Mike Konczal

Roosevelt Institute Fellow

Recent Posts by Mike Konczal

  • Quick Thoughts on Ryan's Poverty Plan: What Are the Risks?

    Jul 25, 2014Mike Konczal

    Paul Ryan released his anti-poverty plan yesterday, and lots of people have written about it. Bob Greenstein has a great overview of the block-granting portion of the plan.

    Paul Ryan released his anti-poverty plan yesterday, and lots of people have written about it. Bob Greenstein has a great overview of the block-granting portion of the plan. I'm still reading and thinking about it, but in the interest of answering the call for constructive criticism, a few points jump out that I haven't seen others make yet.

    How did we get here?

    Republicans obviously have an interest in branding themselves as a "party of ideas." And many liberals and Democrats also have an interest in trying to make the GOP seem like it's been devoid of any ideas in the past several years.

    But it's worth noting that within a year of Democrats and liberal thinkers getting actively behind a serious increase in the minimum wage, and many activists making strides toward it on the local level, Paul Ryan just wholesale adopted President Obama's EITC expansion program. That demonstrates the value of pushing the envelope.

    Complexity and the EITC

    Ryan's plan, correctly, makes a big deal out of the complexity of receiving the EITC. The difficulty of navigating the system, the large number of improper payments, people not receiving what they should, people having to use tax-prep services to get the credit, and so on.

    This is why I'm a huge fan of higher minimum wages as a complement to the EITC. Instead of 40 pages of rules and a dozen potential forms to fill out, you just put a sign that reads "$10.10 an hour" on the wall. Bosses and workers can't trick each other or get confused about this, and nobody has to pay a tax-prep service to figure it out. Easy peasy.

    Ryan wants to "direct the Treasury Department to investigate further" how to fix this, but in practice Treasury just turns around and yells at the IRS. And if the IRS knew how to fix it, they'd probably be on it.

    There is also a simpler plan to fix this issue: just have the government mail people their tax forms already filled out, for them to either sign or correct. When a trial version of this, "Ready Return," was tried in California, people immediately saw the potential for this to fix EITC delivery issues. Perhaps anti-poverty advocates can help provide momentum on this front.

    Bosses and the EITC

    Both Ryan and Marco Rubio have referred to putting the ETIC credit directly into workers' paychecks. Ryan: "[A]nother potential area of reform should focus upon EITC simplicity and delivery. If families received the credit with their paychecks, the link between work and the EITC would be that much clearer."

    I'd be worried if employers were the ones responsible for adding this wage subsidy. I don't think there's a convincing argument that the EITC or food stamps lower wages directly (though there is one indirectly for the EITC), but if employers got a wage subsidy themselves to pass to their workers, it's easy to imagine them pocketing part of it through lower wages, especially in the monopsony of low-wage labor markets.

    A discussion of welfare reform

    Rather than a "welfare reform -- yay or nay?" conversation, it would be really useful if people arguing for the block-granting of the entire anti-poverty agenda would point out what they do and do not like about what happened in the 1990s. Especially as proponents hold up welfare reform as the model.

    As Matt Bruenig notes, the work requirements and other restrictions go against the concept of subsidiarity. Greenstein writes, "the block grant would afford state and local officials tantalizing opportunities to use some block grant funds to replace state and local funds now going for similar services...That’s what happened under the Temporary Assistance for Needy Families (TANF) block grant." In retrospect, TANF didn't survive the business cycle, and it clearly has cut spending by cutting the rolls. Is that what people want to accomplish with food stamps, which have done wonders to boost childhood life outcomes? If not, what can be done other than assert that this time will be different?

    Follow or contact the Rortybomb blog:

      

    Share This

  • Live at TNR: Dodd-Frank at Year Four

    Jul 23, 2014Mike Konczal

    Live at The New Republic, I have a piece describing Year Four of Dodd-Frank, which celebrates its birthday this week. The news coverage of the past year has had a "stuck, spinning its wheels" argument to it. I argue that this past year saw some major and important advancements, directions on where to go next, and also made what will be the biggest challenges going forward very clear. I hope you check it out.

