Student Loans: Revisited, Again

By Richard Vedder

A lunch conversation Friday (to which I will return in a minute) reminded me of something. Throughout the 20th century, business and financial innovators were often viciously attacked --although the distance of history leads us now to conclude that many of these persons did great good. John D. Rockefeller was hounded by muckraking journalists like Ida Tarbell --but he brought affordable lighting to the masses of Americans, and, later, helped develop cheap gasoline to fuel our cars. The University of Chicago and Rockefeller University are great legacies to his benevolent, humanitarian streak. Samuel Insull was hounded as a financial manipulator of utilities of the 1920s and 1930s, yet, as Amity Shales points out in her great new book on the Depression, his methods of financing electrical power was rational and innovative --they worked. Nearer to the contemporary scene, Michael Milken went to prison for alleged financial improprieties, but he developed a great financial instrument, junk bonds, that helped many innovative but poor entrepreneurs.

Back to my lunch. I ate at the Hay-Adams Hotel in DC with Catherine Reynolds, a fellow Spellings Commission member, who has been hauled through the coals by the press and regulators of late. Allegedly, she did improper things while running her student loan company. But she did something good entrepreneurs do --she saw a need, for purely private loans to students, and she developed that market --brilliantly and successfully. Cathy (who knows everyone in the Solar System) no doubt is trying to soften me up with nice meals and fine wine (two of my weaknesses) so I will promote her causes. It won't even take that to encourage me, because I say what I believe, and have some principles (translation: I don't accept small bribes). Here is what I believe about student loans today:

1. Government should get out of the student loan business, period. Government does not make $40,000 car loans, so why should they make or subsidize $40,000 college loans? Where they have intervened in credit markets (e.g., Fannie Mae, Freddie Mac, Sallie Mae) they have typically messed things up royally. Cheap federally subsidized money helped fund the subprime mess, for example. By the way, I wrote about all of this in a study for the Joint Economic Committee of Congress more than 25 years ago while a staffer there. I was right then, and I am right now. By distorting interest rates to consumers, government credit involvement leads to malinvestment, unsafe investment, and to trouble. We are overinvested in student loans in this country, too many kids have borrowed imprudently, etc. The Feds are part of the problem, not the solution.

2. If the federal government feels it has to "do something," let it convert the Pell Grant program to a true voucher situation where the money goes to the kids, not to bureaucrats in college financial aid offices who then use that information and the Pell money to manipulate the institution's own discount policies to fits its designs. Give 7 million Pell Grants averaging $4,000 annually directly to students, and you will massively expand that program --the kids will be happy, competition will rise, student financial aid scandals probably will decline, etc. Tell the financial institutions doing subsidized loans who lobby against this to go to hell. Why don't we do this? We don't want to offend the Bob Rubins (co-architect of Citicorp's current downfall) of the world -- those who are politically powerful and drop money out of airplanes on political campaigns.

3. Subject private unsubsidized lenders to the same types of regulations -- no more, no less --that we place on other lenders. If the price of borrowing for college goes from an unjustifiably low 3.5 percent to, say, 10 percent, so be it. Investing in college kids has risks and uncertainties, and trying to sweep them under the rug leads ultimately to financial upheavals, a misallocation of resources, and a lower national income.