Most Read
    Image 01 Image 02 Image 03

    More on the bad economics of Elizabeth Warren’s student loan proposal

    More on the bad economics of Elizabeth Warren’s student loan proposal

    Pitting Federal Reserve risk-free short-term lending to banks versus long-term risky lending to students was pure political demagoguery.

    My post yesterday, Elizabeth Warren finds way to inflate Higher Ed bubble even more, has received a fair amount of attention.

    The Boston Globe featured the post in its coverage of the debate over Warren’s proposal, Swimming in student debt?  The article included this screen shot for the ages:

    Boston Globe - Swimming in student debt

    Others are joining in to puncture the initial media frenzy for the proposal.

    From Meghan McArdle at The Daily Beast, Elizabeth Warren Wants the Fed to Get Into the Student Loan Business:

    It’s probably true that some say banks need low interest rates to keep the economy growing.  But no one except possibly a lunatic has told Elizabeth Warren that banks are getting 0.75% at the discount window as a thank you for all the hard work they’re doing helping the economy.  Discount window loans are cheap for three reasons: the borrowers have assets and income that are easy to seize, the loans are quite short term, and the banks are required to put up collateral….

    Students, on the other hand, are borrowing for a decade, and the only thing they’re putting up as a guarantee is their character.  How good a collateral is their character?  In 2011, 9.1% of borrowers had defaulted on their student loan within the first two years of the payment period.

    The interest paid by the folks who don’t default is the only thing keeping this program from hemorrhaging money.  Elizabeth Warren proposes to cut that interest rate to less than the rate of inflation.

    Of course, this isn’t really a serious proposal, in the sense that it has any chance of getting passed….

    But passing this bill probably isn’t the point.  Rather, it’s a populist values statement: we like students, we don’t like banks.  As such, it’s probably going to be quite effective.  But only among people who don’t know much about the banking system.

    From Danielle Kurtzleben in U.S. News, What Elizabeth Warren Gets Wrong (and Right) About Student Loans:

    Still, it’s important to note that there is good reason why interest rates for students are higher than the discount rate for banks. One is that the discount window funds short-term borrowing, often for overnight loans. Student loans, as any debtor knows, last much longer than one night. And even the U.S. government faces far higher interest rates than 0.75 percent on its long-term borrowing.

    “The flaw in Senator Warren’s logic is that these are long-term loans that are being presumably funded with longer-term borrowing by the Treasury,” says James Angel, associate professor of finance at Georgetown University’s McDonough School of Business. “So even though the t-bill rate right now is effectively zero, for longer-term debt the government is effectively paying several percentage points more.”

    Even the U.S. government, the epitome of a trustworthy borrower, is paying around 1.8 percent in interest on its 10-year loans now, and nearly 3 percent on its 30-year loans.

    In other words, Warren’s class warfare ploy of pitting Federal Reserve risk-free short-term lending to banks versus long-term risky lending to students was pure political demagoguery, much like the made-for-YouTube moments at the Senate Banking Committee and Senate HELP Committee hearings.


    Donations tax deductible
    to the full extent allowed by law.


    richard40 | May 11, 2013 at 1:37 pm

    Warren says if the fed can loan huge money to banks, why cant they loan money to students. Others here have pointed out that the bank loans are short term and low risk, while the student loans are long term and high risk. But I have an even better answer, dont do either one.

    Leave a Comment

    Leave a Reply

    You must be logged in to post a comment.

    Notify me of followup comments via e-mail (or subscribe without commenting.)

    Font Resize
    Contrast Mode
    Send this to a friend