fiscal
year 2007-2010 is a positive $2.3 billion.
The large estimated cost of current consolidation loans is due to
current historically low interest rates combined with projected higher
future interest rates. These loans will provide significant interest
savings to student borrowers if the projected interest rate increases
occur. The costs and benefits of these loans have already been
committed. This is why the August 2003 report focused primarily on
future loans.
2. The real cost of the Consolidation Loan Program is its
additional cost over and above the cost of the underlying Stafford/Plus
loans (i.e., its ``incremental'' net cost) less lender-paid
consolidation fees.
Measuring the real cost of the Consolidation Loan Program is not
easy, and its further complicated by the many different types of
estimates that are possible. I believe the appropriate cost for
policymakers to consider will include:
Fee offset. The cost of the Consolidation Loan Program from
defaults and special allowance payments is partially offset by the 0.5%
origination fee and the annual 1.05% consolidation loan holder fee.
These lender-paid fees are generated from consolidation loans and
reduce the net cost of those loans.
Incremental cost. If fewer consolidation loans were made, there
would be more interest subsidy paid on the Stafford/Plus loan program.
The cost of consolidation loans is the cost over and above the interest
subsidy on the underlying Stafford/Plus loans, less the lender-paid
consolidation fees.
Discounted present value of future cash flows. The Federal Credit
Reform Act (FCRA) of 1990 requires the budget effect to be calculated
as the net present value of the future cash flows over the life of the
loans issued in each year. Simply adding future dollars without
discounting is inconsistent with the FCRA and overstates the costs of
the consolidation program.
Future interest rate projections. Interest rate forecasts, like
interest rates, change over time as the economy changes. For budgeting
purposes, the Congressional Budget Office and Office of Management and
Budget forecast interest rates over the next 5-10 years. These
forecasts underlie not only student loan costs, but also the
government's interest expense, the macroeconomic forecast of GDP,
employment and tax revenues. Extreme scenarios of interest rate
increases are inconsistent with every other budget forecast.
Estimates that do not take these issues into account will overstate
the cost of the FFEL Consolidation Loan Program.
The Budget Cost of Consolidation Loans
The August 2003 report on ``The Net Incremental Cash Flow and
Budget Effects of the FFEL Consolidation Loan Program, fiscal year
2005-FY2010'' showed that on a cash flow basis the program has been a
net plus to the federal government since 1995. I have updated the
numbers for the most recent Department of Education budget numbers and
loan volume forecasts, plus the CBO's most recent interest rate
projections.
Consolidation loan fees have totaled $2.6 billion through fiscal
year 03 while gross special allowance payments have been only $0.4
billion. Based on the most recent Department of Education fiscal year
05 Budget numbers, the FFEL Consolidation Loan Program will bring in an
additional $2.2 billion of lender-paid fees, with only $0.5 billion of
expenses in fiscal year 04 and fiscal year 05. These cash flow numbers
represent the actual fiscal experience to date of the program, but they
are not the full cost, which requires projecting future interest rates
and the future cash flow for the entire life of the loans.
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The figure below shows the estimated cost of the three groups of
FFEL consolidation loans based on the latest loan volume estimates and
CBO interest rate projections. These estimates take into account both
special allowance payments and fees, the incremental cost of
consolidation loans in excess of Stafford/Plus loans, and the
discounted present value of the future cash flows.
The cost of the Consolidation Loan Program varies over time with
different interest rate environments. When loan rates at the time of
consolidation are high and then interest rates fall (fiscal year 1995-
2002), the program is estimated to have a net effect of positive $3.7
billion. When loan rates at the time of consolidation are low and
interest rates are expected to rise (fiscal year 2003-06), the cost is
estimated to be $6.1 billion over the four years. When interest rates
are relatively stable (fiscal year 2007-10), consolidation loans will
again return to a positive net effect of $2.3 billion. Over the 16-year
period, the FFEL Consolidation Loan Program is estimated to be
essentially cost neutral (less than negative $0.2 billion).
When the HEA reauthorization occurs, only changes to the
Consolidation Loan Program will be scored for budget purposes. The
expected cost of the current loans has already been included in prior
budgets, and will not affect the HEA reauthorization budget.
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The Benefit Side
The FFEL Consolidation Loan Program was enacted to provide student
loan borrowers with a simpler loan repayment plan, plus a one-time
opportunity to lock in a longer payment term and a fixed interest rate
to reduce the likelihood of default. A lower, fixed monthly payment was
thought to result in lower default rates for student borrowers. How
much of the lower default effect is due to the extended repayment
period, the fixed interest rate, or the type of student refinancing the
loans, has not been studied, but that information would be helpful for
policymakers to know.
One benefit, particularly during the current low interest rate
environment, is the ability of student borrowers to lock in a fixed
interest rate. This is similar to what has happened in the residential
mortgage market, where there has been an explosion of refinancing to
lower families' mortgage interest expense and monthly payments. Recent
developments in the mortgage market to allow borrowers to choose fixed
rate or variable rate loans with different maturities have been a major
benefit to both borrowers and the residential housing market. Private
market lenders are willing to lend money at 4-6% interest rates for 15-
30 years. If interest rates go up as the CBO projects, many mortgage
lenders will experience lower returns on those fixed mortgages, while
the borrowers will view them as very beneficial.
Similarly, the potential cost of the FFEL Consolidation Loan
Program for loans originated between July 1, 2002 and June 30, 2004
could be large if interest rates rise as the CBO projects. The total
net incremental cost of those two years of loans is an estimated $3.4
billion in net present value terms. On the borrower side, the student
loan borrowers will benefit significantly from the low 3.5% fixed
interest rate. The March 2004 study, ``The Effect on Student Borrowing
Costs If Consolidation Loans Were Variable Rate Loans Rather Than Fixed
Rate Loans,'' shows the effect on borrower costs if those consolidation
loans had not been available at a fixed rate.
Using a $30,000 20-year consolidation loan originated in July 2003
at 3.5%, and the CBO interest rate projections, the monthly payment
would increase 34% from $174 under a fixed rate loan to $233 in 2008 if
it had been a variable rate loan. The total interest expense would
increase from $11,800 to $22,900 over the life of the loan, a 95%
increase. The variable rate loan would have the same total interest
cost as a comparable 6.32% fixed rate loan, 2.72% above the current
fixed consolidation loan rate.
The benefits of the fixed interest rate include potentially lower
default rates and the ability to lock in a lower rate. Congress has
limited the ability of student borrowers to refinance their student
loans more than once. The budget cost, which provides the interest rate
subsidy for the borrower's benefit, is one reason for the limitation on
student loan refinancing.
Conclusion
The FFEL Consolidation Loan Program is an important part of the
Higher Education Act reauthorization. The Consolidation Loan Program's
benefits and costs are not easily measured, and continually revised
interest rate projections and different methodologies result in a
myriad of numbers. I hope these two reports and these updated estimates
provide the Committee with useful information for your deliberations,
particularly the important considerations that:
<bullet> Consolidation student loans are not all alike from a cost
perspective. The net cost of future consolidation loans will be much
less, even positive, compared to the estimated cost of the current 3.5%
loans.
<bullet> The reported cost of the Consolidation Loan Program will
be overstated unless lender-paid loan fees, the net cost above the cost
of the otherwise underlying Stafford/Plus loans, the discounted present
value of future cash flows, and government interest rate projections
are included in the analysis.
That concludes my testimony. I would be happy to answer any
questions about my testimony and the two consolidation loan studies.
[Attachments to Dr. Neubig's statement follow:]
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Chairman Boehner. Thank you, Dr. Neubig.
Dr. Shapiro.
STATEMENT OF ROBERT J. SHAPIRO, CHAIRMAN, SONECON, LLP AND
SENIOR FELLOW, BROOKINGS INSTITUTION AND PROGRESSIVE POLICY
INSTITUTE, WASHINGTON, D.C.
Dr. Shapiro. Mr. Chairman and members of the Committee,
it's an honor to be here today. I have come to discuss a new
study which my colleague Dr. Kevin Hassett and I conducted to
analyze the long-term costs of the current student loan
consolidation program.
There is no doubt that Federal student loans are a great
success. More than 62 percent of high school graduates go on to
higher education, and one of the reasons is that we provide
more than 7 million students and parents, like Mr. Hamlett,
more than $50 billion a year in Federal assistance.
The loan consolidation program, however, is different, and
not only because it doesn't actually help anybody go to
college.
To limit public costs, and so maintain strong public
support, underlying student loans carry interest rates that are
adjusted annually. This limits the subsidy and ensures a stable
relationship between the price of the funds to the students and
the cost of the funds to lenders.
But under the consolidation program, former student
borrowers consolidate their loans at a subsidized rate that
remains fixed for up to 30 years. This fixed interest rate is
the source of a problem which could well cost taxpayers tens of
billions of dollars over 20 years, perhaps much more.
The greatest costs occur when market interest rates have
fallen sharply, as they did over the last 3 years, and then
rise again.
Unless our economy enters a sustained period of economic
stagnation, it is virtually certain that over the next three,
five, or seven years, market interest rates will return to the
levels of the 1990's, or worse, the 1980's, if serious
inflation were to occur.
When that happens, those who consolidated their loans in
2002, 2003, and this year, will still pay interest based on the
1 percent Treasury bill rates of this period, while those who
lent them the funds will receive payments from the government
based on market rates that have become much higher. The gap
between the locked-in fixed rate and the potential future
commercial paper rate is what determines the additional cost of
this program.