    Follow or contact the Rortybomb blog:
     
      

     

    Live at The New Republic, I have a piece describing Year Four of Dodd-Frank, which celebrates its birthday this week. The news coverage of the past year has had a "stuck, spinning its wheels" argument to it. I argue that this past year saw some major and important advancements, directions on where to go next, and also made what will be the biggest challenges going forward very clear. I hope you check it out.

    Follow or contact the Rortybomb blog:
     
      

     

    Share This

  • Dr. Strangelove and the Halbig Decision

    Jul 22, 2014Mike Konczal

    "Yes, but the whole point of a doomsday machine is lost if you keep it a secret! Why didn't you tell the world, eh?" - Dr. Strangelove

    So the DC Circuit Court ruled in Halbig v. Burwell hat health care subsidies can only go to states that set up their own health care exchanges rather than use the federal ones. That means indivdiuals from the 34 states who get subsidized health care from the federal exchange would no longer be able to get subsidies. (Another court ruled against this logic today.) I don't normally do health care stuff, but I've read a lot about this case and something strikes me as very odd.

    As I understand it, those on the right who are pushing the Halbig case argue that there's a doomsday machine built into Obamacare. (Adam Serwer at MSNBC also caught this doomsday machine analogy.) If states don't set up their health care exchanges then they don't receive subsidies for health care from the federal government. According to this theory, the liberals who designed health care reform did this knowing that if subsidies were pulled, the system would collapse for states that didn't set up their exchanges.

    It's important to note that those on the right are not arguing that this is a typo in the bill, because that wouldn't necessarily be sufficient to overturn the subsidies. They are arguing that Congress intentionally put this language in there to compel, bribe, incentivize, and otherwise threaten states that didn't set up their own exchanges. In the rightwing argument, liberals were saying "we are making the citizens of your state purchase health care, and if you don't set up an exchange they won't get the subsidies necessary to make the system work, so you'd better set up an exchange."

    The right's argument hinges on the idea that since there's no evidence that this isn't the intent, it must be the intent. As the two authors of the legal challenge put it, Obamacare "supporters’ approval of this text reveals that their intent was indeed to enact a bill that restricts tax credits to state-run Exchanges. At no point have defenders of the rule identified anything in the legislative history that contradicts" their reading.

    Here's the thing, though: like Strangelove notes, a doomsday machine only works if you tell others about it. So, why weren't the people in the vast network associated with Obamacare telling everyone about this threatening doomsday device after the bill passed?

    If this was actually the intent, you'd expect that during the period where states were debating whether to set up exchanges, this would have been a major threat raised by somebody. Anyone, from President Obama to congressional leaders to health care experts and lawyers to activist groups on the ground in red states fighting for implementation, would have been saying, "if your state doesn't set up a health care exchange, your citizens are screwed. At the very least, you'll be leaving money on the table." ("Leaving money on the table" is always a good point to bring up, and if this doomsday machine really were the intent of the law, it would be true.)

    I know of no evidence of this being the case. Does anybody? Numerous people are arguing that the legislative intent is clearly on providing subsidies to the federal exchange users. No wonder the dissent argued that the Halbig ruling was "a fiction, a post hoc narrative concocted to provide a colorable explanation for the otherwise risible notion that Congress would have wanted insurance markets to collapse in States that elected not to create their own Exchanges."

    That doesn't change what the DC Circuit did, of course, but it should make a random person stop and wonder how much of a cynical ploy this whole thing is.

    Follow or contact the Rortybomb blog:
     
      

     

    "Yes, but the whole point of a doomsday machine is lost if you keep it a secret! Why didn't you tell the world, eh?" - Dr. Strangelove

    So the DC Circuit Court ruled in Halbig v. Burwell hat health care subsidies can only go to states that set up their own health care exchanges rather than use the federal ones. That means indivdiuals from the 34 states who get subsidized health care from the federal exchange would no longer be able to get subsidies. (Another court ruled against this logic today.) I don't normally do health care stuff, but I've read a lot about this case and something strikes me as very odd.

