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The Chancellor on student loans

The Commons Treasury Committee has announced its own review into English higher education, bringing the number of parliamentary committee inquiries to three.

I’ll be appearing at the first oral evidence session on Wednesday, which you can watch live on Parliament TV. In preparation for that (and for the Economic Affairs committee hearing the following week), I’ve been having a look at Philip Hammond’s appearance before the EAC last month. The transcript is available here.

Hammond’s is a guarded performance. His appearance occurred before the Conservative party conference and before the changes to loan repayment thresholds and the freezing of fees was announced and confirmed.

The most interesting comments are on the sale of loans.

Hammond provides a general justification for the policy:

“It is the Government’s intention, where they find that they hold assets on the public balance sheet for which there is no policy or strategic reason, to realise those assets and thus reduce public sector debt, helping us to achieve our debt targets and/or create capacity to do other things in line with policy priorities.”

Setting out clearly that there is a preference for cash (liquid asset) over the loans (illiquid asset) because of the composition of Public Sector Net Debt – illiquid assets are excluded from that headline statistic. Alternatively, the cash can be spent to ‘do other things’.

But skirts round the issue of selling loans at a loss:

“As regards selling debts at a loss, as I said, the design intention of student loans is that they will not all be fully repaid. That is not the expectation. Clearly, there is a notional anticipated repayment level for any particular tranche of loans. Each tranche of loans has a different design structure. The market will price a book of loans, both to reflect risk and the market view of recovery rates and the market’s requirement for a discount rate.”

First, he conflates the fact that loans are ‘impaired’ (they are worth less than their face value) with the very likely outcome that loans would be sold at less than they are worth. That is, the fair value of loans (recorded in Department for Education accounts) is less than their face value, but an acceptable price might be lower still.*

Second, there is a breezy reference to discount rate, which runs together various rates: the financial reporting rate behind the fair value; the value for money test rate; and a discount that might be offered to purchasers. Unfortunately, no follow-up questions interrogated this statement. But this particular use of discount rate occured twice:

“Of course, the intention is to market portfolios of loans, and the price—and thus the discount rate—will be set by the market when a package of loans is brought to market.”

Again, there is no reference to the separate value for money test, that is meant to test whether the discount rate used by the private sector leads to an acceptable price. (This Vfm test is already skewed so that a sale that leads to a loss would pass).

Elsewhere, Hammond emphasised the clear policy commitment to a sale, but also indicated that we are still at a ‘market-testing’ phase. The tone might lead one to conclude that the government is having to go further than anticipated to get a bite from the ‘market’. It’s hard to see the recent chopping and changing of post-2012 loans not affecting market appetite for what’s on offer (and that’s before remembering that pre-2012 loans have an interest rate of 1.25% at present – well below inflation).

Asked directly about the fiscal illusion of scoring interest accruing as income in the national accounts, Hammond deflected by making vague reference to the general problem of recognising impairment. On other matters of detail – the target RAB and the discount rate change brought in by his predecessor in 2015 – he admitted ignorance.

In light of what we now know, you could also scour the comments on general ‘value for money’ in the fee-loan regime for clues as to what a coming review will look like.

“As far as I am aware, there are no alarm bells at the moment telling me that we should review value for money from a policy perspective. There is clearly another aspect, which is value for money to the individual, and the situation the individual finds themselves in. There is a significant difference between a graduate who leaves university with a significant level of debt and a well-recognised degree in an area known to provide strong employment opportunities and, on the other hand, a graduate who has a similar level of debt but may not have a degree that will enhance his or her employment opportunities in the same way.

“We have a responsibility to look at the way the system is working in practice. It is probably fair to say that the original expectation was that there would be a bigger range of outcomes in relation to fees charged than has actually turned out to be the case.”

So again – we see reference to differential fees (recall May’s recent focus) and reference to gradautes with large debts but limited employment opportunities.

You might want to combine those concerns with the ‘perverse incentive’ he’s been alerted to in the system.

“It is a matter of concern, which several vice-chancellors have drawn to my attention, that universities incur significantly higher costs in teaching some subjects compared with others, and the funding system does not reflect those higher costs in a way that necessarily incentivises universities to focus on increasing their STEM teaching. Indeed, some have argued that there is a perverse incentive in the system, in that they can generate surpluses in relation to some of the humanities subjects that are cheaper to teach.”