Estimating the taxpayer's liability here is
straightforward--apply a baseline projection of interest rates
to the stock of outstanding consolidated debt--but it's not
simple.
For example, loan consolidations are not distributed
evenly. They rise when interest rates are low, and decline when
rates are relatively high. From 1995 to 2001, about 211,000
students a year consolidated FFELP loans. In 2002 and 2003,
with low interest rates, the average jumped to 964,000 a year.
From 1995 to 2001, when the interest rate for a typical
consolidation loan was 7.9 percent, consolidations averaged
about $5 billion a year. As the interest rate fell to about 4
percent in 2002 and 3.5 percent in 2003, the total jumped to
almost $23 billion and $35 billion, respectively, rising from
$5 billion a year to $35 billion.
To analyze these costs systematically, we applied
simulation procedures to generate the most likely paths of
future interest rates, based on historical experience.
Let me say we would have preferred to use CBO.
Unfortunately, the CBO forecast ends 5 years out, and then
simply assumes a stable interest rate environment at that
level.
We also constructed estimates of the likelihood of possible
deviations from these paths.
The results show that the commercial paper rate will likely
rise to more than 5 percent in the next 4 years, and then range
from 5.6 to 5.9 percent. Let me say that for the years in which
CBO was estimating, and we were estimating, our approach
produced an interest rate path entirely consistent with CBO's
forecast.
We also found that the stock of outstanding debt for
consolidated loans is more than $100 billion today. It's
expected average lifetime is nearly 21 years, and the average
fixed rate is 5.52 percent.
With these results, we could calculate the cost to
taxpayers.
Given the most likely future path of interest rates,
taxpayers will pay almost $14 billion over the next 20 years to
subsidize the interest on the existing stock of consolidated
loans, and if interest rates are 2 to 3 percentage points
higher than that--that is what economists call one standard
deviation, an outcome consistent with historical experience--
taxpayers will pay more than $48 billion to service the current
stock of loans.
We can also estimate the cost of future loan
consolidations, assuming that the program is unchanged.
Remember that the high cost associated with the current stock
of consolidated debt came about because interest rates fell
after rising sharply, and then rose again. This will occur
again, and it will affect future loans, and when it does, those
costs will also be high.
We estimate that loans likely to be consolidated over the
next 8 years will cost taxpayers another $36 billion in subsidy
payments over a 20-year term.
One final point:
While student loan programs generally provide equal
subsidies to all students, the consolidation program produces
very large inequities.
The basic problem is that, since the interest rate on these
loans rises or falls each year and then remains fixed for the
life of the loan, the long-term cost of the consolidated loan
to the former student depends on when he or she happens to
consolidate. This produces large disparities in interest costs.
For example, $22,000 in student loans consolidated in 1995
or 1996 will cost a former student borrower $25,000 in interest
over 20 years. That's three times the 20-year interest cost of
$8,600 for the same debt consolidated in 2003. It simply
depends on the moment you consolidate, which is usually the
year you happen to graduate from college.
The current program will generate tens of billions of
dollars in taxpayer costs, along with significant equities. You
can address both problems by shifting the program from a fixed
interest rate to annually adjusted rates, and if the program is
not reformed, taxpayers may not be the only ones bearing the
cost.
As government payments for consolidations rise sharply, as
they certainly will, these costs could squeeze out some of the
underlying loan programs. At a minimum, reforming the loan
consolidation program so that the interest rates on these loans
adjust annually, as they do for all other student loans, will
save billions of dollars that could be available for future
college students.
Thank you.
[The prepared statement of Dr. Shapiro follows:]
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------
Chairman Boehner. Let me thank all of our witnesses for
their excellent testimony.
Mr. Hamlett, we appreciate your coming in, not feeling up
to speed, and let me assure you that you will have no problem
consolidating your loans. I'm sure you're getting all types of
marketing phone calls already getting you all set up for the
day you graduate, and you can go ahead and lock in these
historically low rates.
Now, before we get too far into this, my good friend, Mr.
Kildee, in his opening statement, talked about, well, we need
to do a lot on access, but, you know, we also need to help all
of those who are out of school, as well. While we would all
like to be Santa Claus, you know, we can't be. We got elected
to Congress to be decisionmakers in the public policy arena,
and regardless of what the size of that pie is, there is some
limit to the size of the pie, and we're elected to make
choices.
So if, in fact, our goal with the Higher Education Act is
to help low to moderate income students attend a college or
university of their choice, we need to make sure that we are
meeting our goal in providing the tools for those qualified
students to attend an institution that they wish to attend, and
that means that we need to make choices as we begin to
reauthorize this program.
Ms. Ashby, you pointed out in your testimony that these
consolidated loans do, in fact, receive considerable subsidies.
Dr. Neubig, in his testimony, said, in effect, and I will
paraphrase this--if I am incorrect, Dr. Neubig, certainly
correct me--that the fees paid by lenders are, in the short
term, outweighing the subsidies, and long-term, that it's
basically a wash.
Are you in agreement with this?
Ms. Ashby. Well, I am not sure about the wash and the long-
term.
It is true that the fees--and we're talking about the
annual 1.05 percent, I presume--that the annual fees do reduce
the net outflow to the government and, in that way, reduce the
taxpayer's ultimate cost. But based on the work we did, we
didn't--we took the Department of Education's numbers, and we
looked basically at loans that were consolidated in fiscal year
2003, and we looked at the difference between the subsidy cost
for those and loans consolidated the prior year, prior fiscal
year.
So I really can't comment on Dr. Neubig's study.
Chairman Boehner. Ms. Ashby, Dr. Neubig, Dr. Shapiro, do
you, any of you, disagree with the fact that interest rates are
likely to rise?
Dr. Shapiro. No. Certainly not.
Chairman Boehner. Dr. Neubig?
Dr. Neubig. I guess I don't take a position, you know, in
terms of what's going to happen. I guess I am buying inflation
index bonds at the moment, and clearly OMB and CBO both
forecast higher interest rates.
Ms. Ashby. I am certainly in no position to disagree with
the experts.
Chairman Boehner. So we all agree that interest rates are
going to rise, and we know that if interest rates rise, someone
has to bear that risk. Nobody disagrees with that?
So the question is, who should bear the risk? And whether
the loan was made in 2001, 2002, 2003, or, for that matter,
2006, there is risk that someone has to bear, and there are the
three parties that could bear that risk.
They could be the government, they could be the lender, or
they could be the graduate, the student--not the student, the
post-student years. Those are the three categories.
Now, it will not be the lenders, because they sell off
these, they are pretty well insulated, and if they are not--if
they are exposed to this risk, they probably will not make the
loans. So we can take them out of the equation pretty quickly.
So now we are down to two parties who are going to bear
this risk. Is it going to be the Federal Government and/or,
let's be honest, the taxpayers, or is it going to be people who
have graduated from college bearing that risk?
Now, for those who have received student loans, let us
review the bidding.
The Federal Government provided them, in many cases, a
student loan, whether it be subsidized or unsubsidized. In many
cases, we bore the interest for those subsidized loans during
the life of that student being in school, or at least deferred
the interest for those unsubsidized loans.
After they are out of school, we provide a 6-month grace
period, where there are no payments required, and if the
student wants to, and has multiple loans with multiple lenders,
we allow the student to consolidate those loans to make one
payment.
We also provide for extended repayment in many of those
cases, especially for large loans, over a longer period of
time.
Not only has the Federal Government provided all of this
while the student is in school and for a short time after they
are at school, all the way through these guarantees--these are
all guaranteed loans.
You do not have to apply for them, you do not get rejected,
they are guaranteed, and there is a cost for that guarantee, so
we have subsidized all of this for students until such time as
we believe that most of them are out of school and into the
work force.
I guess the question I am asking the panel is, is it fair
to expect the student to bear that risk of what interest rates
may be in the future--that graduate to bear those risks--or
should the taxpayers continue to bear that risk?
Dr. Shapiro?
Dr. Shapiro. Well, I just want to note that students bear
the risk if they happen to consolidate when interest rates are
high.
That is, there are--the reason that the program has thus
far shown a generally positive cash-flow is because, every year
except one, the consolidation loan rate has been falling. The
problems arise in this program after the rates have fallen and
then they begin to rise again.
So, of course, if you only look at a period in which
interest rates are falling, have been falling, and the
consolidation loan rate has been falling, you're going to get a
kind of rosy scenario.
The fact is, we are subsidizing consolidation loans as well
as the underlying student loans. The fact is that students are
not bearing an even risk today.
When Dr. Neubig said that, based on the CBO interest rate
forecast, that moving to a variable rate would double the
interest costs of students who are consolidating today, the
implication of that is that students who consolidate later will
be paying double the interest of those today, which is, indeed,
what's happened in the past.
We have the interest burden paid by someone consolidating
this year is one-third the level of the interest payment borne
by someone who consolidated 6 years ago. So, students are
bearing a risk, depending on when they happen to graduate. In
fact, the risk would be equalized if everyone's consolidation
loan rate were to be adjusted annually.
Chairman Boehner. Dr. Neubig?
Dr. Neubig. I guess I do not have a view, in terms of who
should bear the interest rate risk. I guess I think there is
the possibility that it's more than just a choice between
taxpayers and the government.
Currently in the residential mortgage market, we have
private sector lenders offering both variable rate and fixed
rate 15-year and 30-year mortgages, and as a result of advances
in the mortgage markets, they have been able to, you know,
hedge those risks to people who are willing to accept those
risks.
So I think it's more than just a choice between taxpayers
and the government.
Chairman Boehner. Are home mortgages, are those subsidized?
Are they guaranteed?
