Thursday, April 24, 2008

Government Failure in Student Loans

By Richard Vedder

Congress is frantically trying to pass legislation subsidizing student lenders, in order to avoid insufficient funds being available for college students this fall. As I indicated earlier, the denial of credit to some students is not an altogether bad thing, and in the market economy credit is generally allocated efficiently between alternative uses, with some would be borrowers unable to get credit at the market interest rate. But Congress wants no students turned away this election year.

As the Wall Street Journal so accurately editorialized today, the student loan crisis is not a case of market failure --of the forces of demand and supply failing to meet human needs. Rather it is a classic case of government failure. As I said before, the two big culprits are the Fed, the nation's central bank and a quasi-governmental institution, and Congress itself. Three points here:

1) The Fed has provided huge funds to fuel credit market expansion since 9/11, pushing interest rates for most of the period below the appropriate rate consistent with human behavior, leading to the housing boom, overlending in housing, and the housing bust.

2) Congress did the same thing with respect to student loans, making large sums available to students with dubious prospects of repaying the loans, and making those loans available at very, very low interest rates.

3) George Miller and Ted Kennedy, aided by both Democrat and Republican co-conspirators, tried to fund a Pell Grant expansion by mandating dramatically lower fees for servicing government subsidized but privately provided loans. This contributed to an exodus from student lending by many providers. The concern about rising student defaults associated with the rush to credit quality occasioned by lender reaction to the housing/mortgage debacle has aggravated this tendency.

Sure, private lenders were over exuberant in their lending. Credit quality fell, in part aggravated by new financial instruments led lowered incentives for banks to insist on high credit quality. The private sector made mistakes --but the environment that led to these mistakes is a product of governmental interference in a market that would be best left to private lenders. We have too many marginal students going to college, dropping out, and facing big debts. The federal government is largely to blame for that phenomenon. Their latest "cure" for the problem they created is worse than the disease itself.


Ken D. said...

The student loan companies must be holding many thousands of bad loans by now, so naturally they would love to off load this mountain of bad paper onto the taxpayers.

After all, how difficult is it to identify student loans at high risk of default. It's simply a matter of comparing the amount owed to the borrowers current or expected annual income. Loan balances in excess of one's annual income are commonly considered to be problematic.

One wonders how many loans Sallie Mae is holding where the borrowers owe twice what they are able to earn in a year. There must be many thousands of such precarious loans already in the loan companies' hands.

The Federal government should not now attempt to ride in on a white horse and bail out the student loan companies - (with our money).

Robert said...

The thing that brings the whole dillema into sight is the fact that 2008 is an election year. I am not as familiar as some others may be at politics, but I can see some candidates playing the card that this current administration is against sending kids to college.

The fact is that, for the most part, the market should decide who goes to college as opposed to a government concerned about votes in November.

As a community college transfer, I believe it is a mistake for the government to be aiding 18 and 19 year old kids into debt for the next 20-30 years of their life.

Of course, if I was a politician, why would I care if I spent somebody else's money to gain votes..

Anonymous said...

it very difficult to trust a student having loans. that my opinion.<

Anonymous said...

For me its better to give loans for the student because it could help them especially when it comes to their financial problem. It could be a reason to have a bachelor's degree.

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