Budgetary Impact of the President's Proposal to Alter Federal Student Loan Programs

March 15, 2010

This afternoon CBO responded to Senator Greggs requestfor estimates of the budgetary impact of the Presidents proposal to eliminate the federal program that provides guarantees for student loans and to replace those loans with direct loans made by the Department of Education.

The Federal Family Education Loan Program (guaranteed loan program) provides federal guarantees on loans for higher education that are administered and funded by private lenders. The guarantee ensures that lenders will receive almost all of the principal and accrued interest owed to them if borrowers default. The William D. Ford Direct Loan Program offers eligible borrowers nearly identical loans that are administered by the Department of Education and funded through the U.S. Treasury. Under the Presidents proposal, all federal student loans originated after July 1, 2010, would be made by the direct loan program.

CBO constructed two estimates of the budgetary impact of that proposal. One estimate follows the methodology delineated by the Federal Credit Reform Act of 1990 (FCRA), which CBO is required to use in cost estimates for most credit programs including student loans. The other estimate was done on a so-called fair value basis that provides a more comprehensive measure of cost by including administrative costs and the cost of market risk (the risk that losses from defaults will be higher during periods of market stress, when resources are scarce and hence most valuable). The idea of a fair value estimate is to represent what a private entity would need to be paid to assume the costs and risks to the government from providing loans or guarantees.

Taking into account administrative costs and the cost of risk increases the estimated costs of both the guaranteed and direct loan programs: Using the fair-value methodology, CBO estimates that under current law, the net budgetary costs of new direct and guaranteed student loans during the 2010-2020 period would total about $158 billion, as compared to total net receipts for the government of $25 billion using the FCRA methodology.

CBO estimates that the Presidents proposal would generate significant cost savings using both the FCRA and fair value approaches, but the savings would be smaller under the fair-value approach. (Both estimates were constructed relative to CBOs most recent set of baseline budget projections, which were issued earlier this month.) Using the FCRA methodology, CBO estimates that replacing new guarantees of student loans with direct lending would yield savings in mandatory spending of about $68 billion over the 11 years from 2010 through 2020. That figure represents the estimated savings in mandatory costs that would be shown in a CBO cost estimate for legislation under consideration by the Congress. However, adjusting for the projected increase in annual discretionary administrative costs in the direct loan program, the net reduction in federal costs from the proposal would be about $62 billion. On a fair value basis, incorporating administrative costs and the cost of risk, CBO estimates that replacing new guarantees of student loans with direct lending would yield savings of about $40 billion over the 2010-2020 period. The primary reason for that $22 billion difference is that payments from the government to lenders are riskythey terminate when a borrower defaults on or prepays a loan. Those payments are less valuable to lenders and less costly to the government when the cost of that risk is taken into account, so terminating those payments by eliminating the guaranteed loan program yields smaller savings for the government.