Dr. Neubig. No, they are not, in most cases, but even on
the private sector side, there are advances in the markets, you
know, that allow some of this interest rate risk to be taken by
people who are willing to accept the risk.
Chairman Boehner. The chair recognizes the gentleman from
Michigan.
Mr. Kildee. Thank you very much, Mr. Chairman.
We have a vote going on over in the House, and I will have
to leave shortly, as all of us will, but let me ask this, so we
can get this on the record.
For students who will consolidate their loans in the next
few years--and without using your crystal ball, just your own
best guesstimate--would changing consolidation interest rates
from a fixed to a variable rate make student loans more costly
for students?
Let me start with Dr. Shapiro and go down.
Dr. Shapiro. It would make them more costly for students
who consolidated today, and probably less costly for those who
consolidated later, when interest rates were high, as interest
rates fell again.
Mr. Kildee. Dr. Neubig?
Dr. Neubig. Again, based upon the CBO projections, it would
increase the cost of students taking out consolidation loans
probably in 2003, 2004, and probably 2005, 2006. At some point,
you know, they will stabilize.
Mr. Kildee. Mr. Hamlett?
[No response.]
Mr. Kildee. You can pass if you want. We do that around
here, too.
Mr. Hamlett. I'm not really an expert on this particular
issue, so I'm just going to speak from my personal experience.
Having a fixed low interest rate would definitely help me, in
particular, and a lot of other American families.
I think that changing it from a fixed interest to a
variable interest rate is going to cost families money, and to
me that's just something that you wouldn't want to do to middle
to lower income families.
Mr. Kildee. Ms. Ashby?
Ms. Ashby. In the simplest case, without considering all
the various factors, and presuming that the experts are right
that interest rates are not likely to go much lower than they
are today, and that they will increase in the future, going to
a variable rate will increase the costs for students.
But one of the other factors is the length of time the
student holds that loan, and one of the advantages, for some
students anyway, is a longer payment period, and of course,
over a longer payment period, you're paying more interest over
the life of that loan.
Mr. Kildee. Thank you, Mr. Chairman.
I believe I will go over and cast my vote now.
Chairman Boehner. Well, we do have several votes on the
House floor, interrupted by 10 minutes worth of debate. I would
suggest that the earliest we would be back here would be about
noon.
So the Committee will stand in recess until about 12.
[Recess.]
Chairman Boehner. The Education and the Workforce Committee
will come to order.
Sorry for the delay. Unavoidable, though.
The chair recognizes the gentleman from Wisconsin, Mr.
Petri.
Mr. Petri. Thank you very much.
Thank you all for your testimony, and the work that went
into your prepared statements, as well.
I wonder if it would be possible to explore an area that
was hinted at in Dr. Neubig's recent answer.
We probably--do you agree or disagree that there is a
problem with the consolidation in that there is a mismatch
between a long-term repayment and a short-term number, and in
the mortgage area and others, they peg a long-term block into a
longer-term bond, so that it's anyone's guess what interest
rates are going to be, but that guess is not made by the
financial institution or the lender, they lay that off on the
market and collect their margin to stay in business.
Would that be a more appropriate fix of this problem, or
what would the implications of trying to emulate, you know, the
student loan consolidation lock-in area, what is done in the
rest of the world, be?
Borrowers are familiar with the options they have now with
refinancing and mortgages and various periods of time.
I don't know what the average student loan repayment is,
but that wouldn't be hard to determine. It's probably somewhere
between--around 10 years, or something like that.
So we could pick a number in the Treasury world and add
some points for overhead or whatever, and let them lock it in
at that, and then, well, it wouldn't be subsidized by the
Treasury or the taxpayer. We could figure out a way of it being
subsidized by an insurance company or whoever buys the parallel
private bond.
Would you care to comment on whether that would be an
appropriate way to approach this?
Dr. Neubig. I think as you identified, there is some
mismatching, you know, between sort of the asset and liability
side in the current program which is causing, you know, the big
positive, big negative, big positive, and there are ways of
addressing it beyond just moving to a variable rate.
Things that are being done in the financial markets are
something that I think the Committee should perhaps explore. I
haven't analyzed, you know, what those might be, but I think it
isn't just, you know, a win-lose situation between the Federal
taxpayer and the student.
Mr. Petri. How would you suggest we go about getting some
help in doing this appropriately? Dr. Shapiro, do you have a
comment?
Dr. Shapiro. Well, you know, I do. You know, I think your
comment about the mismatch is very apt.
It is--part of what we did in our study was to look at a
most likely, what we considered a most likely case, and then
less likely, and nightmare scenarios--how bad can it get--and
there is a range.
When it gets very bad, it is--and indeed all the costs here
arise out of this mismatch--it is essentially the same problem
in form that we saw in the S&L crisis, and that we saw in the
Asian financial crisis, and that is borrowing short and lending
long.
Over interest rate cycles, it might even out if
consolidations occurred evenly, but of course, they don't.
That is, they rise enormously when the rates are very low,
in order to lock in the rate, and that's what causes this
disproportionate problem. It does go positive, negative,
positive, negative, but the negatives are a lot bigger, because
the volume is so much greater at the low rates than of
consolidation than at the high rates.
Mr. Petri. Dr. Neubig, did you have a further comment?
Dr. Neubig. Well, this is an area I would certainly be
eager to explore, because we do have one solution, but it may
not be the optimal solution from the point of view of the
students and the government and the taxpayer. We are in the
business of not just saving the taxpayer money, but trying to
make this a user-friendly program.
I think people would understand they had to pay a higher
rate for locking in a longer-term mortgage, because they face
that every day in the marketplace, and they can make the choice
and decide what is most appropriate in their own--given their
own financial circumstances, but denying a long-term lock-in to
students as one option seems to me to be giving up something
that is beneficial to a lot of people.
Chairman Boehner. The chair recognizes Mr. Andrews.
Mr. Andrews. Thank you, Mr. Chairman.
I would like to thank the panel for its patience during our
vote.
Mr. Hamlett, let me say you did great, you did not sound
nervous at all, and as a student at the University of Maryland,
I am sure that you are aware of the fact that the reason for
the Terrapins' recent basketball success is because their
coach, Gary Williams, grew up in South Jersey, in my
congressional district.
[Laughter.]
Chairman Boehner. And trained as a good coach in Ohio.
[Laughter.]
Mr. Andrews. Well, Ohio is where you go to train, and New
Jersey is where you go to excel.
[Laughter.]
Mr. Andrews. That may just cut my time. I am sure that does
not come off my time, Mr. Chairman.
Chairman Boehner. If I recall, there are some games this
weekend that we may want to discuss.
[Laughter.]
Mr. Andrews. OK. We may discuss, but never wager, because
that is illegal.
Chairman Boehner. Not between friends, it is not.
Mr. Andrews. That is true, and that would be a legal wager
based on that principle.
I very much appreciate the witnesses' testimony on this
very complicated subject.
Ms. Ashby, I had a chance to read the GAO report that you
wrote, or led the authorship of. As usual, it was exceptionally
excellent from the GAO. I wanted to ask you to characterize a
couple of conclusions that I think I drew.
Is it accurate to say from your report that people who
consolidate their loans as a whole are higher-income, when
compared to the student lending population generally? Is that
correct?
Ms. Ashby. Well, we are looking at consolidators versus
non-consolidators.
Mr. Andrews. Right.
Ms. Ashby. So yes, those who consolidated their loans
tended to be higher income.
Mr. Andrews. I think I read that 39 percent of the
consolidators had incomes in excess of $50,000 a year. That is
in your report?
Ms. Ashby. I don't have the numbers, but my colleague is
saying yes.
Mr. Andrews. The other thing I think I read in your report
is that consolidators are more likely to be people that went to
graduate school than people who did not, relative to the rest
of the lending population.
Ms. Ashby. For consolidators, a larger percentage, yes, had
gone to graduate or professional schools.
Mr. Andrews. I believe it was 28 percent had done some
graduate school borrowing, as compared to 12 percent of the
non-consolidators, if I read the report correctly. So that's a
fair characterization of the people who were consolidating.
If I were writing the budget resolution, which I am not, I
would have a very different set of choices here.
I would not have a tax cut nearly as big as the one that we
have, and I would choose to fund a very liberal consolidation
program, as well as significant increases in support for
students who are in school, and if that were the budget
resolution before us, that's what I would do. It isn't.
Realistically, the choice in front of us is what to do with
very scarce mandatory spending higher education dollars, and I
particularly want to focus on that choice with respect to
minority students and the consequences of the choice we have
between liberal consolidation and other choices that we might
make.
Dr. Shapiro, first of all, I appreciate the great work you
did in the Clinton administration over all those years, and I
wonder, do you have a number on your projected cost over the 5-
year future that we're legislating for for the present
consolidation regime?
In other words, if we didn't change it, just left it where
it was, how much do you think that costs the Federal Treasury?
Dr. Shapiro. Well, we have an estimate of the lifetime cost
of loans which we believe will be consolidated over the
following 7 years, and that estimate is about $21 billion.
Mr. Andrews. About $21 billion.
Is it accurate to say that if we made a change to variable
rate consolidation, if, that most of that $21 billion would
then, in effect, be saved, would be recaptured?
Dr. Shapiro. The majority, and it would depend on how you
designed the variable rate program.
Depending on how you designed it and how you adjusted the
fees paid by consolidators, you could go anywhere from a system
which converted it all to savings to one which converted part
of it to savings.
