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Interested Colleagues Barmak Nassirian Petri Bill 1/29/2013

It might be useful to circulate the Petri press release, which provides links at the end to a more detailed description of the policy and to the bill. I thought I'd save everybody some time by quickly jotting down my own reaction for what it's worth. First, I should admit that I am a fan of Mr. Petri's, who has done some heavy lifting on loan reform, and is probably the best informed member of Congress when it comes to educational finance. This proposal has interesting features that ought to be taken seriously and considered carefully after some solid analytical work. Having said that, I find it nowhere near ready for prime time, and believe it would need lots of tweaks before it could be viewed as move in the right direct. The following is a random (and incomplete) list of my issues: The proposed rates are problematic for several reasons. The index (10-year note) makes no sense in view of the much longer repayment periods envisioned in the bill. The "correct" index for loan assets, particularly since they are financed by the U.S. Treasury (as opposed to banks which would need specific Treasury instruments for hedging purposes), was first articulated by Bob Shireman and enshrined in the 1993 OBRA to be an "instrument of comparable maturity," which we may more explicitly articulate as an extrapolated rate for the entire portfolio. This can by itself eat up a couple of hours of discussion, so I'll move on to say that the 3% and 4.1% margins added to the index appear to be entirely arbitrary, particularly in relation to each other. Furthermore, I am generally uneasy with fixed rates, which create massive disparities among cohorts of borrowers solely based on when they happened to go to school. Variable rates with annual resets, provided there are incremental and maximums caps in place, are vastly preferable in economic and political terms. Mr. Petri's argument about simplicity is a bit overstated. There is an indirect acknowledgement in the FAQ section about the need to do a tax-time reconciliation with the IRS to deal with the very significant issue of unearned income, for starters. Then there's the problem of eliminating all methods for cessation or reduction of payments, which makes no sense at all, given that one could conjure up all kinds of scenarios why someone may be unable to make payments despite availability of some income. There can, for example, be court-ordered payments, prior or concurrent wage garnishment, military deployment, or other issues that might push someone into a completely untenable cash flow situation unless loan repayment were subject to some modifications, and out would go simplicity (particularly if you'd have to call the IRS to deal with it.) I would also have t point out the enormous costs this proposal would impose on every employer in the U.S., including so many small businesses that may not have the resources to deal with yet another withholding algorithm. The headaches for employers would certainly be matched for borrowers by the privacy implications of having your employer serve as the loan collector.

I have all kinds of conflicting feelings about whether the operational conversion of loan obligations to taxes is a sound move. No love lost here for Sallie Mae and Nelnet, but unleashing the IRS on borrowers alarms me. This is particularly worrisome in light of the fact that the essence of the Petri proposal is to turn loan repayment into an indenture contract that can run as long as 40+ plus years (until age 65). Given that defaults and non-payments are due to inability (and not unwillingness) to repay, the central feature of the Petri plan is to trade existing (and admittedly imperfect) remedies to the problem of long-term debt-to-income disparity for simple interest and a maximum interest accrual limit.

Speaking of this latter, I find the comparisons between the standard 10-year amortization amounts and the Petri payment amounts disingenuous. The real comparisons should be between current benefits in IBR/ICR and the Petri plan. The main difference between the two would appear to be the elimination of the significant benefits of IBR/ICR for those borrowers who get forgiveness on the one hand, and the significant reduction in rates for everybody else. The former group end up definitely worse off, but those who would have paid their loans off anyway get sizeable benefits from the rate reduction and what is for many of them an accelerated (albeit uncomfortable) repayment pace. I am less concerned about the sub/unsub distinction because I do think that a 380-basis-point drop in rates obliterates the difference for most borrowers (and the lowest income borrowers would find it irrelevant anyway). A more careful financial analysis of the proposal's impact is needed for a definitive judgment, but the subsidy distributions in the bill strike me as less than ideal. The 15%-minus-150%-of-poverty construct is problematic as well. This is a much less sophisticated version of Mr Petri's earlier income-contingent plans, which operated as bivariate formulas that generated different monthly payment amounts as a function of both debt and income. Here, the repayment term is substituting for the modulated 15-year amortization payments that Mr. Petri himself used. This scheme quickly escalates payment amounts to higher percentages of income than most borrowers currently face. My own reaction overall is to say that IRS collection might be acceptable if we could clean up gatekeeping to ensure that people who have been ripped off are not handed to the IRS for life. It does offer some simplification, but raises other issues that can be dealt with. It may well be more efficient for everybody (with the exception of employers) but it carries risks. On the financing front, I think of this as a step back from Mr. Petri's earlier work. To me, the ICR (and not the IBR) model is where the action is. If we were to clean up the confusing and overly complicated repayment options we throw at borrowers in favor of a singular repayment scheme, modifying ICR would be the way to go. And then there are a whole lot of extraneous things (program quality, cost containment and tuition inflation, etc.) that have to be layered on top of the repayment piece for the things to hang together.