This week President Clinton is expected to sign a law that would help banks lending to students manage their interest rate risk better.
That's the good news. The bad news is the fix would last only three years.
Effective Jan. 1, the law would tie government subsidies on student loans to commercial paper rates rather than to short-term Treasury bills. Lenders fought for the change because rates on T-bills do not move in sync with a bank's own borrowing costs, and this presents lenders with a costly hedging headache.
Lenders would receive 2.34% over commercial paper rates on loans to borrowers after they graduate, and 1.74% on loans for students while still in school. That's down from the current rates of 2.8% over T-bills for graduates and 2.2% for students.
The rates students pay on government-guaranteed loans are capped at 8.25%. If there is a gap between that and the interest due to lenders, the government makes up the difference.
Bankers cheered the change to commercial paper, saying lower subsidies would be offset by lower hedging costs.
The Education and Treasury departments opposed the law. Using different economic assumptions, the agencies argued the change would cost the government $600 million over 10 years in additional subsidies to private-sector student lenders. Lenders, however, would gain as much as $1.7 billion over that period, the government argued.
The agencies and lenders are expected to battle again next year.
Bankers are gearing up to lobby Congress to overturn a separate law that changes the subsidy base in 2003 to long-term Treasury bonds. Under the 1993 law that set up the government's direct student loan program, lenders would receive 1% above the long-term Treasury bond rate. The language of that law was written so broadly that experts said it would apply to both government and private-sector student loans.
John E. Dean, a special advisor to the Consumer Bankers Association, said student lenders would make this issue "the top priority" in lobbying Congress next year.
The Education Department might agree to preserve commercial paper as the subsidy base if bankers accept another cut in subsidy rates, industry sources said. They noted that lenders accepted a 30-basis-point cut in their rate in 1998 in exchange for staving off the use of long-term Treasury bonds as the base.