Mr. Andrews. If, as I suspect, we are in a position where
we have to design a bill that is budget-neutral, that doesn't
increase mandatory outlays for higher education, in effect that
gives us a pool of money somewhere short of $21 billion that we
could look at spending by making the reduction in outlays,
which could be offset by an increase in outlays, one of the
increases in outlays I would be interested in would be an
abolition of the origination fees that students pay.
Mr. Hamlett, you have done some extensive borrowing. You
are aware of the fact that there is a 3 percent origination fee
each time you borrow a student loan that you tack on, which is
a lot of money.
I did some research on origination fees, looking at
subsidized loans, and one of the striking statistics is that
86.8 percent of African American students get a subsidized
loan, and 86.8 percent of Hispanic students get a subsidized
loan; so one of the consequences of eliminating origination
fees is, it would have a substantially positive impact for
minority students who are in school.
Dr. Shapiro, would you agree or disagree with that
characterization?
Dr. Shapiro. I would absolutely agree with that.
It is--there are--the student loan consolidation program
does not affect all kinds of students equally.
It is--consolidators tend to be people with larger student
debt, as GAO established. They tend to be people who have gone
to graduate school, because those are the ones who pile up the
largest debt.
The average debt of the current stock of consolidated
loans, which includes loans which have been half paid off, for
example, is $22,000. That is greater than the maximum an
undergraduate could borrow under the FFELP program.
Mr. Andrews. In the difficult choices the Committee faces,
and there are no easy answers to this, one of the things I'm
going to be looking for and paying attention to is which
expenditure of these scarce dollars does the most to help
moderate income students generally, minority students who have
traditionally not had the access that other people have had to
higher education.
I favor the abolition of origination fees. I favor the
expansion of income-contingent and income-sensitive repayments,
so that students like Mr. Hamlett, who may want to take a
career in public service, would not be penalized for doing so,
and frankly, I also think we have to look at higher loan limits
as a way to help people bridge the gap between the shortfall in
Pell aid and the realities of rising tuition.
You know, again, in a world that I would create, we could
do both that and very liberal consolidation, but in a world
where we have to choose how to allocate the scarce dollars, I
think those are issues that we have to focus on.
Thank you, Mr. Chairman.
Chairman Boehner. The chair recognizes the gentleman from
Michigan, Mr. Hoekstra.
Mr. Hoekstra. Thank you, Mr. Chairman.
I have a statement I would like to just submit for the
record.
Chairman Boehner. Without objection.
[The prepared statement of Mr. Hoekstra follows:]
Statement of Hon. Pete Hoekstra, a Representative in Congress from the
State of Michigan
Mr. Chairman, I want to thank you for convening this hearing today.
The issue of a strong loan consolidation program has been very
important to me for many years. We should make no mistake; federal loan
consolidation is an essential tool for making higher education more
affordable for students. It is a program with proven results for
students.
As we've heard from our witnesses today, federal consolidation
loans allow recent graduates to refinance their multiple underlying
student loans into a single, fixed rate loan with a lower monthly
payment. The federal student loan consolidation program benefits
borrowers in all walks of life, and public support for this program is
broad.
With the cost of higher education growing, today's college students
graduate with an average student loan debt 66% greater than 6 years
ago. The problem can be even more acute for those completing
postgraduate and professional programs, many of whom graduate with debt
in excess of $100,000. As a result, a significant number of graduates
at all levels see their debt as unmanageable, and consequently, as
imposing limits on their career choices. A more manageable monthly
repayment obligation is an important factor both in opening up those
choices and in averting student loan default. Loan consolidation is
especially essential in removing the barriers that student loan debt
presents to those college and professional school graduates who want to
work in the public and non-profit sectors of the economy. It is
noteworthy that nurses and teachers combined were the largest group
taking advantage of loan consolidation during the last 5 years.
The widely popular federal student loan consolidation program
(utilized last year by more than 726,000 student borrowers) has proven
beneficial to the federal government as well. In the last fiscal year,
the 0.5% lender-paid origination fee on consolidation loans generated
$210 million to the federal government. Consolidation lenders are also
required to pay a 1.05% portfolio fee/tax each year to the federal
government on the outstanding principal of all consolidation loans held
by the lender. That is, each outstanding consolidation loan generates a
lender-paid fee each year to the federal government. This fee does not
apply to other student loans. Over the past 7 years, the revenue to the
federal treasury from these origination and portfolio fees has totaled
nearly 2 billion dollars.
Fixed rate consolidation loans work for student borrowers. We
should not attempt to change the program to variable rates without
seriously considering the impact of this change on students. It is
imperative that the loan consolidation program be preserved and
expanded as a vital element in graduates' efforts to cope with student
loan debt. I thank the Chairman for this hearing and pledge during our
Reauthorization of the Higher Education Act to work closely with the
Chairman and my Committee Colleagues to ensure that the Committee's
legislation includes a strong federal student loan consolidation
program.
______
Mr. Hoekstra. I want to build off a little bit of what Mr.
Petri was talking about.
Why couldn't student loans be worked much like you work the
home mortgage?
For somebody who is willing to take the risk, you get a
variable rate mortgage. For those who, you know, want a lower
interest fixed rate, they may go to a 15-year, and for somebody
else they go to a 30-year. Why couldn't the same kind of
formula plan be put in place for student loans?
For anybody on the panel.
Yes.
Dr. Shapiro. You could, Congressman. It would maximize the
budgetary costs.
Mr. Hoekstra. Why would it maximize the budgetary costs?
Dr. Shapiro. People consolidating at a time of high rates
would choose variable rates, which would reduce their payments
as interest rates came down, and those consolidating in a low
interest rate environment would pick fixed rates.
Mr. Hoekstra. I do not think you are understanding what
the--
Dr. Shapiro. OK.
Mr. Hoekstra. I mean, if you consolidated a low interest
rate, where it says, ``This will be your interest rate for 7
years,'' it is not going to be adjusted. My 15-year mortgage at
home is not adjusted every year.
So that then becomes the fact of life for the person who is
loaning the money, that you have agreed to the loan at this
rate for 15 years.
Dr. Shapiro. Right.
Mr. Hoekstra. So why would that maximize the cost to the
Federal Government? It would no longer cover the difference.
Dr. Shapiro. Where the Federal Government would no longer
cover--if the interest rates go up, the payments to the lenders
rise with interest rates. Whether or not--
Mr. Hoekstra. No, that is not what I am saying. They would
not rise to the lender.
Dr. Shapiro. Oh. Well, then I think you would have--I do
not know. I would guess that you would have some difficulty
getting private lenders into this market.
Mr. Hoekstra. Why? I mean, you do not have trouble getting
people into the mortgage market.
Dr. Shapiro. Yes, but students have traditionally,
typically, very few assets--
Mr. Hoekstra. But it is a Federal guarantee.
Dr. Shapiro. --no salary history. They are not good credit
risks, which is why, in the private market--which is why we
subsidize it in a public market.
Mr. Hoekstra. But I mean, it is still a guaranteed loan, in
terms of for the principal.
Chairman Boehner. If the gentleman would yield?
Mr. Hoekstra. Yes.
Chairman Boehner. Think about it this way.
We would still have the guarantee for the lenders, the
guarantee, but if the variable rate or the fixed rate floated
at market levels, it would seem to me it would take away the
risk in the marketplace, and the lender could choose.
Is there a way that that would work?
Now, Ms. Ashby, maybe you could shed some light on this.
Ms. Ashby. Well, I am speculating, of course, because no
one has done a study of this, as far as I know.
I don't know. I mean, it is possible that it would work if
lenders, as Dr. Shapiro said, if there were lenders that were
willing to accept such a system, and to make it clear, there
would be no guaranteed lender yield, then.
Is that what you are saying, that there would be the
government guarantee as we currently have, but no guaranteed
lender yield for the FFELP program?
I don't know. It is possible that this might work.
Mr. Hoekstra. I mean, what happens in mortgages is, you
know, you shift the risk, and if we're interested in shifting
the risk from the Federal Government, this is one way of doing
it.
Ms. Ashby. Then lenders would--yes. I mean, currently the
taxpayer or the Federal Government is the only group that has
risk, really.
Students with the current low interest rates have very
little risk, since it is very unlikely the rates will go lower,
and lenders bear almost no risk, because of the guarantee and
their guaranteed yield--
Mr. Hoekstra. Right.
Ms. Ashby.--and the guarantee of repayment, so it might
shift the distribution somewhat.
Dr. Neubig. I think, Congressman, that you have a number of
different policy instruments or variables that you could make
adjustments to that might mitigate some of the risk.
I guess, looking over the last 16 years, we found that the
current fixed rate of consolidation loans probably is cost-
neutral, and the reason is because there is also a lender fee
that offsets that.
Now, I thought I heard you perhaps suggesting that in the
residential mortgage market, people who take out a fixed rate
mortgage currently do pay maybe 100 basis points more than
someone taking out a variable rate.
Mr. Hoekstra. Right.
Dr. Neubig. Currently, you know, consolidation loans only
have the option of a single fixed rate, and it's exactly the
same, other than the one-eighth of a percent rounding up, to
the variable Stafford loan.
So I think both in terms of the rates and also, you know,
the fee, you have got to factor those into the analysis and the
options that you have, in terms of trying to make improvements
to the program.
Mr. Hoekstra. Yes, but I am--yes.
I think the bottom line is, you could go to some type of
more market-based access for the dollars, and students at that
point in time, depending on what lenders made available, you
know, they could at that point in time choose whether they
wanted to go variable rate or whether they wanted to go to a
fixed rate for a certain period of time.