    As I understand it, those on the right who are pushing the Halbig case argue that there's a doomsday machine built into Obamacare. (Adam Serwer at MSNBC also caught this doomsday machine analogy.) If states don't set up their health care exchanges then they don't receive subsidies for health care from the federal government. According to this theory, the liberals who designed health care reform did this knowing that if subsidies were pulled, the system would collapse for states that didn't set up their exchanges.

    It's important to note that those on the right are not arguing that this is a typo in the bill, because that wouldn't necessarily be sufficient to overturn the subsidies. They are arguing that Congress intentionally put this language in there to compel, bribe, incentivize, and otherwise threaten states that didn't set up their own exchanges. In the rightwing argument, liberals were saying "we are making the citizens of your state purchase health care, and if you don't set up an exchange they won't get the subsidies necessary to make the system work, so you'd better set up an exchange."

    The right's argument hinges on the idea that since there's no evidence that this isn't the intent, it must be the intent. As the two authors of the legal challenge put it, Obamacare "supporters’ approval of this text reveals that their intent was indeed to enact a bill that restricts tax credits to state-run Exchanges. At no point have defenders of the rule identified anything in the legislative history that contradicts" their reading.

    Here's the thing, though: like Strangelove notes, a doomsday machine only works if you tell others about it. So, why weren't the people in the vast network associated with Obamacare telling everyone about this threatening doomsday device after the bill passed?

    If this was actually the intent, you'd expect that during the period where states were debating whether to set up exchanges, this would have been a major threat raised by somebody. Anyone, from President Obama to congressional leaders to health care experts and lawyers to activist groups on the ground in red states fighting for implementation, would have been saying, "if your state doesn't set up a health care exchange, your citizens are screwed. At the very least, you'll be leaving money on the table." ("Leaving money on the table" is always a good point to bring up, and if this doomsday machine really were the intent of the law, it would be true.)

    I know of no evidence of this being the case. Does anybody? Numerous people are arguing that the legislative intent is clearly on providing subsidies to the federal exchange users. No wonder the dissent argued that the Halbig ruling was "a fiction, a post hoc narrative concocted to provide a colorable explanation for the otherwise risible notion that Congress would have wanted insurance markets to collapse in States that elected not to create their own Exchanges."

    That doesn't change what the DC Circuit did, of course, but it should make a random person stop and wonder how much of a cynical ploy this whole thing is.

    Follow or contact the Rortybomb blog:
     
      

     

    Share This

  • Search Models, Mass Unemployment, and the Minimum Wage

    Jul 15, 2014Mike Konczal

    How have search models influenced the current economic debates? John Quiggin had an interesting post up at Crooked Timber about how poorly the branch of economics that falls under search theory has done in the age of the internet. (Noah Smith has follow-up.)

    Search and matching models are fascinating to me because they are central to both the debate over mass unemployment during the Great Recession as well as how economists understand the minimum wage. And here you can see search model being deployed for worse and for better.

    The Great Recession

    In his 2010 Annual Report, Federal Reserve Bank of Minnesota President Narayana Kocherlakota gave a presentation using the popular Diamond-Mortensen-Pissarides (DMP) search model to explain what he thought was wrong with the labor markets. Given that Kocherlakota was dissenting against QE2 at the time, a lot of eyes were on his arguments. Many focused on his infamous argument he later reversed that low rates cause disinflation, but I found this equally fascinating at the time.

    The economy suffered from low job openings. But why were employers not creating job openings and hiring? Kocherlakota summarized the DMP model in this graphic:

    Job openings and hires are a function of unemployment, productivity, and what was going on with the unemployed. He concluded that productivity after taxes was falling because of an increase in government debt, regulations and the proposed repeal of some of the Bush-era tax cuts. Also expansions of social insurance, including unemployment insurance and presumably the Medicaid expansion in Obamacare, was increasing the "utility" of not working. This, he believed, was the major reason why unemployment was so high and job openings so low. Using a back-of-the-envelope estimate with made-up numbers, he proposed that the natural rate of unemployment could be around 8.7 percent - very close to the then current 9.0 percent unemployment.

