Congress is once again arguing about how—or whether—to pay for the bills it’s run up, as the United States inches closer to the unthinkable: default.
One faction wants to force an austere future in exchange for a yes vote today. The other insists on honoring the obligations that Congress has willingly undertaken in the past.
Legend has it that Winston Churchill once said, “Never let a good crisis go to waste.”
The government happens to be sitting on a trillion-dollar asset that’s financed with a virtually equivalent level of debt: the Department of Education’s Federal Direct student loan portfolio.
Suppose the ED were to sell it all.
Every last loan.
Theoretically, it would then have the means to pay off—dollar-for-dollar—all the debt that it had incurred to fund this activity in the first place.
What’s the catch?
To start, roughly half of all student loans that are currently in repayment are either delinquent (31 or more days past due), in default or forbearance, or enrolled in one of the governmental income-based repayment plans because the borrower is otherwise unable to meet his or her originally agreed-to payment terms.
Ordinarily, this would make selling these contracts to the private sector a challenge. After all, what investor would want to undertake that kind of risk for an investment that pays so little? (The 2017–2018 interest rate on Direct Undergraduate Student Loans is 4.45%.)
In this instance, however, the loans are guaranteed by the full faith and credit of the U.S. government. In other words, the investments are backed entirely by taxpayers.
That’s no small matter to consider, given the increasing number of contracts that are ending up in default.
The next concern has to do with the rate at which the loans would be sold.
The nation’s sovereign debt rating once stood at triple-A: the highest designation possible. That was before the Great Debt-Ceiling Battle of 2011 led the three-principal credit-rating agencies (Standard & Poors, Moody’s Investor Services and Fitch Ratings) to downgrade it to double-A-plus.
Given that Washington is even more dysfunctional today than it was then, another downgrade could be in the offing. Should that occur, the government’s interest costs would likely increase, resulting in even greater losses for taxpayers when these loans are later sold.
So too would the rates that student-borrowers are forced to pay because Federal Direct loan rates are indexed to U.S. Treasury notes.
So where does that leave us right now?
If the proceeds from divesting the government’s trillion-dollar Federal Direct student loan portfolio can be used to reduce a trillion dollars’ worth of federal debt, and that divestiture depends on favorable interest rates, and favorable interest rates depend on the continued one-notch-below-great creditworthiness of the United States… it’s clear that all that Congress has to do is raise the debt-ceiling, right?
Yes, but there’s also the not-so-small matter of the profits that the federal government records on the student loan program.
In 2016, the Congressional Budget Office estimated that the feds would clear $81 billion over the ensuing 10-year period—profits that are routinely used to offset the government’s recurring budgetary shortfalls.
Revenues that would vanish when the ED embarks on a program to sell at par all the loans it owns today and originates tomorrow.
Then there’s the even bigger matter of the poorly performing student loans that are currently in repayment plus those that will become payable in the coming years. Taxpayers will continue to face significant financial risks if the durations of all these contracts are not extended so that the attendant monthly payments are reduced before the government acts to divest its holdings.
Couple that with the implementation of definitive and just set of servicing standards which, among other things, mandates the automatic application of added payment amounts (always against principal first, unless the added dollars are needed to satisfy outstanding late-payment and bounced-check fees) and you have a portfolio of loans that is much more likely to be repaid in full, and therefore much less likely to place at financial risk the taxpayers who remain on the hook.
To sum it up, divesting the Federal Direct student loan portfolio can yield a trillion-dollar reduction in federal debt, a (finally) functional and potentially sustainable student loan program and, as a direct consequence of that, diminished risk for taxpayers, all for the worst-case price of an $81 billion budgetary shortfall spread over 10 years.
A sovereign default will cost us all significantly more than that.