Elizabeth Warren has a bill out to cut student interest rates. I am in favor of refinancing student loans, but Warren’s proposal is just downright strange, excepting its value as a public relations gimmick.
The jumping off point for Warren’s policy is an observation that the Federal Reserve operates something called the discount window. Through this window, the Fed gives out temporary (often single day) collateralized loans to provide temporary liquidity to banks that suffer a temporary shock. The rates on these loans tend to be set slightly higher than the Federal Funds Rate. Since the Federal Funds Rate is basically zero, the Discount Rate has also been set very low, 0.75% currently.
What does this have to do with student loans you might ask? I haven’t a clue. Warren’s populist line is that big banks can borrow from the discount window for such low rates, but students cannot. Which I guess could connect to those who have no real idea what the discount window is.
But whatever. The discount window connection is attenuated at best. That’s just the way things go in political theater some times. What about the policy? Is it good? Not really.
Warren’s bill directs the Federal Reserve to make its own funds available to the Department of Education to finance student loan disbursements in the 2013-2014 school year. The interest rates on those loans will match the discount rate (which again is 0.75% currently).
The best thing you could say about refinancing student loans is that it would be economically stimulative. But oddly, Warren’s bill does not refinance any student loans. The way she has gone about this is the least stimulative way imaginable. The rate cuts apply only to loans that would be issued in the 2013-2014 school year. So these loans will be disbursed in September 2013 and January of 2014. Graduating seniors who get the loans wont make payments on them until November 2014. Freshmen who receive them wont be in line to make payments on them until November of 2018! This rate cut would have basically no short-term stimulative impact, the short-term being exactly where stimulus is so important.
So with stimulus off the table, what else is there? Presumably there is a general argument about how we should ease the burden on students who borrow money next year. That’s fine, but this is just a weird way to go about it. For one, why does the federal reserve need to be involved? If you want to cut rates, then just cut rates. They are set by statute. So you can pass a bill to cut them. In picking a rate to apply, the discount rate makes no sense. The risk profile of student debt is different than that of large banks. Why hook it to the discount rate?
These loans would almost certainly be money-losers. That too could be defended as fine because these losses (which I guess will be borne by the Fed now) enable this really indirect strategy for easing the burden on students. But surely putting the money the Fed/DOE would lose on such a scheme directly towards students would be a better way to go about it.
Finally on the theoretical front, 0.75% students loans will create some really fascinating incentives. A smart student would be wise to totally max out their student debt and pour the amount they don’t need into safe investments. You should be able to get returns above 0.75% after all. At that point, it becomes clear how unfair this scheme would be if it only allowed students to participate. If you are going to so low that it is literally possible to dump your loan into a savings account and make a net financial return, then really every person, non-students included, should be allowed in.
Again, I understand that there is maybe some PR game going on here, but to treat it as anything more than that is mistaken.