    Think about this model and the recession long enough, and two things should jump out. The first is that this model, going back to Robert Shimer’s (2005) seminal work on the topic, is terrible at explaining movements in unemployment. The volatility in vacancies and productivity aren’t anywhere near the magnitude necessary to cause unemployment movements that we see in recessions. Productivity would need to drop significantly to create the changes in unemployment we see in recessions, and it doesn’t move to anywhere near that extent.

    The second is that, as Robert Hall and many others have pointed out, productivity actually increased during the recent recession. It’s moving the wrong direction for it to impact unemployment the way we’d see it during the Great Recession. The unemployment-to-vacancy ratio also increased - 2009 was a fantastic time to create job openings according to this model, yet they collapsed. This is extra problematic given that economists have tried to respond to the initial problem by amplifying productivity movements in their models. But, out here in the actual world, the thing is simply moving in the wrong direction to make any sense.

    Note that there’s no place for things like aggregate demand or the zero lower bound to plug into the equation. The only things that can matter are things like taxes, government uncertainty and social insurance, and they all work in the negative direction. That search models have become so influential to the background knowledge of unemployment helps explains the default ideology of why economists were so eager to find "structural" explanations for why unemployment was so high.

    Minimum Wage

    There’s some debate on this, but it looks like economists are softening on their opposition to raising the minimum wage, particularly if the question is phrased as whether or not a slightly higher minimum wage would pass a cost-benefit test. Search theory might be a reason why. If you are schooled in thinking of the labor markets in a search model, the idea that the minimum wage might not have an adverse employment effect makes more sense. A higher minimum wage means that low-wage workers will search harder for low-end jobs. They’ll be more likely to accept those jobs, and less likely to turn them over as well. These all would help raise the equlibrium employment level.

    Even further, if you think that each job has a bit of a search friction surrounding it, then the idea that the employer has a little bit of monopoly power over the job makes sense. Employers might not raise wages to a market clearing rate because that, in turn, would mean having to raise the wages for all their workers. A minimum wage pushes against that. Understanding the labor markets through this lens ideas helps explain why any disemployment effects are minimial compared to the economics 101 story.

    As I read it, much of this theory took hold in labor economics to help explain the data people were seeing. Why were there so many vacancies in fast food? Why didn't minimum wage hikes obviously cause unemployment in the data? This should tell us something - theory, when built up out of observations and data, can tell us something useful. But the same theory moved over to the business cycle, where it ignores conflicting data and is propelled downward by partisan and ideological forces, can be an utter disaster.

    Follow or contact the Rortybomb blog:
     
      

     

    How have search models influenced the current economic debates? John Quiggin had an interesting post up at Crooked Timber about how poorly the branch of economics that falls under search theory has done in the age of the internet. (Noah Smith has follow-up.)

    Search and matching models are fascinating to me because they are central to both the debate over mass unemployment during the Great Recession as well as how economists understand the minimum wage. And here you can see search model being deployed for worse and for better.

    The Great Recession

    In his 2010 Annual Report, Federal Reserve Bank of Minnesota President Narayana Kocherlakota gave a presentation using the popular Diamond-Mortensen-Pissarides (DMP) search model to explain what he thought was wrong with the labor markets. Given that Kocherlakota was dissenting against QE2 at the time, a lot of eyes were on his arguments. Many focused on his infamous argument he later reversed that low rates cause disinflation, but I found this equally fascinating at the time.

    The economy suffered from low job openings. But why were employers not creating job openings and hiring? Kocherlakota summarized the DMP model in this graphic:

    Job openings and hires are a function of unemployment, productivity, and what was going on with the unemployed. He concluded that productivity after taxes was falling because of an increase in government debt, regulations and the proposed repeal of some of the Bush-era tax cuts. Also expansions of social insurance, including unemployment insurance and presumably the Medicaid expansion in Obamacare, was increasing the "utility" of not working. This, he believed, was the major reason why unemployment was so high and job openings so low. Using a back-of-the-envelope estimate with made-up numbers, he proposed that the natural rate of unemployment could be around 8.7 percent - very close to the then current 9.0 percent unemployment.

