Thursday, April 17, 2008

The Student Loan Mess Revisited

By Richard Vedder

An old joke says that whenever we see light at the end of the tunnel, the government goes and adds more tunnel. I was reminded of that joke yesterday when I read two stories regarding student loans.

First, the Project on Student Debt issued a study in which it claimed that one million college students (I think a bit of an exaggerated number) go to community colleges that do NOT participate in the federal student loan program. These colleges tend to be in poor areas in the South, and have high concentrations of minority students. This horrible injustice is denying access to higher education to many deserving students, or so I read.

Here is a different perspective. The colleges not in the loan program are afraid to join it, for fear that the default rate on student loans will be so high --above 25 percent --that it will make students at the schools ineligible for Pell Grants. Translation: people at those schools tend to not pay back their loans, leaving the taxpayers with the bill. As a believer in the rule of law, I think people who fail to meet legally binding agreements should face adverse consequences, and institutions where contract violations are routine should similarly suffer.

Beyond that, however, why are default rates high? Almost certainly, because those borrowing money are unsuccessful in getting their education and/or jobs that would allow loan repayment. We are sending many unqualified people to college, setting them up to fail. Those in power now want to make that problem bigger by loosening the rules. High default rates are a signal that we have over allocated resources to an activity --the return on human capital investment is low or negative. In the private sector, people go out of business when that happens. In higher education, people complain that they need more subsidies to keep the uneconomic practice alive.

This brings me to the second, related point --the antics of the Gang of 535, aka the U.S. Congress. It is rushing through legislation that will bail out lenders and guarantee money to students wishing to borrow this fall. Markets are saying: "some of these kids are questionable risks. The potential of default is high, and we wish not to lend to them --it is too risky." Markets are not always right, but on average they are more right than politicians. Markets are saying "we are overinvested in higher education." Congress is saying --the hell with human behavior, the hell with the fact that resources are scarce and need to be rationed --this is an election year, and we will take any move, however irresponsible, to appear to give kids whatever loan money they want --and enable colleges to continue on their high spending, inefficient ways. Shame.

The most disgusting part of the drama was the appearance of that downtrodden lender, Sallie Mae, begging Congress to let the Federal Financing Bank (aka the U.S. Government) loan money to it at below market interest rates so it can make highly profitable loans to individual students. Sallie Mae will drop a few million in campaign contributions (indirectly and legally, of course) on the Gang of 535, and will probably get what they want. Sometimes I wonder if Churchill was right when he said democracy was the worst form of government --except for all others.

Teddy Kennedy is the worst, of course. He is urging students to borrow directly from the feds --let us socialize the process even further. There is nothing worse than the intellectually challenged, guilt-ridden son of a plutocratic capitalist taking the helm of a committee (Senate Education) that ostensibly is charged with the responsibility of protecting and nurturing our youth.

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