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Project Hero deserves a zero: comment on our student loans interest increase story

Further to our Guardian story on proposals to raise interest rates on student loans taken out in the last 15 years, Higher Education specialist Andrew McGettigan, who analysed the proposals for that story, discusses the realities and costs people will face with "monetising" of student loans:

Did you graduate from university in the last decade? Did you take out a student loan? Would you mind if your loan account was sold to private investors? No?

What if the total amount you had to repay on your loan was raised to facilitate such a sale? Or if the taxpayer was left footing the bill to guarantee private profits?

These are the two recommendations made in a study produced for the government by Rothschild on how to ‘monetise’ student loan accounts. Possible buyers include insurance companies and private pension funds.

This complex, technical study is not an idle ‘think piece’ or independent research. In 2010, Rothschild were hired by the government to conduct this work. We have seen the end-of-project report, dated November 2011, which analyses investors’ appetite for a sale and sets out recommendations.

In response to False Economy’s Freedom of Information request, BIS told us the recommendations were still under consideration, and refused to disclose the un-redacted document on the grounds that it would jeopardise commercial negotiations:

“In our view, the balance of public interest lies with withholding the information you have requested.”

Well, in our view, the public interest lies in knowing that recent graduates– and possibly taxpayers in general - may have to pay more under any deal. It is in everyone’s interests to know what efforts the government might go to in order to shift the student loan book off the national balance sheet and to manage public sector net debt, the key headline statistic through which all parties now try and portray economic competence.

Project Hero – for that is what the report is called – even speculates on how the government might sell the plans to recent graduates:

“We all live in difficult times. You have a deal which is so much better than your younger siblings (they will incur up to £9,000 tuition fees and up to RPI+3% interest rates); it won’t make any difference to how much you pay in the short or medium term, just how long you pay it for”. [my emphases]

The report goes on to make a frank admission of the problems of the higher student fees that came into effect last September, revealing that no sale of the newer, “much riskier” loans appears feasible before 2020. These new student loans are described as requiring“very significant refinancing”. For this reason, the focus is on existing borrowers and ‘cohorts’ of graduates where loan repayments first fell due in 2002, 2003 and 2004. Rothschild further outline an “offer of compromise”:

“To make this more acceptable to students [sic; they are referring to graduates], several alternatives exist, such as increasing the £15,000 threshold, reducing the 9% repayment rate, offering them a payment holiday to ensure that borrowers are not disadvantaged, etc.”

Given that those graduates could face loans that otherwise last until retirement (when remaining student debt is written off), those additional years of repaying 9% on all earnings above £15,000 could be significant.

Terms of sale – borrower, beware!

Removing the lower cap for borrowers, which according to their report Rothschild “understands that the government would consider”, would increase the estimated sale volume from £2bn to £10bn.

The report makes it clear that many Investors don’t want to buy student loans if the interest rate continues to be capped at “the lower of the Retail Price Index … or 1 per cent above the highest base rate of a nominated group of banks”.

The relevant RPI for the academic year is set by the preceding March’s inflation figure.

Currently the bank base rate is only 0.5% meaning that interest rates (i.e. the base rate plus 1%) are 1.5% - far below March 2012’s RPI of 3.6%.

Investors want protection against precisely these below-inflation interest rates. Rothschild suggests a new clause: “the highest [sic] of 0% or RPI”, effectively also incorporating insurance against deflation.

But hang on? Didn’t you sign a loan agreement specifying the terms of repayment?

No. The relevant clause in loans issued in the last few years reads:

“You must agree to repay your loan in line with the regulations that apply at the time the repayments are due and as they are amended. The regulations may be replaced by later regulations.” [my emphases]

The Rothschild report proposes just such an amendment as the precondition for a suitable sale. The effect of this would be to increase the rate by which the amount of money owed by a graduate grows.

With outstanding balances accruing higher rates of interest the average-earning graduate would take longer to repay, would have to make more repayments, and would repay more money overall.

Those sitting on the new ‘2012’ loans should realise that the ‘impediment’ at issue here was removed by the 2011 Education Act. No such protection now exists for new borrowers, who face real rates of interest and possibly more. Plenty of kibbitzers are already mooting changing those loan terms to fix the ‘black hole’ in the undergraduate finances.

“Synthetic Hedge”

That said, Rothschild suggest an alternative plan whereby the government would artificially replicate such a change. The government would agree to compensate investors for the difference between the cash flow actually received from the student loans, and the estimated cash flow that would have been received without the Base Rate cap. This is termed a ‘synthetic hedge’ against what are seen as adverse inflation and interest rate conditions.

Since these cash flows would only be at issue in the final years of the loans, due to how repayments are structured, the current government would be committing a future government to covering these payments. It is not clear what current provision would be made to ensure that the future administration is not left with an unpleasant bill. The last few decades have seen governments repeatedly prepared to ‘kick the can down the road’.

If changing the terms of repayment for graduates is too politically risky, the government may well plump for this option – and leave future taxpayers forking out to guarantee private investors’ cash flows.

Martin Wolf of the Financial Times put it succinctly – the sale of student loans in the medium to long run is ‘economically illiterate’, since the government always has the lowest cost of borrowing. Rothschild indicated that the government would, in the long run, lose the equivalent of 3p in the pound even if the impediment were removed.

In reality, such a sale is politically motivated, designed to massage the headline national debt statistics in the run up to the next election.

Current intentions

The government’s current plans are hard to discern. Project Hero is dated November 2011 – we are led to understand that it is the last advice Rothschild prepared. They were pressing for sales to commence in October 2012, bringing forward the government’s original target of April 2013.

In summer 2012, the government did indicate that the sale of these ‘income contingent repayment’ loans was not currently a ‘priority’, though the Office for Budgetary Responsibility revealed that a ‘partial sale’ of outstanding accounts was planned.

A Sunday Times story from May claimed officials were looking again exactly the sort of sale outlined here (in addition to a sale announced in March of the remaining outstanding balances on earlier, pre-1998 loans – nominally worth £900m but likely to raise only £200m).In the first week of June, Baroness Garden of Frognal, BIS spokeswoman in the House of Lords, said that the coalition continues to “explore options for monetising student loans”:.

“Any future sale of income-contingent repayment student loans would take place only if it reduced the government’s risk exposure to the loan book, represented value for money for the taxpayer and ensured protection of borrowers.”

‘Value for money’ is boosted by the two options outlined above: Rothschild saw the government receiving a price of roughly 70p per pound of outstanding balance. With the interest rate ‘impediment’ in place, much less could be shifted at only 63p. That said, If the government held onto the loans, returns were expected to total about 72p. Given the stagnation in the economy since November 2011, these figures must have been revised, but the relative pricing may still stand.

Public Interest

The last qualification in the quote above does not amount to ruling out changes. It offers a gloss on the ‘offer of compromise’ that might be made. Its composition resembles the equivalent passage in the 2011 White Paper: ‘under any solution borrowers would be placed in no worse a position as a result of a transfer of their loans.’ (§1.41)

Since the government is not required to consult with borrowers, nor gain their consent for any sale, this pitch could be made to MPs: “Yes, we are changing the interest rate terms, and extending borrowers period of repayment, but as a result of the offer of compromise, we deem borrowers to be in no worse position.” (Purchasers are unable to alter terms and conditions themselves).

Here’s the rub. It must be for individual borrowers to determine where their own interests lie. The Minister does not know best. We need a clear statement taking some of the recommended ‘Heroics’ off the table. But frankly, the government is probably more concerned about what the financial markets think than what you think of what is revealed here.

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