    Think about this model and the recession long enough, and two things should jump out. The first is that this model, going back to Robert Shimer’s (2005) seminal work on the topic, is terrible at explaining movements in unemployment. The volatility in vacancies and productivity aren’t anywhere near the magnitude necessary to cause unemployment movements that we see in recessions. Productivity would need to drop significantly to create the changes in unemployment we see in recessions, and it doesn’t move to anywhere near that extent.

    The second is that, as Robert Hall and many others have pointed out, productivity actually increased during the recent recession. It’s moving the wrong direction for it to impact unemployment the way we’d see it during the Great Recession. The unemployment-to-vacancy ratio also increased - 2009 was a fantastic time to create job openings according to this model, yet they collapsed. This is extra problematic given that economists have tried to respond to the initial problem by amplifying productivity movements in their models. But, out here in the actual world, the thing is simply moving in the wrong direction to make any sense.

    Note that there’s no place for things like aggregate demand or the zero lower bound to plug into the equation. The only things that can matter are things like taxes, government uncertainty and social insurance, and they all work in the negative direction. That search models have become so influential to the background knowledge of unemployment helps explains the default ideology of why economists were so eager to find "structural" explanations for why unemployment was so high.

    Minimum Wage

    There’s some debate on this, but it looks like economists are softening on their opposition to raising the minimum wage, particularly if the question is phrased as whether or not a slightly higher minimum wage would pass a cost-benefit test. Search theory might be a reason why. If you are schooled in thinking of the labor markets in a search model, the idea that the minimum wage might not have an adverse employment effect makes more sense. A higher minimum wage means that low-wage workers will search harder for low-end jobs. They’ll be more likely to accept those jobs, and less likely to turn them over as well. These all would help raise the equlibrium employment level.

    Even further, if you think that each job has a bit of a search friction surrounding it, then the idea that the employer has a little bit of monopoly power over the job makes sense. Employers might not raise wages to a market clearing rate because that, in turn, would mean having to raise the wages for all their workers. A minimum wage pushes against that. Understanding the labor markets through this lens ideas helps explain why any disemployment effects are minimial compared to the economics 101 story.

    As I read it, much of this theory took hold in labor economics to help explain the data people were seeing. Why were there so many vacancies in fast food? Why didn't minimum wage hikes obviously cause unemployment in the data? This should tell us something - theory, when built up out of observations and data, can tell us something useful. But the same theory moved over to the business cycle, where it ignores conflicting data and is propelled downward by partisan and ideological forces, can be an utter disaster.

    Follow or contact the Rortybomb blog:
     
      

     

    Share This

  • Do Taxpayers Care if Student Loans Are Paid Off Too Quickly? (On Fair Value Accounting)

    Jun 11, 2014Mike Konczal

    With President Obama’s student loan announcement in the news this week, an argument over whether or not taxpayers make a profit from student loans is no doubt close behind. We do make a profit using the government’s accounting tools, but there’s an argument that we should instead use “fair value accounting,” or the rate at which the private market adjusts for risk (here’s Jared Bernstein with a recent piece). By that standard, we see a much smaller profit.

    Most people reference the CBO on this, though its numbers are entirely opaque. For instance, it says that it “relied mainly on data about the interest rates charged to borrowers in the private student loan market,” but there are gigantic adverse selection problems right out of the gate. The private student loan market is where the worst credit risks go, so of course they have higher rates. Is the CBO able to control for this? Nobody knows.

    But beyond that, there’s a simple finance logic reason for why I don’t buy the argument for fair value accounting. I don’t believe that taxpayers face prepayment risk, and to whatever extent they do, it’s a matter of politics, not economics, that determines this.

    The concept of prepayment risk might not make sense for people without some financial background, so let’s walk through it. If you lend money to a person you know, whether it’s a questionable relative or a partner who asks to hold some money until they get their check next week, you just want to get paid back in full. And, here’s the kicker, you are really happy if you get paid back sooner than you had expected. You want the money back.

    Is that how private capital markets work? No. Let’s say you manage a large portfolio of private student loans. And let’s say you get a note at the office that they are being paid back more quickly than you had expected. Are you happy? No. You are not, and you might even get fired.

