Special Notice 12

"THE BIGGEST ACCOUNTING FRAUD IN HISTORY"

By William J. Dodwell

August 26, 2019

The Wall Street Journal published an editorial 8/21/19 headlined “The Great Student-Loan Scam”.  Briefly, it claimed income-based repayment plans, as well as loan deferment and forbearance allowances, adopted during the Obama administration conceal the real cost to taxpayers.  Thus, the reported results of operations are grossly overstated.  In fact, The WSJ says, “This may be the biggest accounting fraud in history.” 

 

Separately, the editorial reports a mere 10% outright default rate in addition to the two repayment categories mentioned.  But in my 2015 white paper entitled “The Developing Federal Student Loan Debacle and the Real Cost to Taxpayers” at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2653119 , I detail how the CBO methodology for default accounting severely understates defaults, and thus further conceals the huge taxpayer cost of the student loan program. (I sent a copy of my report to the WSJ Editor of the Editorial Page upon publication.)  In other words, nonpayment is even worse than what the WSJ says.  Until recently, the government reported the student loan program as profitable since inception in 2010.  Now, finally recognizing the drag from the repayment concessions cited by the WSJ, the CBO reports a loss over the next 10 years.  But it has not fully recognized economic reality by changing its misleading default accounting method I disclosed in my paper.

 

Citing statistics of the Federal Reserve Bank of New York, the WSJ reports that 30% of the $1.5 trillion loan portfolio is subject to income-based capped repayment plans, and 20% is in deferment or forbearance.  Adding the reported 10% default rate, this means that 60% of loans is non-performing or heavily discounted. However, my 2015 study shows that according to CBO accounting, defaults are effectively amortized over the remaining term of a loan (up to 20 years or more), rather than entirely charged off in the period incurred, as a bank would do according to Generally Accepted Accounting Principles (GAAP).  On this basis, the default rate would be much higher than 10%.

 

The Trump administration recently hired McKinsey & Co. to analyze the accounting for the student loan portfolio, particularly with respect to a possible sale.  Given a 60% effective non-performance rate, the $1.5 trillion face value would decline to only a $600 billion valuation.  This would result in an immediate $900 billion write-off added to the already $1 trillion projected FY 2019 budget deficit.  But considering the greatly underestimated 10% default rate, that charge would be significantly larger. 

 

This massive portfolio devaluation renders the loan forgiveness political argument almost moot.  Heck, the government has forgiven most of the loans already in the form of foregone repayments.  But the public would not know this from CBO reporting.
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