Chairman Boehner. The gentleman's time has expired.
Mr. Hoekstra. Thank you, Mr. Chairman.
Chairman Boehner. Mr. Miller?
Oh, Mr. Tierney is recognized for 5 minutes.
Mr. Tierney. I am happy to yield to the Ranking Member, if
he wants.
Thank you, Mr. Chairman.
You know, I listened to all of the conversation, and it
seems that the only choice that is being presented is to cut
the support for subsidies and increase the cost for students
that graduate so that now we will have, you know, students that
graduate paying enormously higher loan rates on their loans
over a period of time, as well as having difficulty having
children or students fund their way through college to begin
with.
This is a fairly profitable area. I mean, look at Sallie
Mae, who deals primarily in student loans. They are a pretty
big bank, and they make a lot of money.
So I am wondering a little bit why we do not look at the
element of dealing with the people that are making the money as
lenders, why aren't we looking at their aspect of this, so that
perhaps there is money to be had there from the situation,
instead of just cutting the subsidies.
What do people think about that, going at that end of it?
We can start--anybody that wants to step forward, we can
start from right to left or left to right.
Sir?
Dr. Neubig. Well, I guess looking over the last 16 years,
the lender-paid fees roughly equal the special allowance
payments, and--
Mr. Tierney. The special what payments? I'm sorry?
Dr. Neubig. The special allowance payments, the interest
subsidy.
So over the long term, there are lender-paid fees, and that
has been profitable to the U.S. Treasury for the last 8 years
and will be, you know, profitable probably for the next two or
3 years. It has sort of averaged out over the cycles.
So they already--you know, there is a potential risk, but
part of the interest rate risk is that interest rates are
unlikely to go up to double-digit levels for extended periods
of time.
They might go up for--they did go up during the oil shocks
of 1973 and 1979, but it looks like the current program, with
its lender fees, does get payments that are offsetting the
interest subsidies.
Mr. Tierney. Wouldn't we want to move in a direction to
make sure that that is ensured as we go forward, and not run
the risk of having that fall into a contrary situation?
Dr. Neubig. I guess part of the question is we are using
the CBO interest rate projections in terms of looking at the
future for the next 5 years, and looking at it over the life of
the loans.
You know, if you think that things are going to get, you
know, much worse than what CBO and OMB are predicting, then
perhaps you should consider some additional things, but a lot
of other things will get enormously worse if we have, you know,
double-digit short-term interest rates for, you know, the next,
you know, 15 or 20 years.
Ms. Ashby. As the discussion always gets around to in this
area, it depends on what you believe will happen to interest
rates and what assumptions you make about various payments and
what's likely to happen.
Given what you have proposed, assuming that lenders would
still be--and assuming that we continue with two programs, the
direct loan and a guaranteed loan program--that lenders would
be willing to loan money to students and their parents in the
market without, either without a guaranteed yield or with a
guaranteed yield that is somewhat different than the current
one, and that is--
Mr. Tierney. Well, given how profitable they are, I think
it is a pretty fair assumption that they will continue in the
game.
Ms. Ashby. Well, that is the issue, and the work we did, of
course, did not address this directly because we were not
looking at that.
But we certainly, in recommending that the Department do an
assessment of the consolidation programs, that is certainly an
option and something that should be considered.
Mr. Tierney. Well, I mean, why hasn't anybody looked at
that, I guess?
We are sitting here, we are testifying here today. It seems
to me that that would be an area that we would hone in on. This
is a profitable area.
We have one of the largest bank institutions in the world
doing primarily this type of loan, and no matter how much
people want to complain that it's a bad deal, it seems to be a
pretty good deal, so it seems to me that we would look at that
and talk about what could be done there.
If they are not willing to do it, then we could do direct
loans, but my feeling is there will be more than enough people
lining up for this market. Everybody is just doing what
businesses do, trying to make sure they get as much profit as
possible.
Mr. Miller. Will the gentleman yield?
Mr. Tierney. I will yield.
Mr. Miller. Just on that point and Mr. Hoekstra's point
earlier, there have been a number of suggestions--I am sorry, I
have been in and out of this hearing.
But in the time I have been here, there have been a number
of suggestions from different members about, isn't there a way
that the students could have more choice, or they could--this
thing could look more like the mortgage market.
But what is before us, I guess, is sort of a suggestion
that we are going to take this program and we are going to
convert it to a variable rate program, and we are going to go
on about our business, and there will be some huge savings, and
that would be converted to help other students as opposed to
the graduating students.
I am kind of struck each time these questions get asked.
Ms. Ashby, you keep suggesting we really do not know,
because we have not looked at the particulars of the impact of
this over a period of time.
You can tell us what has happened historically, but if you
were to change the mix, the suggestion is that there are only
two groups of people here. You can shift the cost between those
in school and those out of school, and somehow that is the
choice--or the taxpayer.
But there is also, as Mr. Tierney pointed out, there is the
question of the fee structure. Should that be modified or not
modified?
It's modified so a student can have a choice and make those
decisions and decide, based upon what they think their career
opportunities are going to be, or what their immediate
lifestyle. They can take a choice. One might be higher than
another, one fee might be different than the other. I do not
know.
All I see is, I think the group of lenders are saying, ``We
want to hold onto this the way it is, and it will not work any
other way.''
Well, you are just deciding to dump thousands of dollars of
additional interest cost on the backs of people, depending on
where they show up, which is a decision they do not make.
That, you know, that is not just a ``Well, I am out of
school now, so now I am going to make a fresh decision,'' when
people look at, ``Am I going to school, what is my lifetime
cost, what is my lifetime opportunity, what is my lifetime
revenues, does this make sense for me?''
So to pretend like these are two different audiences, these
are just the same people at a different place in their life,
and they have got to make those adjustments.
We spend a huge amount of time here talking about forgiving
loans to people because they can't make choices to become
policemen, firemen, teachers, nurses, and what have you--we
really do not do that, we talk about it more than we do it--but
we recognize that the cost of paying off loans impacts people's
decisions and works against the public interest.
So why is it we are just now, without a lot of evidence,
suggesting we are just going to throw this onto these people
after they graduate?
And I think the answer is, we do not know. Maybe we should
be asking the department or somebody else.
I mean, we sort of have dueling studies here, both of which
each side can raise questions about, but we ought to be asking
something else before we decide we are going to saddle these
students with, with apparently very little notice, that all the
sudden the cost of their education could increase dramatically.
As you pointed out, you are buying interest index bonds.
You know, somebody thinks this is going in the other direction,
and so their costs are going up. They have already incurred the
debt. We are now just restructuring what the cost of that debt
is going to be to them.
I think we ought to know a lot more about this before we
just dive off this cliff and we start ruling out who is a
participant and who is not a participant. We do not know enough
about this, at least from what I see, in terms of the questions
from the members.
Maybe you do, and maybe I am wrong, but it seems to me the
answers keep coming back from that side of the table, ``We need
more information. We would have to know more about this if you
want to structure it this way or not.''
That is a comment, you do not have to respond to it, but I
think this hearing has pointed out a real dearth of information
here that could be helpful to the members.
Chairman Boehner. The chair recognizes the gentleman from
California, Mr. McKeon.
Mr. McKeon. Thank you, Mr. Chairman.
Actually, the students that graduate this year, probably
when they started school four or 5 years ago, were looking at
an 8 percent interest rate. Now they are looking at a much
lower interest rate. So this varies with time and with the
cycle of lending and borrowing.
Back to that mortgage comparison again. I think we need to
clarify that a little bit.
If you tried to compare a student loan with a--that is a
subsidized loan that is a government loan, for the most part--
with a mortgage that really is free market, I mean, any of us
can go out at any time and refinance our mortgage.
We might have to pay points, depending on what we get, and
we could get a fixed rate or we could get a variable rate, and
again, that would vary. There are all kinds of options, but
there is no government subsidy on any of that.
Now, when we talk about a student that graduates and then
wants to refinance or consolidate his loan, then it just seems
like there is not much of a comparison there.
Can you address that?
Dr. Shapiro. Well, the reason the comparison is hard to
make is that the interest rate, the fixed interest rate for
consolidated loans is not set by the market, it is set by the
government, it is set by law, and then there is, in addition, a
guarantee and a subsidy built into that rate.
Mr. McKeon. It has a rate and it has a top that it cannot--
Dr. Shapiro. Yes.
So that if I understood the proposal which was described 10
minutes ago by your colleague, sir, that you would have a
choice of a fixed or a variable rate, but that the subsidy to
the lender for the fixed rate would be reduced or eliminated,
then the lender would simply charge the borrower a higher fixed
rate.
Mr. McKeon. I am not sure I understood that, either. I do
not think he was--I cannot speak for him, but I do not think he
meant to eliminate the subsidy, but if you eliminate the
subsidy, then you are just going out and refinancing your loan
on the open market.
Dr. Shapiro. Right. Then it is a market.
Mr. McKeon. And then--
Chairman Boehner. Will the gentleman yield?
Do not forget, there is a guarantee here. There is a
guarantee on the part of the government to the lender that they
are going to get paid. Now, that is worth something.
Mr. McKeon. Yes, but what I was getting at is, if you
eliminate that guarantee, then you should be able to, you know,
go to the open market and refinance your loan; and I don't
think anybody has any quarrel with that. It is where you want
to refinance that loan and keep the guarantee and keep the
lower rate.
In other words, then the government and the taxpayers are
left on the hook for that cost.
Dr. Shapiro. We can certainly provide the guarantee and the
subsidy and a very, very low fixed rate. There is no way to
provide that without it having significant cost consequences.