    Why wouldn’t you be happy about getting paid back earlier?

    1. You have to physically do something with the money you get paid back to get it earning more money again. No matter what you end up doing -- reinvesting it in student loans, putting it into a different set of assets, or just stuffing it in the equivalent of a mattress -- it takes time, energy, and resources, all of which cost money.

    2. Often you want to set a certain time frame for repayment. Say you really want to have a cash flow at a certain date far off into the future because you are funding a pension or insurance liability. Getting paid back earlier doesn’t meet that goal, and it confuses your expectations for cash flows.

    3. Crucially, you are likely to get paid back exactly when you don’t want the money. Say you locked in private student loans at a high interest rate, but then interest rates decline dramatically. At this point students will pay back their loans more quickly, which leaves you with more cash on hand at a time when interest rates are low.

    This isn’t some partisan ideological point; it’s just basic finance. You can see it described in a CFA study guide under call and prepayment risk and reinvestment risk. (People more baller than I who actually did the CFA can nitpick specifics, but the general layout is correct.)

    So private investors in student loans are genuinely worried that they’ll get paid back too quickly, and as a result charge a higher interest rate which leads to a larger discount rate. Because, and follow this, their goal isn’t to “get paid back.” Their goal is to achieve a consistent rate of return given a risk profile, with predictable cash flows given other institutional constraints. Getting paid back quickly is a risk to all this.

    So, here’s my question: do taxpayers face this prepayment risk? If you saw a headline that said “student debtors are paying off their public student loans faster than expected,” would you be happy as a citizen, or furious?

    I’d say happy. As a citizen, I’m not interested in earning a certain amount of profit consistently and with certainty over time, especially with the money paid back by student debtors, though I am as a private investor. If citizens were paid back more quickly, we could return the money to taxpayers, or use it for different purposes, or whatever. I certainly wouldn’t say “how are we going to continue to make the profit we were making?” as a citizen, though that’s exactly what I’d say if I were an investor in a private student loan portfolio. We could debate this -- perhaps you think the goal of the government here is to extract maximum financial profits no matter what. But it would be a political debate, divorced from the logic of financial market valuation.

    This is not a trivial concern. Anyone with experience modeling a mortgage-backed security is very conscious of how greater prepayments impose massive risks and uncertainty. Normally the private sector goes to great lengths to imposes penalties and limitations on paying back loans early, though the government doesn’t do this for student loans. And since citizen do not face prepayment risks the way the private sector does, the discount rate for public funds, by definition, must be less than private funds when it come to student loans. Hence private sector discount rates aren’t a valid benchmark.

    Note that the Financial Economist Roundtable (cited approvingly by Jason Delisle here) brings up prepayment risk specifically as something that fair value accounting is meant to capture. But the prepayment risk they specify -- which is “costly to lenders because prepayments are most likely to occur when market interest rates have decreased and loan values have appreciated,” reflecting the third issue noted above -- exists primarily because private capital has to reinvest money in a worse environment. Do taxpayers have to reinvest money they get from student loans? No, unlike private lenders, they don’t. The financial logic has broken down. (And don’t even get me started on using the private sector’s liquidity risk as a measure of the state’s.)

    I have yet to see an argument addressing this head-on, much less a convincing one, but perhaps this post will change that.

    Follow or contact the Rortybomb blog:
     
      

     

    With President Obama’s student loan announcement in the news this week, an argument over whether or not taxpayers make a profit from student loans is no doubt close behind. We do make a profit using the government’s accounting tools, but there’s an argument that we should instead use “fair value accounting,” or the rate at which the private market adjusts for risk (here’s Jared Bernstein with a recent piece). By that standard, we see a much smaller profit.

    Most people reference the CBO on this, though its numbers are entirely opaque. For instance, it says that it “relied mainly on data about the interest rates charged to borrowers in the private student loan market,” but there are gigantic adverse selection problems right out of the gate. The private student loan market is where the worst credit risks go, so of course they have higher rates. Is the CBO able to control for this? Nobody knows.

