May 7 2014
Bring the Market Back to Student Lending
Enrollment in student loan forgiveness programs has skyrocketed in 2014, up 72 percent from the middle of 2013. These income-based programs cap monthly payments for enrollees and, after a set time period, forgive the remaining debt.
Obviously, a slow economy and high college costs are burdens to many American youth. But the solution to America’s student loan crisis – more than $1 trillion in debt – is not forgiveness. Other reforms to higher education would be much more effective at reducing college costs and equipping graduates for better careers. But forgiveness programs increase costs to taxpayers and distort borrowers’ decisions.
Default rates have risen the past six years in a row, to a rate of 14.7 percent in 2010. This means that about one in seven student borrowers are ending up in default, which can create more financial headaches and negatively affect one’s credit score.
In an attempt to curb default rates, Congress instituted and the Obama administration promoted two federal programs that now benefit 1.6 million people with a total of $88 billion in debt.
The “Pay as You Earn” program caps debtors’ payments at 10 percent of their income and forgives their balances after years of working – 10 years for people working in government or the non-profit sector, 20 years for people working in for-profit industries. (Note the unfair disadvantage for private-sector workers, driven by the misguided attitude that their work is less noble or less valuable to society.)
These forgiveness programs – especially given the recent enrollment surge – come with great costs to taxpayers: as much as $14 billion annually, one study suggests.
Given the many other pressing budget priorities facing the nation, and given that annual deficits are already adding to a national debt of over $17 trillion, it’s hard to justify this additional spending on higher education, which only benefits a certain group of people (namely college grads who fail to repay their loans).
But aside from the public cost, these programs should be rejected because of the bad financial incentives they create for colleges and student borrowers. More than that, our entire college financing system needs reform to eliminate bloat and to expose colleges to price competition, forcing them to vie for students on cost and quality.
Consider this: The average student debt is approximately $30,000, which can take serious sacrifice for young (read: lower end of the income scale) Americans to pay back. But news about forgiveness programs would discourage any smart graduate from hurrying up their repayment efforts.
What if, one day, he or she qualified for forgiveness? It would be a shame to discover this the day after writing the last check for tens of thousands of dollars in debt. The incentive is to delay repayment, fostering hope that the changing rules could one day make repayment unnecessary.
Colleges and universities can also use student loan forgiveness programs to their advantage. Now some law schools are offering to pay students’ monthly repayment bills until their loans are forgiven. This means some students could get degrees without paying very much at all, which makes advertising easier for the institutions.
But it’s our entire student lending scheme – not just the forgiveness programs – that colleges and universities can use in their favor. Easy money leads to bloat, and we see this now at American colleges.
Tuition currently increases about 6 percent annually (much higher than the rate of inflation). Considering also the costs of books and transportation, the College Board found an increase of 27 percent in 5 years for attending a 4-year public school.
Instead of offering to forgive more student loans, policymakers should focus on two other strategies to control college costs and encourage loan repayment:
First, market forces should be reintroduced to student lending. Government had no business getting involved in student lending the first place; this business should be returned to the private sector so that interest rates could better reflect supply and demand.
Second, our national and state governments should pursue a pro-jobs economic agenda so that hardworking student debtors can find stability in their careers, with salaries that reward their investment in a college or graduate degree.
In the same way, degree-holding graduates should be equipped for today’s workforce with the right knowledge and skills. This means holding colleges accountable for what they are selling, which is, for many students, a higher earning potential throughout life.
Many people view a college degree as an important step in upward mobility, and a chance to pursue careers that otherwise would be out of reach. In order to allow for lower costs and higher quality in higher education, we should reduce the federal government’s role in lending and focus on fostering a robust education marketplace instead. This approach would be more economically sound and more equitable than the misguided policy of continuously expanding loan forgiveness programs.