It’s hard to see how the current market mechanisms can eradicate that incentive. It will probably require the imposition of subject-level limits on fees or loans.

 

*The government has indicated that it is prepared to sell loans for less than they are worth. Whether this is a good or bad position depends on how far it is rational for government to prefer cash today over holding a financial asset that will realise its value for several years. Most commentators, myself included think it’s approach is misguided and driven by a misplaced short-termism or obsession with presentational matters (like PSND) over genuine concerns for fiscal health. The level of this short-termism can be gauged by the difference between the financial reporting rate and the VfM rate: RPI plus 0.7% against RPI plus 3.5%. That’s a big difference.

What this isn’t though is: “like buying a sofa on HP then selling it cheap on eBay to pay the grocery bill”.

The government has loaned students the money to study (to buy the sofa) and then wants to sell the loan (or at least the income stream associated with the loan): the student still has the education (or the sofa).

And the government used to provide sofas for free, so would be in a better cash position after a sale than previously. There are really three stages to the analogy:

  1. Providing sofas to students for free;
  2. Providing loans for students to buy sofas;
  3. Selling the loans.

The position at 3 is better than the initial position (1) in cash terms, but is 3 better than 2? How should the government value the financial asset compared to cash?

 

 

 

 

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HoL Economic Affairs Committee inquiry – oral evidence starts today

The House of Lords Economic Affairs Committee is running an inquiry into tertiary education. It’s holding its first oral evidence sessions this afternoon. You can watch Paul Johnson (IFS) today at 3.35pm.

Sessions will be held weekly in that slot. I will be appearing with Gavan Conlon of London Economics in a fortnight.

 

 

 

 

Loan repayment thresholds announced

Jo Johnson provided a written statement to the House of Commons yesterday, which confirmed that maximum tuition fee levels would be frozen for 2018/19 and that the loan repayment threshold for post-2012 loans would increase to £25 000 this coming April and then be uprated annually in line with average earnings (undoing Osborne’s 2015 freeze and more). The lower threshold for the interest rate taper will also rise to that level, while the upper threshold will increase to £45 000, with the taper maintained at RPI to RPI + 3 percentage points.

The repayment threshold for pre-2012 loans, currently set at £17 775 will continue to increase in line with RPI, while the threshold for postgraduate loans will remain frozen at £21 000. PGT loans now look an even worse deal as their interest is fixed at RPI +3pp (no taper) and so can prove expensive for those who earn above the threshold, but not enough to erode the debt quickly. Since the loan limit is only £10 000 in total, PGT borrowers are likely to repay a higher percentage of interest.

Back to post-2012 loans: a major review is likely to be announced at the Budget on 22 November. Even if the Treasury had had a welcome change of heart and was prepared to support greater investment in HE, this isn’t the way to do it.

London Economics and the Institute for Fiscal Studies have costed the measure independently and concluded that it would cost at least £2bn per cohort of borrowers (IFS: £2bn; London Economics: £2.78bn), with the RAB charge rising from around 30% to 45%. That is, for each £1 lent, the government would expect to get back 55p … which leads us to the problematic optics. The loan subsidy is opaque and much harder to present to the public than lower or zero fees (as a result of direct teaching grants to institutions).

Without futher review, the scheme is more expensive than what we had before 2012, fees are over £9000pa, graduating debt is still enormous, and the interest rate is unchanged. An expensive measure which benefits almost all borrowers will scarcely address the concerns aired continually in the press over the last year. (Although a repayment rise benefits all existing borrowers and that would appear to have advantages over Labour’s offer of zero tuition to future students, Labour’s interest in debt write-offs would come into the picture here.)

Moreover, from the Treasury point of view, repayments from all post-2012 cohorts will be lowered immediately, thus affecting cashflow and short-term projections for public sector net debt.

As I said in the previous post, I expect a review to look at loan outlay, not just fee levels.  The Conservative line against Labour has to be that undergraduate study is worth it and that requires making value for money the focus. From both lender and borrower perspective, you want to focus on lending less so that what goes unpaid is reduced. It seems unlikely that Hammond will want to replace loans with teaching grants (except in specific subjects like engineering and mathematics), so institutions (and staff) should be preparing for some delayed austerity and may need to think about how they would operate in an environment where the tuition fee loan on offer to their students did not match the maximum tuition fee.

