Wednesday, September 1, 2010

The student loan, via the Dept of Education, has become an additional tax on the lost generation

The student loan portfolio has become Congress new slush fund apparently. The Dept of Education has originated and/or insured at least 600 billion in loans and this number will only continue to grow. The last few weeks I have been pondering our collective predicament and was thinking about how Congress stands to gain as a result of our student loan woes.

The Treasury department, which happens to do the borrowing for the US, can now borrow at extremely low interest rates. The 10 yr treasury is yielding a paltry 2.5%. 2 year paper has hit yields as low as .48%. US borrowing costs have never been lower.

On the other hand, consider that the US Dept of Edu has become THE biggest player in the student loan market. I bet many of you have noticed that your loans have been purchased by the DOE. Furthermore, the feds have effectively pushed out the middle man (private banks) from the student loan business and are now dominating the student loan market.

Average interest rates on Federal backed loans range anywhere between 6-8%. In addition, many private loans have also been purchased by the DOE. When the Treasury borrows for 2 yrs at .48% interest, and then gives the 50 billion to the DOE, which then makes loans to students at 6-8% interest, they make the spread. This is how wall street gambled and lost big time, by borrowing short term at low interest rates and lending out long term to other borrowers at hgher rates.

By looking at the DOE budget, the 2011 budget allocation to this lovely department is 49 billion per year. However, when you look at this section called "credit activity", you see the true numbers. Federal Direct Student Loans have exploded higher from 2009 to 2011 by growing from 37 billion to 137 billion dollars! This is a 300% increase over a 2 yr period. These numbers basically tell us that the DOE has become the Fannie Mae for the student loan market.

So the gov borrows at .5%, lends it out at 6-8%, and makes a killing on the spread. The loans are NONDISCHARGEABLE, they never go away, they keep growing bigger if you dont pay and sometimes keep growing if you dont pay enough over the stated amount. This has become a new revenue stream for the government. How else is the Treasury dept going to come up with all the trillions to pay off all the SS and Medicare beneficiaries? By raising taxes of course. However, this student loan provides a new method of obtaining gov revenue from the younger segment of the population. This "student loan tax" mainly applies to younger people that recently went to college with bubble valuations in tuition. Surely some older people are getting whacked with these loans, but by and large its the lost generation that is paying the student loan tax.

A 2009 pie chart showing where the federal government spends its money further supports my theory. In fiscal 2009, 38% of all federal expenditures went to Social Security, Medicare, and Medicaid. It is projected that these entitlements will eventually require more than 100% of the current revenue stream. Surely there will be some form of "soft" government default on these programs, but until that happens expect the boomer politicians to fight tooth and nail to save these programs.

The repurcussions of my theory suggest that student loan reform will be hard pressed to take place. Because the gov by virture of the DOE has now become lender to so many of us, the gov has a vested interest in seeing that the money it lent to us at X gets paid back at X plus Y. Owing money to your own government, especially when that loan is one of the few nondischargeable loans in the market, is a flashing red warning sign. This gov of ours needs money BADLY to fund the retirements of all these boomers who failed to save. Now they will "tax" us with these loans in order to cover the shortfall.


  1. Yes, because this group needs another tax, after all. This is simply not sustainable. When the student loan bubble POPS, it will further hurt the economy - as bailouts will take place and money is diverted from social programs and other vital areas. After all, we can't let the thieving banksters suffer the effects of their (stupid, selfish) actions, can we?!?!

  2. i really wish we let the banks fail... why didn't we again?

  3. The banks were not allowed to fail for several reasons; fear, political connections, cronyism, and the golden rule being he who has the gold makes the rules. Here the gold is the USD, our fiat currency, and the gold holder is the federal reserve, which has the legal mandate to "create" the USD. Do realize that the fed works for both the banks AND the US government as it monetizes both government deficits and toxic assets from bank balance sheets.

    However, do realize that the bankers are no longer involved in the student loan market. Uncle Sam is now the forefront lender to students seeking loans. Watch as the Dept of Edu loan portfolio explodes higher, with the payments being sent to the Treasury and then to the Social Security Trust Fund and Medicare. Consider this a massive tax increase on all grads. Everyone basically goes to school and almost every has to get student loans, so tax pretty much gets tagged on most of our generation.

  4. Should this be the case (and I agree with your prediction except for private student loans) every regulator in the dept of Ed needs to come under the highest of scrutiny as they fill the holes in the new healthcare/Ed law

    additionally, private student loans are still legal and thus wells Fargo supported lobbyists for example need to be neutralized to avoid loopholes that allow for capitilization of student loan principle amounts

  5. It's tempting to look at the current student lending scheme and criticize it, and, to be sure, a lot of your criticism I can't disagree with. That said, the way it worked before was much, much worse. For-profit corporations trolled around for tiny schools with regional accreditation, making their students eligible for federally-guaranteed loans from private banks like Sallie Mae, Citi and others; the corporations massively grew the size of the schools; and hooked hundreds upon hundreds of new students up with loans that the government would have to pay if the students couldn't. Then, the private lenders misrepresented their cohort default rates - both to Congress and, by extension, to the taxpayer; that rate was what Congress used to decide, effectively, what percentage of the private banks' student loan portfolios to guarantee; the private banks then turned around - with the benefit of the fraudulently-obtained guarantee - and issued debt-backed securities on which they earned a profit. So, in essence, under the old scheme private banks defrauded Congress, and in so doing, manipulated the risk profile of their portfolios (i.e., student default rates), and in the same breath "priced" their securities fraudulently on the market.

    It's great to criticize government, and I have no shortage of complaints on my own account. For example, unless you just peg student loan interest rates to inflation, there is exactly zero argument for charging any interest at all on student loans, exactly because they are non-dischargeable. But drawing a straight line between the spread on student loans and the social security and medicare program shortfalls, and claiming that this is a "tax" that will pay for it, makes for somewhat dubious logic, to say the least. I could as easily argue that there is a shortfall in the funding of those programs directly because we spend over $1 trillion per year on defense, more than all countries in the entire world combined.

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