I do want to make one point, and that is that--one
additional point.
We have not really been through a full interest rate cycle
with the consolidation program. We have only been--we have--
with 1 year of the last 8 years, the rate has been consistently
falling, so we have not had the experience yet of what happens
when you have very large rates of consolidation at very low
rates, what happens when the rates rise.
So when the--I guess I do not agree that we have seen that
there is a wash over the cycle, because we have not had the
whole cycle. We are about to enter it over the next three to 4
years.
Mr. McKeon. That was a question I wanted to ask Dr. Neubig.
We have had--the chart that we had up here from GAO showed
that as the interest rates have gone down, consolidation has
been really a big thing these last couple of years, and I was
wondering how you can guarantee these numbers going out into
the future.
Say that it is going to cost the government a lot in the
next couple of years, but then it will change. I guess that is
what you were talking about, Dr. Shapiro, about we have not
gone through that cycle and we really do not know how these
numbers are going to be until we complete that cycle.
Dr. Neubig. I definitely cannot guarantee these numbers.
I can tell you that they are based on the, you know, volume
forecasts of the consolidation loans, you know, from the
Department of Education and the CBO's interest rate
projections, and so it is linked to what the government is
assuming, and those assumptions affect a lot of other programs
besides the Consolidation Loan Program.
This is sort of the best estimate, based upon the CBO
interest projections. Clearly, interest rates do fluctuate, and
CBO does keep their rates stable at historical levels out
beyond 2010, 2011, and we know that they are going to bounce
around.
I guess, you know, part of a sensitivity analysis is
showing not only what happens on the upside, or the bad news,
but also what would happen on the downside, the good news, and
there is sort of a 50 percent chance that things would go worse
than the CBO projects and a 50 percent chance things would go
better than CBO projects, and so these numbers going out into
the future might be both too low, if things go south on us, or,
you know, the cost might be too high, you know, for these
current loans if interest rates were to stay at rates below
what CBO is projecting.
And you know, there are some forces in the economy, in
terms of, you know, concern about deflation, that might make
the, you know, interest rates be lower than what CBO--
Mr. McKeon. Wouldn't that argument lend itself, then, to go
to a variable rate, which would fluctuate with those changes?
Dr. Neubig. Well, that is one of the possibilities that you
have.
Chairman Boehner. The chair recognizes Mr. Miller.
Mr. Miller. Thank you, Mr. Chairman.
Ms. Ashby, in your testimony on if you consolidate through
the direct student loan program, that we earn--what is it, for
every $100 the government earns $1.12, or something? Is that
right?
Ms. Ashby. Yes. We did have an example in the testimony. I
have to look at it to get the exact numbers. Are you referring
to Table 2 in our testimony?
Mr. Miller. I had it here, but I do not have it.
Ms. Ashby. And we have updated the numbers in the
testimony, so they will be slightly different than what is in
the report.
Mr. Miller. Are we better off directing students to
consolidate through the direct program?
Ms. Ashby. Are we better off in terms of the taxpayer, the
government? Well, as with everything else, it depends on what
is going to happen with interest rates. It looks like today we
are, but depending on what happens in the future, in terms of--
and with the direct loan program, there are a number of
variables. There is the rate that the government pays to borrow
from the Treasury. There is the rate that is charged to
students.
I cannot give you a definitive answer on that. It would
depend on what happens with these various rates and how much
the interest spread is, and so forth. But with this example,
yes, $1.22 is lower than $1.59, but this is only for one cohort
at one point in time.
Mr. Miller. You are saying that to read your information
correctly, again, we have to know a lot more about the various
moveable parts in terms of the cost of borrowing money, and the
rest of that?
Ms. Ashby. Correct.
Mr. Miller. But potentially, in some environments, interest
rate environments, it would appear that it is better for the
taxpayer to have people consolidate through the direct program?
Ms. Ashby. Well, given the current interest rates and what
the rate was to borrow from Treasury at the time that these
numbers were calculated--and this is based on a Department of
Education re-estimate, we should have a report in October--that
would appear to be true, but as I said, the volume of loans
makes a difference. There are at least two interest rates that
come into play here.
So there is not a definitive answer to your question.
Mr. Miller. No, and I appreciate that.
I think that is part of the point I am trying to make here,
is that to make this single sort of dramatic shift, I am just
not convinced that we have the evidence that suggests that that
is the--that that should be done without further examination of
what truly makes sense for all the parties involved.
We are each presenting the scenario from one point of view,
saying, ``This is kind of the good way to go, based upon our
needs here and our needs here.''
But I think at some point the policymaker has got to kind
of look at all the parties and play out a number of different
scenarios. If low interest rates continue for a decade, or if
the interest rates move back to--if they tend back to norm, I
guess which they will over various periods of time, you would
want to know that.
Ms. Ashby. That's right, and that is why we recommended
that the Department do an assessment of the consolidated loan
program--
Mr. Miller. We are getting the bill ahead of the assessment
a little bit here. That is my problem.
Thank you.
Chairman Boehner. The chair recognizes the gentleman from
Florida, Mr. Keller.
Mr. Keller. Thank you, Mr. Chairman.
I kind of watch this debate as sort of like an umpire here.
I don't have a dog in this fight. I have kind of dedicated
myself on this Committee to focusing on Pell Grant-related
issues, and after reading your complicated testimony, I think I
am going to stay with the Pell Grant-related issues.
[Laughter.]
Mr. Keller. But as I sit here as sort of a layman, I kind
of see three issues from where I sit.
One, do we allow consolidation or not? Two, if so, should
it be fixed or variable? And three, will there be a second bite
of the apple through reconsolidation?
And to tell you my two cents analysis, having sat through
this--and I do not pretend it to be worth that--on the first
issue, do we allow consolidation, I know that there is some
powerful interest against it. I am near certain that we are
going to allow consolidation. That is just too valuable a tool.
As someone who is in his thirties and not that far removed
from college and law school, I remember how valuable a tool
that is to be able to take various diverse loans and put them
into one source and extend the payments. That is really helpful
to a young person when you are first coming out of college,
when you can least afford it. So that is going to happen.
We are not going to--I can't imagine, I am not leadership
here, but I cannot imagine that we are not going to allow
consolidation.
The second issue, fixed versus variable, if I was sitting
where Mr. Hamlett is and someone told me the choices between a
long-term fixed rate or an unlimited variable rate, I of course
would say essentially what he said. I would like the long-term
fixed rate. On the surface, that seems to be the best thing.
But I think what we are looking at is the scenario on the
variable side, where you would give young people the benefit of
the low variable rates. Like right now, they are at 3.42
percent, but you would cap their exposure at, like, 8.25
percent, so you are never going to pay the super jacked-up
rate.
If you look at, in fact, what the law is, that effective
2006 the fixed rates are going to go to 6.8 percent, and you
are faced with 6.8 percent versus the variable rate of 3.42
percent with a cap slightly above the 6.8 percent, you may well
be better off with a variable rate.
So I do not know what we are going to do there, but I am
pretty sure it is going to be in the strike zone. Either we are
going to give you a pretty good fixed rate, or we are not going
to expose you to unlimited rates, we are going to cap it at
some amount.
On the reconsolidation, the second bite of the apple, I do
not know what the Committee is going to do there, but even if
the Committee does not allow the second bite of the apple on
reconsolidation, you still have the option to go to your
private sources.
If you have a home, you may be better off getting a home
equity loan and paying off that student loan so you can write
off your home equity loan.
So I think there is good news, no matter what we do for
students here in the future. I am not pessimistic at all. But
again, I look at this as sort of an amateur here.
Let me start with you, Dr. Shapiro.
Isn't it the current situation that we are set to go to a
fixed rate, effective 2006, of 6.8 percent?
Dr. Shapiro. We are set to go to a cap. That is not a--that
is the capped rate, not the--yes, as I understand it.
Chairman Boehner. Well, that is in a basic program he is
referring to.
Mr. Keller. Yes.
Dr. Shapiro. Right.
Mr. Keller. The basic loan, yes, of 6.8 percent.
So if you were a student and you had to choose between a
variable rate of essentially half that versus the 6.8 percent
cap, there could be scenarios where it is beneficial to go with
a variable rate. Is that right?
Dr. Shapiro. Yes, certainly.
Mr. Keller. Dr. Neubig, I know you have had kind of
competing reports.
What is your opinion on that same question?
Dr. Neubig. My understanding of the 6.8 percent fixed rate
is that that would be for loans that are taken out in 2006--
Mr. Keller. Right.
Dr. Neubig.--and beyond. If someone is taking out a loan in
2003, you know, they are--or in 2004--they are going to lock in
the 3.5 percent, you know, for the life of that loan, and it is
only if they take out a loan after 2006 that it would be 6.8
percent.
Mr. Keller. Well, as I understood your testimony, it is
essentially you believe it's better for the existing graduates
now to go with a long-term fixed rate, that they would save
more money than if you switched to variable, but my question to
you, what about the students who graduate or who are in college
after 2006?
If they were faced with the fixed rate of 6.8 percent
versus whatever the market is for variable rates--and at 3.42
now--wouldn't there be scenarios that they would be better off
with a variable rate, provided there is a cap?
Dr. Neubig. We are definitely seeing CBO interest rate
projections, the variable rate would be very close to the 6.8
percent in 2006 and beyond.
Mr. Keller. OK. Mr. Chairman, I will yield back.
Chairman Boehner. The chair recognizes the gentleman from
Oregon, Mr. Wu.
Mr. Wu. Thank you very much, Mr. Chairman.
