The Case Against the Federal Student Loan Program

 

If you haven’t already heard, most federal student loan rates are set to go up soon. Scheduled to double from 3.4% to 6.8% on July 1st, both parties have treated the issue more as an opportunity for leverage than an opportunity for any well- or even moderately-informed debate. And with little chance of seeing any consequential changes in terms of policy, the ensuing congressional “debate” may nevertheless serve as a timely moment for me to give my case for why the federal student loan program is not only a failure, but an institution that betrays nearly every solution it professes to achieve.

The worst laid plans

With tuition costs rising year over year well above the rate of inflation, it would be hard to guess that the federal student loan program began under the mantra of “making college more affordable.” To be sure, it has made college more immediately accessible, but to say it has made college more affordable is to ignore reality. As CollegeBoard notes,

“Over the past decade, from 1997-98 to 2007-08, published tuition and fees for full-time in-state students at public four-year colleges and universities rose 54 percent in inflation-adjusted dollars — an average of 4.4 percent per year. This increase compares to 49 percent for the preceding decade and 21 percent from 1977-78 to 1987-88.”

And this isn’t some wild coincidence. Just like any good or service, college education is not immune to the laws of supply and demand. When demand is rising (primarily because of federal loans) and supply can’t keep pace, prices will rise correspondingly. Whether or not government involvement has caused prices to rise is not the question. The question is, why on earth would we let it continue?

Bubble trouble

What government intervention has done to college prices is no different from what government intervention did to home prices during the housing bubble: they spurred easy lending policies by socializing lender risk and by enticing borrowing through artificially-low rates, ultimately resulting in high demand for houses (except in this case, the house is a college education).

Eventually the party ended, and people who bought during the boom saw their home equity plummet, consequently forcing hundreds of thousands of foreclosures. The difference, though, is that a house can be given back to a lender as collateral for default. An education cannot. Student loans, therefore, cannot be discharged through bankruptcy, and students are stuck with them for life. When the federal student loan party ends, recovery from the hangover isn’t going to be quite so easy.

And we are, make no mistake, in the middle of a student loan bubble. The only difference is, the government is the big banks, colleges are the snake oil home-salesmen, and students (in general) are the suckers that paid full price for a wildly overvalued asset.

More money, more problems

Aside from rising costs and false market incentives, what else has been wrought by the federal student loan program?

Apparently, lower quality. With the loan program making college more accessible to students who did poorly in high school, college boards have a steep economic incentive to manipulate their curriculum in order to maintain high student admission and retention. To boot, a few colleges have confessed to lowering academic standards in order to admit the growing market of students, which, if nothing else, should serve as the horrible, ironic poetry of it all.

Exaggerated demand for college ed has put colleges, rather than consumers, in control, leaving colleges to pursue dubious revenue-driving tactics with little pushback from students and parents jockeying for competitive admissions.

But perhaps most tragic among the boondoggles is the fact that federal student loans have detached students from the main incentives to major in market-demanded fields, an unfortunate phenomena well evidenced by recent-graduate underemployment statistics. Years ago, if a student sought a private student loan, one of the first questions of the lender would have been, “what do you plan on majoring in?” The lender would have based their decision to lend at least in part on whether or not they believed the student’s major was likely to produce a return on their investment.

Nowadays, that’s out the window. Today, any student pursuing a degree that is in low demand by the labor market will receive the same amount in loans as a student pursuing a highly-demanded degree. This has served to scramble the allocation of labor away from fields with demand, and toward fields without demand, consequently directing students toward underemployment.

In fact, just two weeks ago the NY Federal Reserve released their quarterly report which noted that 20-25% of former students are currently 90 days delinquent or more on their loan repayment. Moreover, roughly half of college grads are working in fields that do not even require a bachelor’s degree, let alone a degree in the specific field in which they majored.

The end is nigh

Eventually, though, this all will come to an end. All bubbles burst, and American higher ed is no exception. In the same way that mortgage securities were sold off like hot potatoes when they were discovered to be wildly overvalued, so too will the American dollar be sold off when its true value is laid bare. In the same way that confidence was lost in mortgage securities when their toxicity was realized, so too will confidence be lost in the dollar when its toxicity is realized.

With the dollar currently relying on $45 billion worth of Treasury purchases every month (that we know of) just to keep interest rates down, the current high-confidence, low-rate loan market is a transient affair. The fate of our loan market will be shared by our dollar, and with time being the greatest compounder of interest, this isn’t more than a few years away. When creditors refuse to accept paltry returns on Treasury bonds, rates will have to rise. And when at happens, the ability for the feds to borrow (and therefore, finance the student loan program) will become impossible.

In summary:

Put simply, the federal student loan program helps students gain a lower quality-than-otherwise education at higher-than-otherwise prices, inflates a higher-education bubble dooming colleges and students through false economic signals, misdirects degree choices away from high-demand careers and toward low-demand careers, entices financially brazen students to take out expensive loans to get a depreciated degree, all under the politically ingratiating guise of “helping students.”

All these problems and more are the reaping of what our current federal student loan program has sown, and all these problems and worse will be the reaping if it continues. A good friend tells a friend when he’s had enough to drink. But our government isn’t a friend, much less a good one; it’s the bartender, and it’s paid by commission. The government wants to cheapen the liquor while we’re already drunk. I want to take it away.

If the federal student loan program continues, we can be sure to see more debt, more delinquencies, more underemployment, more misallocation of labor, higher tuition costs, and the continued erosion of quality in American higher education.

While it is improbable that ending the federal student loan program will happen by any willful act of congress, it is still worthwhile to understand the consequences any such program carries. But whether by action or inaction, the student loan program will end. Basic math will eventually succeed where appeals to logic have failed. Interest rates will rise, and the ability for the federal government to finance its extravagance will be throttled. To be sure, if prudence and foresight won’t end the federal student loan program, basic economics will.