 

 

May blinks on loans and fees

Last Sunday saw Conservative leakers floating several options regarding the reform of English HE financing; today sees Theresa May confirm what has been clear for months: that planned rises to the maximum tuition fee have been shelved beyond £9250pa for the time being. More promising for borrowers is the pledge to increase to increase the repayment threshold from £21 000 to £25 000pa (and apparently to index the threshold to average earnings thereafter). This benefits the majority of borrowers in the near term – immediately saving a maximum of £30 per month for those earning over the new threshold . In the long run, this should benefit almost all, though very high earners may have a complicated decision to make about voluntary additional repayments (the trade-off between avoiding RPI +3pp interest and losing the ‘insurance’ features of ICR loans).

Unfreezing the repayment threshold undoes some  of the damage inflicted by Osborne in 2015. But it is much harder to restore public goodwill towards the fee-loan regime. All this chopping and changing serves to remind people that income contingent loans are also policy contingent and that an individual – May – can apparently make major alterations to the scheme for what ultiamtely are reasons of political contingency.

Can we still go through the pretence now of telling university applicants what they are likely to repay? We’ve barely got through 2 years of loan repayments and the scheme has been changed twice; loans last roughly 35 years.

Critically, what leaves you on the hook to future policy changes is the graduating debt. It becomes very hard to ignore the debt (plus interest the accruing) and focus on the lower mandatory monthly repayments today. This uncertainty for borrowers needs to be reduced and that imperative shouldn’t be overlooked when cheering the real benefits to post-2012 borrowers this announcement brings.

And, of course, that last point only focuses the political optics: how does this compare to Labour’s offer? May has targeted existing and new borrowers; Labour’s election pledge is now on offer to future students.

Creditworthiness

There is also to be a fundamental review. One which will apparently tie course funding to graduate outcomes. I’ve been writing about the shift to a system based on creditworthiness of institutions and borrowers for a few years now (a pithy outline can be found as a chapter in the new book, The Death of Public Knowledge). We used to fund HE on the basis of cost of deliver; we are edging towards one explicitly built on likely ability to repay loans (and at the same time contribute to central coffers through higher income tax).

What that might mean for a review isn’t straightforward, since the government has been attempting to reconcile two incompatible features: competition of price and quality funded by an ICR loan scheme that mimics a graduate tax. The loan scheme means that the headline fee is not a price.

Imposing differential course funding admits that the original market reforms were misguided. This could be done in two ways – by setting out a schedule of maximum tuition fees (e.g. against benchmarked targets for earnings outcomes rather than old-style Hefce banding) or by limiting the amount that the SLC is prepared to lend to different courses.

I would expect attention to be paid to the latter: it won’t make HE funding less complex, but would sidestep issues around institutional autonomy and would allow institutions to seek alternative financing arrangements for their students (or move to a model seen in the US where high sticker prices are only paid by some, who fund fee waivers for others).

(If you had stakes in TEF, I’d be making a SELL recommendation).

 

New public course: Coding for Beginners

Fine Art Maths Centre (which I help to run at Central Saint Martins) will be offering a new public course this Autumn.

In collaboration with The Photographers’ Gallery, we will be running a version of our popular, introductory progamming course on Monday evenings from 30 October 2017. ‘Coding for Beginners’ teaches Processing from scratch. Processing  is a variant of Java tweaked for visual practice. As with all our courses: no prerequisites required.

Our courses at Citylit for 2017/18 include:

Introductory course

Philosophy & History of Mathematics: A Brief Introduction
Two Saturdays  – 25 November & 2 December

More advanced 10-12 week courses

Philosophy of Mathematics 2: Arithmetic (Spring 2018)

Advanced Philosophy of Mathematics: Gödel (Summer 2018)

Reasoning with Uncertainty (Summer 2018)

 

Write-offs: not as costly as Conservatives would have you believe

The Institute for Fiscal Studies has published a note on writing off tuition fee loan debt.

It focuses on the impact on Public Sector Net Debt and opens by making the same arguments I made back in July, though the IFS does not name Jo Johnson as the source of the erroneous claims about debt write-offs.

IFS instead estimate £20billion in today’s terms would be added to PSND by 2050 if all post-2012 tuition fee loans were abolished today: there is little to no immediate impact and debt increases only because repayments that were projected to arrive over the next three decades have been lost.

