One of the weirder sub-fields of student loan policy concerns how loans are accounted for in national budgets and statistics.  This sounds like an abstract consideration, but in fact it has the potential to drive student aid and access policy in some very unexpected directions. 

(I know, I know, this may be my wonkiest post ever, and I may get one or two things wrong because I’m not an accounting expert, so bear with me).

For a really good primer on how to think about how to assess the costs of a student loan program, it’s worth reading this piece from 2014 co-authored by my colleague Jason Delisle, who outlines the basic conundrum faced by all governments: how does it value the future flow of payments into a loan program?   In any system of loans where interest rates are positive, it is possible to make the system look as if it is “making” money for the government.  The basic problem is how do you account for risk of non-payment? 

In the US, there are two ways of doing this, which generate hugely different results and have created a ludicrous amount of acrimony over what should be a non-problem.  The Congressional Budget Office (CBO), for baffling reasons, officially reports the “future income” of the loan programs as a “best guess” of the percentage of loans that will be repaid, plus interest (zero while in school, significant thereafter), while the “cost” of the loan is the current yield on treasury bonds.  (The Canada Student Loans Program is costed on roughly the same basis).

Now, student loans are inherently risky and government “best guesses” can be wildly off (for instance, the guesses for the early part of this decade significantly overestimated repayment): pegging them to the yield of US Treasury Bonds, which are quite literally the global benchmark for safe investments, is odd.  What many people suggest is that loans should be costed on a “fair-value” basis: that is, with a higher discount rate in order to reflect risk.  By raising the discount rate, one necessarily raises the (projected) cost: in the US, the variance can reach tens of billions of dollars just for a single year’s lending.  And that variance is why some right-wing politicians can decry the loan program’s burden on the taxpayer at the same time that politicians on the left claim the program is viciously profiting from student misery.

If the U.S. example seems weird, wait until you get a load of how the UK values student loans.  I’m going to oversimplify here because it’s as complicated as all get out (but if you want to know more go read the excellent Andrew McGettigan). Basically: the UK lends students stonking amounts of money: $45,000 or so to cover tuition over three years plus, if you meet a need test, living expenses as well.  Repayment is income-contingent and has a high-repayment threshold, meaning that for a substantial number of borrowers, total repayments will never cover the principal.  At present the best estimates are that 70% of current borrowers will not repay in full, but since loan repayments are meant to take 25 years and no one really knows what future repayment patterns look like, this is just a guess.

With all this uncertainty about future losses, one ponders: “how is this reflected in government books”?  And the answer is that it isn’t. Essentially, the UK is treating loan losses on a cash basis and the costs of all these massive loans that no one believes will ever be fully repaid are magically transported into the future.  This is what is known in the UK – with reason – as “the fiscal illusion”, and it basically means government has felt no pressure to rein in lending because the costs are all being passed to governments a generation hence.

Or at least, that was true until last December when the Office of National Statistics decided that this arrangement was, in fact, as dumb as a bag of hammers and suggested that for proper accrual treatment, the government had to give a best estimate of how much of each year’s aggregate loans will be repaid, and write off the rest immediately (which, with minor variations, is what both the Canadian and American systems both do).  Turns out this single change will cost the UK government £12 billion annually (call it C$20 billion or so), which is roughly equivalent to 100% of Canadian public expenditure on universities, so this is big.  This is so big that the government is now considering a) sharply cutting back tuition so that government won’t be on the hook for so much in tuition costs (obviously, since reducing expenditure is the goal, there would be no question of compensating institutions for the loss of income), or b) restricting loan eligibility by, say, cutting off students who don’t meet a certain grade-point average (which would be a disaster for access) or c) both.

In short, loan accounting may be abstract and boring but getting it right is key to maintaining trust and stability in the system.  It’s not something we should take for granted.