Friday, February 29, 2008

King Canute (c.985-1035) on Student Loans

By Richard Vedder

Rep. George Miller and Sen. Teddy Kennedy have written a letter to Education Secretary Spellings lecturing her on the need to keep student loan money flowing if those nasty lenders (like state-sponsored providers in Michigan and Pennsylvania) decide to curtail lending.

For some reason, this reminds me of King Canute the Great, the Danish king who conquered England a half century before the Normans (if you think the 20th century was bloody, take a look at the 11th). Almost precisely one thousand years ago, or so legend has it, King Canute ordered the waves to stop rolling. His order was only slightly less silly than the Miller-Kennedy proclamation. His Serene Danish Majesty found he could not countermand laws of physical science any more than Miller-Kennedy-Spellings can countermand laws of economic science.

To be sure, that is not entirely true. With various subsidy schemes, the cost of borrowed funds can be artificially lowered to borrowers --but only at a real cost to society, if not to the borrower of the money. While Fed Chairman Ben Bernanke continues his suicide mission that may well culminate in stagflation if not reversed, in a true sense risk premiums on loans are rising, meaning interest rates are going up for this type of lending. Given the nervousness of bankers who have suffered billions in losses on imprudent lending in the past year, the supply of loanable funds to immature 18-22 year old kids wanting to borrow several times their net worth is understandably drying up. As supply falls relative to demand, the price of borrowing --interest rates -- will rise.

While part of the reason for the current credit problems relate to bad decisions by private lending entrepreneurs (the Bob Rubins of the world), it is noteworthy that the ultimate villain is central bank monetary manipulation. The Austrian economists Ludwig von Mises and Fredrich Hayek taught us, correctly in my view, that when the price of loanable funds (the interest rate) to borrowers falls below its true sustainable rate dictated by human time preferences this will inevitably lead to a temporary boom, but ultimately brings about a bust. Low interest rates lure too many people into borrowing, and, in this case, too many expensive houses were built for too high prices --and too much money was borrowed by sub-marginal students with dubious job prospects. Engaging in Latin American financial manipulation to solve the problem is not sustainable. Drinking can provide a high for a while --but then it produces physical discomfort manifested in vomiting and hangovers. We are in that phase of the monetary binge of this decade, and rather than taking Aspirin or Alka Seltzer and toughening it out, the Fed wants us to start drinking again.

Although mandarins of DuPont Circle like Terry Hartle of the American Council of Education (a fine and very able person, by the way) or fellow travelers of the Establishment like Sandy Baum can tell people college is not overly expensive and a hugely profitable investment, many borrowers are starting to wonder (and for very good reason, in my opinion). As I kept saying on the Diane Rehm show yesterday, the rise in college costs relative to income levels is ultimately non-sustainable, and the current student loan crisis is merely a manifestation of this. Had college costs risen at only the rate of inflation over the past generation, student loan debt today would be a small fraction of what it actually is, and the student loan crisis would not exist. And the crisis will not go away because two politicians tell a bureaucrat to make it happen --any more than the waves did not stop when a mighty monarch ordered them to.


Cowboy said...

I meant to mention after a trip to Oz that "The Australian" newspaper has a "Higher Education" section in their paper:

Home Page Online:

Higher Education section:

In the higher education section today, I found the following story that I though was somewhat interesting:

Unis may lose right to students in weak disciplines

UNIVERSITIES would no longer be able to sign up research masters and doctoral students in research fields where they are weak, under a proposal being developed by a sector working party.

The party, involving key members of the Group of Eight and Universities Australia, hopes to put a common position to the Rudd Government on its proposed funding compacts for the sector, The Australian understands.

Under a research training reform, universities weak in a given field would lose the right to take on research students but they would retain the associated federal funding, as long as they redirected it to, for example, coursework, innovation or community service.

This and other ideas in draft discussion papers have been circulated in the sector with a view to finding the consensus necessary for universities to present a united front when lobbying the new Government.

Reform of the $540 million research training scheme - under which all universities get a share of money for research students - is expected after Labor, when in Opposition, promised to abolish the scheme for being too “complex”.

In last year's election campaign Labor said public investment in universities should target their strengths, especially where these reflected long-term national priorities, “rather than all Australian universities trying to do everything across the board'.

Innovation, Industry, Science and Research Minister Kim Carr has been dissatisfied with the research training scheme.

It is believed that the cross-university working party has picked up on this by adopting his proposal that universities cease admitting students of masters by research and doctoral candidates in disciplines where those institutions cannot show they are strong.

Under the working party's proposal, each university would assess its own research performance.

But the Australian Research Council and the National Health and Medical Research Council - lead agencies involved in developing the Rudd Government's new research quality exercise - would check the universities' evaluations through peer-review and metrics.

Read more higher education stories online and in print on Wednesday.

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