How are interest rates on federal student loans set? Who sets them?

Finance 408 Writing Assignment

Your grade on this writing assignment will be determined both by the content that you include, and by how well you communicate it. This means the material, as well as spelling and grammar, will be factored into your final grade. If you are concerned about your writing skills, there are resources all over campus to assist you.
This paper will be submitted via Canvas, and **MUST** have a title in the following format: “FIRST_LAST_408_PAPER” (where FIRST is your first name, and LAST is your last name…). Microsoft Word documents are preferred, but PDF files will also be accepted – no other submission types are acceptable.
Also, plagiarism of any kind will result in a grade of zero. All papers will be run through Penn State’s “turn it in” software to compare. Please create a bibliography of references you use to write this paper, and cite as needed. If the majority of the ideas/facts in a single paragraph come from one source, you need only cite it once at the end. If the ideas/facts come from two sources, cite both at the end, and so on. If you want to use an exact phrase from something you found online, please include a citation immediately, regardless of where in the test it is used. An example would look like this: “The company owns a 40% share in the South Natuna Sea Block B group of rigs.” [Investopedia (2015)] , with the corresponding full citation in your bibliography.

Student debt is a major concern in the United States. There is currently $1.3 trillion outstanding in student debts, with the average recent graduate carrying a little over $37,000 in debt. More than 1.3 million students graduate each year with some level of student debt. Yet, despite the size and pervasiveness of this market, no long term fix has been implemented – though many different policy changes have been proposed.
In approximately 2000 words (no less than 1700, no more than 2300), please discuss *one* of the following topics (either #1 or #2, and the questions associated with them). Presumably you will do this by addressing all of the questions associated with the topic. However, if there is another aspect of student debt that is applicable to your discussion, you may include that as well.

STUDENT LOAN INTEREST RATES: A common complaint about student loans is that the interest rates on student loans are too high. But the vast majority of student debt outstanding ($1.2T of the $1.3T) are federal student loans, which means the interest rates are not set directly by market forces (though market forces surely play a role).
How are interest rates on federal student loans set? Who sets them?
How do they compare to privately issued student loan rates?
Why do you think this difference exists?
How do interest rates on federally issued student loans compare to average mortgage rates or APRs on car loans?
Are there differences? Are these differences large or small?
Do you think the differences should be larger or smaller, why?
What does it mean for someone to be in forbearance or deferment?
When would a person enter into these situations?
What does it mean for a borrower to be delinquent on a student loan? What about in default?
What are the delinquent rate and default rate on student loans? (If you can only find combined figures for these, that is acceptable.)
How do these compare to default rates for other consumer loans (mortgages/car loans)?
What’s different about student loans and mortgages in terms of the “good” that the loan is used to acquire? Does this play a role in student loan default rates?
We discussed information asymmetry in class. Please include a short discussion of how both adverse selection and moral hazard could play a role in why interest rates are so high. Specifically, why do these raise the risks of the loans, and why is it so difficult to eliminate the information asymmetries here?
Suggestions to think about if you’re stuck on Adverse selection: Think about what both government and private lenders know about students (not their parents) before loans are made? Are there any reliable signals of student quality available? Think about scholarships – both in terms of why they’re given and what they do to the amount the student needs to borrow – do these influence either federal or private loans? How do these things affect the overall pool of borrowers?
Suggestions to think about if you’re stuck on Moral Hazard: Do all institutions offer the same quality of education? All majors add value to society (though clearly Finance is the best, psssht!), but do all of them offer the same expected salaries? Are all jobs associated with different majors equal to each other? Can lenders control any of this?

REDUCING PAYMENTS: There are many different ways to reduce student loan payments: Income driven repayment plans, graduated payment plans, extended payment plans, consolidation, refinancing if your loans are private, help from employer, changing states, autopay, Upromise, etc.

Please describe the methods for reducing payments. Discuss the pros and cons of those listed above, as well as any other methods you identify for reducing loans.
One payment reduction method that is common for some types of loans is bankruptcy protection. Can student loans be discharged through bankruptcy?
Reducing payments is effectively a way to reduce the cost of borrowing for students, which in turn reduces the overall cost of an education. Another way to reduce the cost that has been suggested is to lower the interest rates on student loans. Think about and discuss how lowering the cost of education might affect the supply and demand of both education and financing for education.
If cost declines, will a larger or smaller number of students pursue higher education?
Based on your answer to i., how will the overall level of human capital change? Human capital is the knowledge and skills a person possesses.
Given this change in human capital, what is likely to happen to the overall level of innovation? What about the impact on jobs that require manual labor?
Based on your answer to i. and ii., what might this mean for salaries? Think about competition for wages, and how a larger/smaller number of people chasing specific jobs will impact wages. Will the effect be different for higher-skilled salaries and lower-skilled salaries?
Based on your answer to i. and ii. iii., is it possible to say what the overall impact on student debt outstanding will be? Why or why not? Things to consider: Cost of education is lower, there is an increase/decrease (depending on which you pick in i.) in the number of people pursuing this funding as a result, salaries are going to shift, competition for jobs will shift, etc.
How would lowering the cost of education affect delinquency/default rates on student loans? [Think about what lower interest rates or amount borrowed would mean for people’s ability to repay, but also consider your answer with respect to the impact on salaries.]

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