IFS also model a partial write-off designed to equalise the tuition fee loans taken out by pre-2012 and post-2012 borrowers. This they estimate would cost around £10bn.

Both estimates assume that the write-off is done now. The difficulty with this policy is that as loan outlay touches £15bn this year (and repayments remain low) the stock of outstanding loan balances grows rapidly. Were a political party to contest the next scheduled general election in 2022 with a full tuition fee loan write-off, IFS believe the long-run cost would climb to £60bn.

IFS downplay the immediate impact on the deficit of writing down outstanding loans, because this impact has no cash implications. It is largely a paper exercise which records the loss on loans; the cash impacts (loan outlay and repayments) have already happened, it’s just that they had no impact on the deficit at the time.

Even though there would be a one-off hit to the deficit today of £34billion, the real consequence is the lost future repayments, these push debt up by £20bn but only much, much later.

As has been explained here before, the way loans score as income and expenditure is bizarre (the deficit is a measure of how much expenditure exceeds income) with only interest accruing counting as income (even though that’s not repayments) and loan write-offs counting as expenditure.

The bottom line is that loan write-offs are a feasible policy option and the IFS appears to have gone out of its way to remind politicians of this.

You might read this summary as an endorsement of Neil Collins’ article in the FT about student loans and quantitative easing. But that piece is seriously confused, typifying a common failure to think through the connection between student loan interest and the much-quoted line that three-quarters of borrowers will not clear their loan accounts before balances are written off (30 years after repayments first fall due on “English” post-2012 loans).

One day, [graduates] suspect, [the loan scheme] will collapse and their debt will be written off. Even under the current rules, an analysis from the Institute for Fiscal Studies concluded that three-quarters of graduates will never pay off their loans. Meanwhile, the government is so unpopular with freshly enfranchised youth that Philip Hammond has signalled changes to the scheme and there’s another Budget coming up.

Writing off the entire £100bn would destroy the fantasy that the chancellor can ever balance the books. More likely is some variant on “extend and pretend” where the student’s liability continues to grow but the date when it’s actually due recedes into the distant future. It would amount to a sort of quantitative easing for students, rather as PPI mis-selling became QE for poorer borrowers, and the real thing helped the rich. Taking what looks like expensive money may not be so silly after all.

That three-quarters of borrowers do not clear their accounts indicates that you need to understand more than compound interest to understand income contingent repayment loans.

Firstly, you need to appreciate that the interest accruing may not be repaid. Student loans are not ‘expensive money’, unless you become a very high earner (in which case, you can repay early without penalty). The repayment threshold, policy write-off and built in death and disability insurance offer serious protection to future low earners.

Secondly, clearing balances is not the same as repaying the equivalent of what was borrowed in the first place. ‘Never pay off’ can easily conflate these two and mislead about what the cost to government is.

Thirdly, and most importantly, the loan scheme is not self-financing. It is supported by a large (projected) public subsidy (as well as the government balance sheet that allows so many loans to be issued before repayments rise to significant levels). What ‘balancing the books’ means in this context is that the current level of projected subsidy continues to be tolerated.  We already have the precedent for the ‘active management’ of variance from those projections (the freeze on repayment thresholds).

Fourthly, don’t be misled by the quantiative easing analogy: the government funds student loans by borrowing (issuing gilts) to cover the annual shortfall between loan outlay and repayments. It isn’t printing money or creating loan accounts out of thin air (like a private bank might do).

If Collins had made his point about ‘pretend and extend’ in the context of predicted growth in graduate earnings, he might have had been on firmer ground, but not in relation to interest accruing. It’s well understood that interest will accrue without being repaid. In fact, it’s a feature not a flaw. Write-offs are planned, the issue is whether they could and should be brought forward.

(You might though wonder why such interest is counted as annual income in the national accounts, but that’s another matter and reinforces the point above about why the IFS downplays the deficit impact of loan write-offs).

 

 

Fiscal illusions & student loan interest

I have tended to neglect the impact of student loans on measures of the “deficit”, whether Public Sector Net Borrowing, the Current Balance or whatever. In this context, the deficit measures the amount by which public sector spending (explained here by the Office for National Statistics) exceeds income (taxes and the like).

