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A Framework for Projecting Interest Rate Spreads and Volatilities
CBO memorandum rept.
CONGRESSIONAL BUDGET OFFICE (U S CONGRESS) WASHINGTON DC
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Several recent bills before the Congress have proposed changing the benchmark used in setting interest rates for the federal student-loan program. Lenders participating in the program have urged the change to tie the rates they must pay to borrow funds in private-sector markets more closely to their returns on loans. The Higher Education Amendments of 1998 directed the Congressional Budget Office CBO and other organizations to study the issue and, in particular, to evaluate the spreads, or differences, between rates on three-month Treasury bills the benchmark at that time and the proposed alternatives, which include rates on commercial paper issued by financial companies and London interbank dollar deposits. The study group that was formed asked CBO to develop a framework for projecting the future behavior of the alternative rates and the probability that they would exceed the interest rate threshold of the student-loan program. CBO prepared a technical paper in response to the request and presented its model at a study group meeting in August 1999. Since passage of the 1998 bill, the Congress has enacted a temporary change in the benchmark in December 1999 to use rates on three- month commercial paper as the reference rate for student loans until 2003. CBOs projections will contribute to the debate about whether to make that change permanent.
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