I am going to make a couple of general comments, probably
inquiring as much of the Chairman and the staff as of our
witnesses.
We perhaps--or I, perhaps--along with others had, you know,
brought up a concept of permitting variable rates under certain
scenarios, partially to address inequities going forward, and
partially to address inequities looking backward, and so like
Mr. Keller referred to, in multiple bites of the apples and in
reconsolidation, and the desire was to eliminate or to permit
people who had consolidated once at high interest rates to
reconsolidate, and to reconsolidate perhaps multiple times, and
as a quid pro quo for that reconsolidation, to reconsolidate at
a variable rate to reduce the cost to the Federal taxpayer
going forward.
Sitting where I am today, I do not know if this
reconsolidation or potential multiple reconsolidation concept
is on life support, or beyond consideration.
Chairman Boehner. Will the gentleman yield?
Mr. Wu. I certainly would.
Chairman Boehner. It is deader than a doornail, and let me
explain why.
We allowed people who had consolidated their loans to make
that choice, to consolidate them at a fixed rate, and they made
that decision based on their own economic viability.
Now that paper is issued. It is out there in the
marketplace, at some rate, you know?
We've got a staffer over here who did hers at 9 percent.
She would probably like to have--sorry, Kathleen--she would
probably like to have another bite at the apple at 3.42
percent, but she made that election herself. But somebody holds
that paper.
Now, when you talk about reconsolidation at a lower rate--
fixed rate, market rate, pick your rate--somebody loses,
somebody. Either we stick the investor, who has loaned the
money to the loan program, we stick it to the lender, or we
stick it to the taxpayer. Those are the three options, and I,
frankly, do not understand why.
If you look at your proposal, $6 billion, $8 billion, $10
billion cost, who is going to pay that?
I do not think we want the lenders to do it, because if
they do, guess what? They are not going to loan money to the
program. We will run them away. I do not think we want to stick
the taxpayers with that.
And the fact is that those graduates made those choices
when, in fact, they took out their consolidation loan.
Probably another argument why we ought to be looking at
something more like a variable rate is, because if we had had a
variable rate over the last eight or 9 years we would not have
this problem with people making an election to consolidate at 9
percent, 8 percent, et cetera.
Mr. Wu. Well, reclaiming my time, Mr. Chairman. The
proposal we had would have substantially--first of all, we have
not been able to get an accurate scoring, so I do not know how
much it costs, and I am not sure that anyone does, but with the
origination fees and reconsolidating at a variable rate, all of
that was intended to reduce the cost of reconsolidation, and
the variable had a cap on it of 6.8 percent.
We are looking at a proposal today of a cap which is higher
than that, and part of the argument for having this variable
rate is to prevent inequity by cohort, depending on when you
fixed, and if you permit a variable rate instead, then you
eliminate that inequality by cohort, by when you fixed, and I,
as one member, would find it more appealing to try to fix the
future inequality, while at the same time addressing some of
the past inequality, based on when someone chose to consolidate
that one time, and perhaps if your staffer at 9 percent wants
to move over to this side of the aisle, she would be very, very
welcome.
Chairman Boehner. Would the gentleman yield?
Mr. Wu. Yes, absolutely.
Chairman Boehner. I appreciate the gentleman yielding.
And the way your proposal is structured to allow for a
reconsolidation--or we will call it a second bite at the
apple--and going to a variable rate, the variable rate part of
it I think makes a great deal of sense.
The problem is--you have got two problems. You have got
there is a cost associated with it, and I would suggest to you
there is a real cost, you know, the paper that is out there and
who is going to lose.
Secondly--and I think maybe even the bigger cost you cannot
quite calculate--and that is the undermining of the paper for
the student loan program in itself. If you look at the student
loan program and the capital that comes to it, it is a very
thin market, as opposed to home mortgages. There are very few
players out there that are--I am talking about investors--that
bring capital into this loan program, and frankly, we are
dependent upon that capital in order to lend out to students.
Over the last two higher ed reauthorizations, there were
serious cuts in fees and yields to lenders. There was a lot of
money saved going after the lenders and after the servicers in
order to spend it somewhere else.
I have to tell you, I have grave concerns. It came up
earlier about going after lender yields. I think Mr. Miller
brought up the subject.
You don't see people clamoring to get into this business.
As a matter of fact, since the last reauthorization, you have
seen an awful lot of people leave. You have seen an awful lot
of originators--originators, people who originate loans--
leaving the system. Of course, there are a lot of people in the
consolidation business there today. But we have to be concerned
about undermining the very paper, or the very foundation of the
loan program, and that is the real huge under-estimated cost of
reconsolidation.
I have to tell you, I have looked at--I have been looking
for 2 years, trying to find a way to deal with reconsolidation.
Now, I have not found one. I have not found one that does not
cost billions and billions of dollars. As a result, really, I
am kind of at a standstill.
Now again, I said this earlier, but let us go back to who
these people are. These are the people that we guaranteed them
a loan, guaranteed. There is a cost associated there.
It could have been a guaranteed subsidized loan, where we
ate the interest for four or 5 years, or at least we deferred
the interest for four or 5 years.
We gave them a deferment after they were out of school for
6 months. We gave them a chance to extend their payments based
on their income. We gave them a chance to consolidate, if they
wanted to. And now we are suggested THAT maybe we want to give
them another bite at the apple.
My question is, what is fair?
If we are going to spend a lot of money at the back end of
this program to reconsolidate at the expense of poor kids and
moderate income kids who are trying to get into school, you
know, as a public policymaker I would suggest that that does
not seem to be fair, and as you all know, what we are trying to
do here is to find a fair balance for students and those who
are out of school. It is a tough choice. Go ahead.
Mr. Wu. Mr. Chairman, reclaiming my time.
We have tried to propose this in a workable, responsible
way, which holds costs down as much as possible to the taxpayer
with a sense that that is ultimately where the cost is going to
go. That is why the origination fee is there, that is why the
proposal is made with a variable rate and with a cap.
If we wanted to take a further step toward limiting the
cost of reconsolidation or multiple reconsolidations, another
concept that we could put on the table is limiting the multiple
reconsolidations to those who have loans above a certain
interest rate.
My understanding is that those cohorts are relatively
small--that is, those people who have a big difference between
the loans that they are holding and what is currently available
on the market.
By doing that, we certainly hold down the cost, and I think
that it is, in many situations, difficult to justify large
inequities in the system, and for that consideration alone,
perhaps we should look at those folks who have large deltas,
large margins between what they are currently holding and what
the market is, and that would further reduce the cost.
Chairman Boehner. Well, if the gentleman will yield?
Mr. Wu. Yes.
Chairman Boehner. There is nothing that prevents someone
who has already consolidated and does not like their interest
rate, there is nothing to prevent them from going out and
borrowing money in the real world, whether it be a home equity
loan, borrowing any--there are all kinds of ways of financing
all kinds of products.
But what you are suggesting is a Federal guaranteed loan.
That means money, because our guarantee means that we are
guaranteeing the lender they are going to get paid, and do not
forget the serious problem we have of undermining the existing
paper that is out in the market place, and I'm not sure anybody
could calculate what that is worth.
The last point I would make is this. Let us say it cost $1.
Let us just say it cost $1. That is $1 that could go to
lowering origination fees, increasing loan limits, maybe
something even on an enhanced Pell for kids.
It is--again, let us get back to this fairness question, as
to what is fair for all who are part of the system. The chair
would recognize Mr. Miller.
Mr. Miller. No, I would just say you can argue this round
or square, but the point is--I think Mr. Wu has raised it--if
we are going to argue the fairness question, I think you have
also got to incorporate in that the cost of the program.
You know, we have increased the subsidy in this program. We
guarantee the loans. You know, I think if we are really going
to talk about changing the program, we've got to lay all of the
costs, all of the benefits down on the table--
Chairman Boehner. Which program?
Mr. Miller.--and decide how you want to apportion this--
Chairman Boehner. Which program are we talking about?
Mr. Miller.--between the cost of all the programs, whether
it is the reconsolidation or it is the person getting out and
making a choice of where they are going to enter. I mean, that
is what has got to be done. I do not think you can look at one
segment of this program and say, ``Well, the costs of this are
such that we are going to shift them over onto this
population,'' you know.
Chairman Boehner. Well, if the gentleman will yield, you
know, the proposal that--as most of you know--that I have been
looking at is going to a variable rate for both the
consolidation programs and the basic program itself. That is
the marketplace.
The idea that the government can fix a rate, we can, but
because it is guaranteed we take all of the risk, and the fact
is that most of the marketplace is the variable rates for
everything.
Yes, you can get a fixed rate on your mortgage, your home
mortgage, and if you do, you are going to pay a much higher
percentage, a much higher interest rate, because you want a
fixed rate, and you want to lock it in.
But my goal here is to try to put this program, the entire
student loan program, on a solid financial foundation for the
long term, where we can control what our costs are, we know
what our costs are, we know what the benefits are, and I think
we can do that, but if there are other proposals that people
want to pursue, I am happy to look at them.
I think the idea offered by Mr. Hoekstra, and personally,
by Mr. Petri, to say in a consolidation program, ``All right,
you can have a choice, you can have fixed or you can have
variable without the subsidy,'' and that fixed would be based
on a market rate, means that someone who wanted to consolidate
on a fixed basis, there would be a different rate, I'm sure,
for 10 years, probably a little higher rate for 15, and maybe
even a little higher rate for 30.
That is what the marketplace would probably dictate,
because the longer you go, the more risk that you take and the
higher the rate is going to be, and they may decide that makes
sense. They may decide, ``Well, let's go with a variable.''
