Securitization of Student Loans: A Proposal to Reform Federal Accounting, Reduce Government Risk, and Introduce a Market Mechanism for a New Quality of Education Signal

Abstract

This paper outlines looming budgetary and accounting issues with federal student loans and proposes using securitization as an innovative mechanism to reform federal accounting, reduce federal balance sheet risk, and provide a new education quality signal. The current federal loan program is unsustainable because it overestimates the repayment rates and underestimates the cost of certain loan programs. This, and not bad outcomes for individual students, will necessitate reform in some form. This paper proposes using securitization mechanisms to reduce federal risk while also forcing institutions to bear some of the risk created from student loans (similar to risk retention provisions in Dodd-Frank for mortgage originators). This would create a neutral pricing mechanism outside the direct control of federal regulators which would fairly show whether certain institutions provide a quality education (i.e., closing the education quality feedback loop). While complicated, this proposal is a back-end loaded solution to introduce risk-based pricing into the student loan programs without placing the risks fully on uninformed students. Updated to to reflect new changes to student loan interest rates from the Bipartisan Student Loan Certainty Act of 2013 (H.R. 1911). The legislation was signed by President Obama August 9, 2013, and retroactively effective July 1, 2013. Final Published Version uploaded January 9, 2014.