Tilly: An interest rate mess

BY ZACH TILLY | JULY 11, 2013 5:00 AM

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A Senate student-loan plan that would have extended a discounted interest rate for low-income students was filibustered to death Wednesday by a bipartisan group of lawmakers.

On July 1, the interest rate on federally subsidized Stafford Loans doubled from 3.4 to 6.8 percent because Congress failed to reach a long-term agreement on student loans. Most student loans are issued right before the school year starts, however, so Congress effectively has until August to get a deal done with minimal collateral damage.

If Congress can’t manage a deal, average subsidized student-loan borrowers would see their overall borrowing costs rise by $2,600, according to a report issued by the Congressional Joint Economic Committee. Those subsidized Stafford Loans account for 35 percent of the student loans issued in the Unites States, by the way.

It seems odd that no agreement has yet been reached to solve this problem. There doesn’t seem to be any political upside to screwing subsidized student-loan recipients — their budgetary impact is relatively small, and higher education is usually popular.

So, what’s the problem?

The bill that failed Wednesday was a stopgap measure that would have frozen the low rates for another year to give Congress more time to craft a comprehensive plan. That temporary plan was killed by bickering among the Democrats. The Senate’s Democratic leadership refused to bring a proposed bipartisan compromise bill to a vote, so the handful of moderate Democratic compromisers, led by West Virginia’s Joe Manchin, joined up with the GOP to scuttle the short-term fix in hopes of salvaging their compromise later.

The reason for all this infighting is in the minutiae. The student-loan fight boils down to a few small differences in the plans on the table.

Currently, all federal student-loan rates are set directly by Congress. That’s unsustainable in the long term because when interest rates inevitably need to go up, a nasty fight will break out in Congress. It’s in the best interest of most members of Congress to ensure they don’t have to have this fight in the future.

So, to prevent such a battle, the Obama White House, the House GOP, and that bipartisan group in the Senate all developed plans that would tie interest rates to the performance of 10-year Treasury notes. As the rate of return on those notes goes up, interest rates would go up, too.

President Obama’s plan would add 0.93 percent to the Treasury rate to get the new subsidized loan rate. The House GOP plan would add 2.5 percent to the Treasury rate. Not much difference there.
The problem is that returns on Treasury notes — currently 2.7 percent — are expected to rise fairly substantially in the next decade as the economy improves. The Congressional Budget Office projects that Treasury notes could return as much as 10.6 percent by 2023. That means that interest rates could skyrocket correspondingly.

That threat has led many more liberal Democrats, most notably Elizabeth Warren of Massachusetts, to call for a maximum cap on interest rates tied to market performance. The Senate’s failed compromise was cap-free — hence the discord among the moderates and liberal Democrats that’s clogging the process up.

For now, the House has little to do until the Senate passes a bill; the representatives are content to lay this budding failure at the feet of the Senate Democrats. Incidentally, the House GOP plan features the highest initial interest rates, but it’s also the only major plan on the table that features a maximum cap on interest rates.

As it stands, the sides don’t seem too far away from a mutually acceptable compromise, but the question is — once again — will they act in time?

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