Federal government underestimates college loan program costs

By: Nicky Corbett

Posted: 3/8/05

A new study reveals flaws in the calculation of federal student loan programs' costs.

A Price Waterhouse Coopers study released last week revealed biases in the current cost-calculating system, leading federal budget scorekeepers to underestimate the costs of the Federal Direct Loan Program and overestimate the costs of the Federal Family Education Loan Program. This means direct loans appear cheaper to the federal government than they really are.

"The scores are not an accurate reflection of actual costs," said Peter Warren, director of government relations at the Education Finance Council, one of the three major student loan groups to sponsor the study.

The FFELP, established in 1965, provides federally guaranteed student loans from private lenders, such as banks. The direct loan program came on the scene in 1993, providing loans straight from the federal government.

As universities can only participate in one loan program or the other, SU only participates in the FFELP, said Christopher Walsh, dean of financial aid. About 6,000 SU students borrow money through FFELP.

When the direct loan program came out in 1993, about 25 to 30 percent of colleges and universities switched over from the FFELP, Walsh said.

Although some schools might have chosen the direct loan program because they think the government is a reliable source of money, Shelly Repp, general counsel for the National Council of Higher Education Loan Programs, one of the study's sponsors, said the FFELP has attracted schools by dramatically enhancing its services over the past 10 years.

"We know schools are generally happier with the services they get from private banks," Repp said.

SU chose to stay with the FFELP instead of switching because of problems with the direct loan program, Walsh said. Funding delays have caused some colleges to drop out of the direct loan program.

"Our main interest is that we provide the best program of value for our students," Walsh said.

Now, about 30 percent of schools participate in the direct loan program, while 70 percent use the FFELP, Warren said.

Universities generally prefer there be two loan programs so they can compete against one another, Warren said.

"That way (universities) can choose one or the other," Warren said.

Both the Office of Management and Budget, for the executive branch, and the Congressional Budget Office, for the legislative branch, handle federal budget scorekeeping for programs like FFELP and the direct loan program.

The principal cost calculation biases the study found include underestimating the gap between short- and long-term interest rates, failure to include the FFELP's tax revenues and leaving out the direct loan program's administrative costs in its cost estimates while including them in the FFELP's estimates.

Debates over distortions in the cost estimates of the two loan programs are nothing new.

"There's been a lot of discussion over which loan is cheaper," Walsh said.

However, Warren said the interest rate bias is a new and significant finding.

Repp said the gap between short- and long-term interest rates has historically been greater than the government assumes it to be. This means the direct loan program has cost the government more than it realizes.

The biases partly result from the Credit Reform Act of 1990, which outlined a new way to measure the costs of federal credit programs, such as loan programs, Warren said.

The loan programs used to be measured on a cash-flow basis, which created biases that did the reverse of the current system; it overestimated the costs of the direct loan program and underestimated the costs of FFELP, Repp said.

The Credit Reform Act was then created to eliminate the biases of the former cost-calculating system, but overcompensated.

Harrison Wadsworth, special council for Consumer Bankers Association, another of the study's sponsors, said he thinks the Credit Reform Act, written before the direct loan program was created, needs to be changed.

"The bias is built into the way the scoring is done according to the law," Wadsworth said.

The CBO is currently in the process of reviewing the Credit Reform Act.

It is important the baseline scores be accurate when passing legislation affecting student loan programs.

"Those policy decisions should be made on the best information available," Repp said.

The Price Waterhouse Coopers study came out in time for the reauthorization of the Higher Education Act. The act gets updated every five to seven years, Warren said.

The reauthorization will update federal student loan program interest rates and the Pell grant eligibility formula, Warren said.