The very same loan-relief programs that the federal government has put into place to help millions of financially distressed student borrowers is wreaking havoc within the investment community.
According to a recent Wall Street Journal article, the issue is no longer a matter of whether these borrowers will be able to repay their debts; it’s become the uncertainty of when.
In a stable economic environment—when interest rates are higher for longer-term obligations and investments than they are for those that mature more quickly—loans (and the investment dollars helping to fund these) that are structured to terminate within, say, 10 years are priced lower than for those that span 20.
There are many reasons for that: longer-term inflationary, default and liquidity concerns (i.e., an inability to dispose the contract on demand), to name just a few. And that’s before taking into account overhead costs and target profitability.
As such, although loans that pay off more quickly are irksome to investors (because the resultant cash will have to be reinvested sooner than expected), debts that take longer to retire are a nightmare, particularly when interest rates have moved higher in the interim.
So in this Bizarro World of higher-ed finance, the more the feds succeed in restructuring their problem loans, the less inclined investors are to fund those deals in the first place. And when that so-called secondary market begins to falter, new loans become harder to finance because the money has to come from someplace.
Granted, we’re only talking about a $40 billion problem at this point—a mere drop in the bucket compared with the $1.2 trillion of education-related debts that are owed.
Or are we?
The Department of Education is currently sitting with approximately $1 trillion worth of student loans on its balance sheet ($924 billion as of Sept. 30, 2014, and growing at a rate of about $100 billion per year). At some point a portion, if not all, of these contracts will have to find their way into the capital markets because, as one of my former board members is fond of saying, “Trees don’t grow to the sky.” The government simply cannot afford to bankroll eight to nine out of 10 college students in perpetuity.
When that happens—and I believe the reckoning is at hand—lawmakers will also come to realize that transitioning this program to the private sector is easier said than done.
As long as these loans continue to be structured with one repayment term, only to be restructured later for another that’s twice as long—if not forgiven altogether—the investment community will balk at anteing up the massive amount of capital needed to move these contracts from the Department of Education’s books.
It is therefore time for lawmakers to correct what has long been a fundamental weakness of the government’s student-loan program.
How We Can Fix the Repayment Term Problem
When Congress first enacted the Higher Education Act (50 years ago next month), the average cost of tuition and fees at the nation’s four-year schools represented roughly 9% of median pretax household income. Today, that number is closer to 30%, which helps to explain why student-loan payment delinquency rates and contract defaults are higher than for any other form of consumer credit.
It also explains why so many of these loans require relief, which brings us back to the investors.
The only way to address both issues once and for all—borrower distress and investor uncertainty—is to suck it up and modify the entire portfolio of loans for terms of up to 20 years (so that the monthly payments consume less than 10% of median household income) and establish that same duration as the official repayment period for all new loans going forward.
And one more thing.
Not only will taking this action help pave the way for the government to off-load the loans it currently holds, but it will also result in a roughly dollar-for-dollar reduction in the national debt.
Take a look at page 34 of the Department of Education’s balance sheet. The $924 billion worth of Credit Program Receivables (i.e., student loans) is supported by a roughly equivalent amount of liabilities (i.e., departmental borrowings).
Consequently, selling the former will likely generate enough cash to pay off the latter.
So there you have it, a plan that kills three birds with one stone: Troubled borrowers will be able to pay off their debts; Investors will keep on investing; and $1 trillion can be knocked off the government’s tab. All that’s needed is the political courage to do the right thing.
Something else that’s easier said than done.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
More on Student Loans:
- How Student Loans Can Impact Your Credit
- How to Pay for College Without Building a Mountain of Debt
- Strategies for Paying Off Student Loan Debt