My neglect was premised on the basic point that student loan outlay (new lending) and annual repayments (from borrowers) are classed as ‘financial transactions’ and are therefore not scored as expenditure or income in this way. They are outside “the deficit”. They do though require cash to cover the annual shortfall between outlay and repayments and this makes its way through to Public Sector Net Debt. I have then tended to focus on the cash impacts and how they bear upon PSND. (Note that this nuance in accounting leads people to mistake student loans as being somehow off-balance-sheet. They are on the national balance sheet they just don’t score as you would expect in the normal headline fiscal statistics).

These accounting quirks are one of the main attractions of student loans to politicians. You can reduce the “deficit” dramatically by switching from expenditure (e.g. on tuition or maintenance grants) to loans. The whole cash outlay disappears from expenditure regardless of the amount you expect to get back from loans. It looks like you are doing more with less.

However, elements of student loans do score against income and expenditure: interest receivable scores as income each year and the face value of outstanding loan balances scores as expenditure when such write-offs occur (and loan accounts are therefore closed). For a single set of loans, the net effect of this set of transactions is to record the cash loss or surplus generated.

This might be a bit surprising but it is based on the following accounting identity:

(1) Loan Outlay + Interest Accrued = Outstanding Balance + Repayments

A little algebraic manipulation tells us that when repayments are less than outlay:

(2) Loan Outlay – Repayments = Outstanding Balance – Interest Accrued

Since Loan Outlay – Repayments is defines our loss, we can also capture it with the right-hand side of our equation (2) above.

That is, loan outlay and repayments are never recorded directly in the deficit. Loss is captured by recording Interest Accruing each year as a benefit and then charging the outstanding balance as expenditure at the end.

There are three consequences to this:

  • Interest Accruing is recorded – but this is Interest Receivable not any measure of interest repayments. It is also non-cash.
  • Timings matter. The deficit benefits from the Interest Accruing for the whole lifetime of the loans (a maximum of 30-35 years for new loans) until at the end the deficit takes the negative hit and undoes those years of benefit!
  • Write-offs are also non-cash – they are simply recording the effects of the financial transactions once they are finalised. Loans went out the door and repayments came back in previous periods. (Write-offs count as capital expenditure and do not score in the Current Balance).

You might then conclude (like I did) that it’s better not to look at deficit measures when thinking about loans and instead concentrate on the impact on cash and debt and on the departmental accounts (which are run on an accruals basis, not on cash in, cash out). Indeed the Office for Budgetary Responsibility identified this student loan interest as a ‘fiscal illlusion’ in its most recent report.

I think that neglect is a mistake. We need to consider all of these fiscal and budgetary aspects and impacts. If only, because post-2012 loans run with real rates of interest (for graduates and university leavers, 3.1% to 6.1% from September; current students will see 6.1%). These real rates exceed the cost of servicing any borrowing used to create student loans in the first place.

Here are the OBR’s projections for Interest Receivable over the next five years:

2017/18

2018/19

2019/20

2020/21

2021/22

Interest Receivable
billions)

3.0

4.5

 

5.5

 

6.2

 

7.1

That’s a substantial impact on PSNB (and the Current Balance) when you consider that the current government is aiming to eliminate the deficit.

Here is the OBR’s March 2017 projection for PSNB:

deficit projection

With that to mind, it is perhaps no surprise that the Conservatives have chosen not to review current interest rates on student loans. (Though I think there are other budgetary considerations at play).

Governments have their main fiscal statistic “flattered” for decades after the introduction of higher loans with real interest rates. We won’t see the first substantial policy write-offs until the 2040s. (Loans are also written off annually in the event of death or disability but these unfortunate events affect only a very small number of loan accounts). Unfortunately, at that point it’s not as if the illusion will be pricked – you will have one year of loan write-offs set against the interest accruing against three decades and more of loan accounts!

A more general lesson follows: it’s a mistake to talk about “the deficit” and “the debt” without some awareness the composition and interrelation of those headline statistics (let alone what they mean for the state of the economy more generally). Student loans  represent a very particular case of what Simon Wren-Lewis calls “mediamacro”, as that is characterised by a focus on reducing the deficit.

Now that student loans are so sizeable it may make sense to develop new ways of capturing the fiscal position. So long as loans are loss-making and so long-lived, it makes little sense to include interest receivable (but likely never to be received) as income.