Originally posted by roadgravel
This is the Enron style of accounting. Books all future potential profits now. Looks good on paper - we saw how it worked in real life.
Accountant here. It sort of is but what Enron was doing was taking debts and more that would be associated with an asset and shoving them into
subsidiaries for the purpose of simply holding debt (called "special purpose entities"). Basically, Enron was transporting its massive debts to
SPE's and then, not reporting those SPE's to basically provide a false value to Enron's holdings and profits. I had to do a financial analysis on
Enron's final 10k and what they did was jaw dropping. Not even remotely close.
The method that is being used for the student loans is sort of
based on the the "fair value" method. Although there is a great deal of
debate in terms of estimating the value of an asset, fair value accounting for loans takes the original value of the loan and all expected payments
from it into consideration of its value minus a discount for the time value of money.
Let's put it this way. Let's say you loan a friend $10,000 at 10% annual interest and one yearly payment of $1000 over the next 10 years (keeping
it really simple). Now, circumstances change and you kind of need that $10,000 back so you decide you're going to sell the contract for the loan to
another guy. Here's the question to consider...do you sell the loan for the $10,000 or do you sell the loan for the amount of the loan plus the 10
years of interest, which would be $15,500? If it were me, I'd sell it for the actual value of the loan and not the original outlay of $10,000
because that is what the loan is actually worth over the 10 year period (less the time value of money, which I hate calculating so I didn't do lol).
Subtracting the uber fun stuff to calculate (read sarcasm) and you end up with what is the present value of that loan to your friend, which would be
technically less than $15,500. To witness why I refuse to go into deeper explanation, behold the horror of present value calculations:
Governmental accounting differs from public sector accounting in terms of the reporting of revenues and outlays.
Forbes sums it up rather neatly:
In issuing student loans, the federal government incurs a large up-front cost (the loan given to the student) and then receives revenues (the
student’s gradual repayments of the loan) over a period of several years. The government budgets for these transactions by taking the initial cost
of the loan and subtracting all the projected repayments to create a single cost figure.
So that's the quick and dirty explanation of how it's done. The problem is in both the calculation of cost and the expectation that the repayment
So far, so good. But things start to get complicated when we remember that students sometimes default on their loans, meaning that the average loan
repayment is going to be less than what taxpayers are owed. So the government estimates an “expected” repayment and uses that lower figure to
calculate future revenues.
The government, because it is the government, treats the repayments of student loans as guaranteed. Considering that it's a loan via the government,
there are some reasons for that feeling. For one thing, even if someone with a student loan declares bankruptcy, they cannot shed the student loan.
They are stuck with it until it's repaid or the day that they die. Defaulting on a student loan permanently would most likely require being paid
under the table, living underground, and never owning another asset in your life. It's like owing money to the IRS. Not a good place to be. That
said, it's still entirely feasible that a student may never
repay their student loan so they are still not, with all that power, guaranteed.
Worse yet, defaulted student loans probably accrue even more costs associated with the pursuit of payment which brings down the happy little expected
repayment profit down further.
That's the problem. Using a proper fair value method for the value of a student loan would actually account for market risk. The market is
absolutely tied with employment and wage and if the market is risky, those things are going to falter as we've seen. That also means more defaults
for student loans. Hence the screaming by economists.
Hopefully that helped clarify some of the rationales and nightmares of accounting.