But the market should set the rates, and if the market sets
the rates and people make choices, I think in the long run
students, graduates, the government, and taxpayers are all
better off.
I'm sorry. I forget that Mr. Wilson had not asked any
questions yet. Would you like to ask questions, Mr. Wilson? You
are recognized for 5 minutes.
Mr. Wilson. Thank you, Mr. Chairman. I, at this time, would
like to submit a statement for the record.
[The prepared statement of Hon. Joe Wilson follows:]
Statement of Hon. Joe Wilson, a Representative in Congress from the
State of South Carolina
Mr. Chairman, I want to thank you for convening this hearing today
and I commend you for examining solutions on how to make college more
affordable for every American. Many parents and high school students in
South Carolina and around this great country are concerned that college
is no longer affordable and students leave school with too much debt.
The consolidation program alleviates much of this concern.
As we all well know, the cost of higher education has grown and
today's college students will graduate with significantly more debt
than when we last examined this issue 6 years ago. As a result, a
number of graduates see their debt as unmanageable, and consequently,
as imposing limits on their career choices, further depleting the pool
who want to work in the public and non-profit sectors of the economy.
The federal student loan consolidation program benefits borrowers
from a wide spectrum of professions. It is especially attractive to
those graduates wishing to enter into public service, as evidenced by
the fact that nearly 20% of student loan borrowers who choose to
consolidate their student loans are nurses, teachers and civil
servants. Further, by lowering monthly payments, the program gives the
borrower more flexibility and decreases the probability of default.
This widely popular program has proven beneficial to the federal
government as well. While consolidation loans are less profitable to
lenders than the underlying student loans, the 0.5% origination fee and
1.05% portfolio fee paid to the federal government by consolidation
companies have generated significant revenue for the federal treasury.
These fees do not apply to other student loans.
Fixed rate consolidation loans provide a great benefit to recent
college graduates. For many students, the cost of college is only
realized after they graduate and start repaying their student loans.
Changing the program to variable rates could double the cost of a
college education. I thank the Chairman for this hearing, and I pledge
during our Reauthorization of the Higher Education Act to work closely
with him and my Committee Colleagues on this Consolidation portion of
the legislation.
______
Mr. Wilson. Additionally, I would like to thank all of you
for being here today, and Mr. Hamlett, in particular, I want to
commend you, at your age, for being here. I am excited for you,
as an undergraduate student, to be with such distinguished
persons as you have to your right and to your left, and so
thank you for coming.
Additionally, I have enjoyed the topic. I was a real estate
attorney for 25 years, until 2 years ago when I was elected, so
these issues--I have been at closings and seen the discussions,
and with contracts of sale for decades now, and it is
interesting to see how this relates, and I appreciate the
Chairman educating me on the difference between a mortgage and
a student loan which is subsidized.
So with that in mind, Dr. Shapiro, in your study--direct
quote--``As a general proposition, economists usually favor
adjustable interest rate debt instruments over fixed interest
rate instruments because they make the economy more
efficient.'' And can you just tell us what would be the
decision factors as to which route to go, say as an economist,
as a consumer, or as an individual?
Dr. Shapiro. The reason that economists generally prefer
variable interest rate instruments over fixed rate instruments
is that they reduce certain kinds of risk, and in particular,
they reduce what economists call the wealth risk--that is, the
value of the asset, of the loan, which changes if inflation
changes in unexpected ways.
We have a projection of inflation which we build into long-
term interest rates. Those are our inflationary expectations.
We are sometimes surprised, and inflation is greater or less.
We had the kind of positive inflationary surprise in much
of the 1990's, when we had less inflation than we expected, for
various reasons. A variable rate instrument eliminates that
risk, because it is adjusting at some regular interval to
changes, whether they were anticipated or not, and
consequently, it means that the resources can be distributed
more efficiently.
Mr. Wilson. And how does this relate, say, to the consumer?
What should they be looking at? Obviously, the short-term
monthly payment, but how would the consumer look at this, or
student?
Dr. Shapiro. Well, for a student, there is a--we say there
is a risk associated with variable rates as well. It is called
an income risk, rather than a wealth risk.
I think for a student, a student getting out of school, the
most important economic consideration with respect to a
consolidation loan is, frankly, not whether the rate is fixed
or variable.
The most important consideration is that the loan, the
duration of the loan is increased significantly, and that
reduces the monthly payment; and most students, most new
graduates are most concerned with their monthly payments, as
are most new homeowners.
What is most attractive about a consolidation loan is it
takes a 10-year loan and makes it a 15 or a 20, or a 25, or a
30-year loan, depending on the size of the total debt being
consolidated. That advantage, from the point of view of the
student, is there at any time.
I think the advantage of a variable rate, as opposed to a
fixed rate for a student, there is an obvious advantage if they
are consolidating at a time of high interest rates. When the
interest rate goes down, their payment is going to go down.
The other advantage is that it is a--it means that the
burden is, in some sense, predictable.
That is, it will increase or fall with the entire economy,
and if changes in interest rates reflect changes in economic
activity, which reflect--which lead to changes in income, then
a variable rate allows an individual to feel some security that
they will be able to adjust, that as conditions change they
will be able to afford the interest payment on their loan.
Mr. Wilson. One final question, and it would relate again
to variable interest rate loans. Is there a concern there may
be more borrower defaults with the variable rate, or how would
you address that?
Dr. Shapiro. Well, one of the primary purposes of the
consolidation program was to reduce defaults, and the way it
primarily did that, again, was by reducing the monthly payment
by stretching, by extending the duration of the loan, and I
think that it depends on when you consolidate it, sir.
Mr. Wilson. Right.
Dr. Shapiro. If you consolidated at 9 percent or 8.25
percent, which is the cap since 1997, you may be much more
inclined to default in an interest rate environment of 3
percent. You are continuing to carry relatively high payments.
If, look, if we offer, you know, large numbers of people
the opportunity to consolidate a large amount of loans at 3.5
or less, I mean, if you do it in the 6-month grace period
today, something I would recommend to Mr. Hamlett, you get
another benefit, and it is actually, the interest rate is about
2.8 percent on current consolidated loans if you do it in the
first 6 months after leaving school.
Chairman Boehner. Mr. Hamlett, have you got that?
Mr. Wilson. Thank you very much. And I noticed Mr. Hamlett
wrote notes.
Chairman Boehner. OK. Well, let me thank our witnesses for
their patience and their valuable information, and all of those
who have come today for your patience. It was a long day, but I
think that the information that was presented was very helpful
to the Committee, and I thank you.
This hearing is adjourned.
[Whereupon, at 1:38 p.m., the Committee was adjourned.]
[Additional material submitted for the record follows:]
Statement of Hon. Charlie Norwood, a Representative in Congress from
the State of Georgia
Mr. Chairman I thank you for holding today's hearing to examine the
future of the Federal Consolidation Loan Program. I look forward to the
testimony of our witnesses, and as always, I appreciate their expertise
in shedding light on this critical issue the Committee must consider as
we continue to strengthen American Higher Education policy.
More and more students each year are attending institutions of
higher learning. As a result, the demand for student loans and
financial assistance to help pay for the rising cost of an education at
an American university is increasing as well. This rising demand for
assistance in an era of economic change has created new challenges for
the federal government, and we must therefore examine all aspects of
our policy regarding federal aid; including the Consolidation Loan
Program (CLP).
Born during the reauthorization of the Higher Education Act in
1986, the CLP provides an opportunity for borrowers with more than one
loan holder and a high debt level to consolidate that debt into one
monthly payment under one lender. This gives borrowers the ability to
stretch out a loan repayment period to a maximum of 30 years, which
lowers their monthly payment, at a fixed interest rate determined by
the weighted average of the loans being consolidated.
Since the inception of the CLP in 1986, and especially since 1994,
graduates have increasingly taken advantage of the program as interest
rates have declined--spurred on by new organizations that exist
specifically to aggressively market consolidated loans by way of mail,
phone, and the Internet.
And while the proliferation of the consolidated student loan
certainly has allowed borrowers to save considerable sums over their
loan repayment period at a low fixed rate, the savings do not come
without cost to the American taxpayer. In fact, the government pays
subsidies (in the form of deferments interest paid on behalf of the
borrower and allowances paid directly to vendors) to cover the cost of
these consolidated loans over the life of their repayment period. This
amounts to yet another burden on the American taxpayer to cover the
cost of consolidated loans, even when it is unclear that a borrower
needs to consolidate their loans.
Mr. Chairman it is important for this Committee to take these
considerations to heart as we continue the Reauthorization process for
the Higher Education Act. Is the CLP fulfilling its original intent in
light of recent trends in light of recent trends? Should the taxpayer
continue to finance and subsidize the CLP at a fixed rate; or should
Congress explore a variable rate structure to make the system more
equitable? More importantly, should taxpayers continue to subsidize
borrowers at a low fixed rate at the expense of providing access to
students entering and attending post secondary education?
It is critical to find commonsense answers to these questions if
Congress is to ensure the future of the CLP in a fiscally responsible
way. Borrowers must continue to enjoy access to consolidated loans over
the lifetime of a long-term repayment period; but Congress must also
ensure that students seeking access to higher education have the
resources necessary to achieve their dreams.
Mr. Chairman I look forward to hearing our witness' thoughts on how
Congress can achieve both of these worthy goals as we continue to work
towards Reauthorization of the Higher Education Act, and thank you for
providing continued leadership on this very important issue.
I respectfully yield back the remainder of my time.
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