    But beyond that, there’s a simple finance logic reason for why I don’t buy the argument for fair value accounting. I don’t believe that taxpayers face prepayment risk, and to whatever extent they do, it’s a matter of politics, not economics, that determines this.

    The concept of prepayment risk might not make sense for people without some financial background, so let’s walk through it. If you lend money to a person you know, whether it’s a questionable relative or a partner who asks to hold some money until they get their check next week, you just want to get paid back in full. And, here’s the kicker, you are really happy if you get paid back sooner than you had expected. You want the money back.

    Is that how private capital markets work? No. Let’s say you manage a large portfolio of private student loans. And let’s say you get a note at the office that they are being paid back more quickly than you had expected. Are you happy? No. You are not, and you might even get fired.

    Why wouldn’t you be happy about getting paid back earlier?

    1. You have to physically do something with the money you get paid back to get it earning more money again. No matter what you end up doing -- reinvesting it in student loans, putting it into a different set of assets, or just stuffing it in the equivalent of a mattress -- it takes time, energy, and resources, all of which cost money.

    2. Often you want to set a certain time frame for repayment. Say you really want to have a cash flow at a certain date far off into the future because you are funding a pension or insurance liability. Getting paid back earlier doesn’t meet that goal, and it confuses your expectations for cash flows.

    3. Crucially, you are likely to get paid back exactly when you don’t want the money. Say you locked in private student loans at a high interest rate, but then interest rates decline dramatically. At this point students will pay back their loans more quickly, which leaves you with more cash on hand at a time when interest rates are low.

    This isn’t some partisan ideological point; it’s just basic finance. You can see it described in a CFA study guide under call and prepayment risk and reinvestment risk. (People more baller than I who actually did the CFA can nitpick specifics, but the general layout is correct.)

    So private investors in student loans are genuinely worried that they’ll get paid back too quickly, and as a result charge a higher interest rate which leads to a larger discount rate. Because, and follow this, their goal isn’t to “get paid back.” Their goal is to achieve a consistent rate of return given a risk profile, with predictable cash flows given other institutional constraints. Getting paid back quickly is a risk to all this.

    So, here’s my question: do taxpayers face this prepayment risk? If you saw a headline that said “student debtors are paying off their public student loans faster than expected,” would you be happy as a citizen, or furious?

    I’d say happy. As a citizen, I’m not interested in earning a certain amount of profit consistently and with certainty over time, especially with the money paid back by student debtors, though I am as a private investor. If citizens were paid back more quickly, we could return the money to taxpayers, or use it for different purposes, or whatever. I certainly wouldn’t say “how are we going to continue to make the profit we were making?” as a citizen, though that’s exactly what I’d say if I were an investor in a private student loan portfolio. We could debate this -- perhaps you think the goal of the government here is to extract maximum financial profits no matter what. But it would be a political debate, divorced from the logic of financial market valuation.

    This is not a trivial concern. Anyone with experience modeling a mortgage-backed security is very conscious of how greater prepayments impose massive risks and uncertainty. Normally the private sector goes to great lengths to imposes penalties and limitations on paying back loans early, though the government doesn’t do this for student loans. And since citizen do not face prepayment risks the way the private sector does, the discount rate for public funds, by definition, must be less than private funds when it come to student loans. Hence private sector discount rates aren’t a valid benchmark.

    Note that the Financial Economist Roundtable (cited approvingly by Jason Delisle here) brings up prepayment risk specifically as something that fair value accounting is meant to capture. But the prepayment risk they specify -- which is “costly to lenders because prepayments are most likely to occur when market interest rates have decreased and loan values have appreciated,” reflecting the third issue noted above -- exists primarily because private capital has to reinvest money in a worse environment. Do taxpayers have to reinvest money they get from student loans? No, unlike private lenders, they don’t. The financial logic has broken down. (And don’t even get me started on using the private sector’s liquidity risk as a measure of the state’s.)

    I have yet to see an argument addressing this head-on, much less a convincing one, but perhaps this post will change that.

    Follow or contact the Rortybomb blog:
     
      

     

    Share This

Pages