Friday, January 29, 2010

The Student Loan Debate

By Richard Vedder

Two issues are important at the moment regarding student loans. First, should repayment of loans be tied to income, and to what extent? Second, should the current system of private providers and a federal direct lending program be replaced by one where the private providers are cut out of federal guarantees and subsidies?

On several occasions, I have suggested that perhaps college students could sell equity rather than debt instruments to investors, with investor return dependent on earnings. Charles Miller, chair of the Spellings Commission, good friend, and, most relevantly, investment guru, says the idea is hare-brained, and he has some good arugments showing practical problems with it. The concept of relating loan terms to repayment potential is not necessarily unsound, however. The Obama administration wants to tie repayment of conventional loans to post-graduate income, limiting the payments to 10 percent of income beyond subsistence (is a wide-screen television, nice car and a smart phone part of a subsistence income these days?). Currently the payment limit is 15 percent. I think this is a very bad idea. Some students will have interest payments on their loans that alone approach 10 percent of all income, much less income beyond subsistence. What this proposal is is a disguised way for the federal government to make more grants via loan forgiveness. It increases the contingent liabilities of the federal government, very bad from a macroeconomic standpoint. Moreover, it is a disguised, not transparent, loan program. The idea that if you work for the good guys (government) you will eligiible for loan forgiveness, but if you work for the bad guys (private sector), you will not get this perk is repugnant and indicative of the Obama Administration's hatred of capitalism. Is it no wonder the inflation-adjusted Dow-Jones Industrial Average today is nearly 30 percent lower than it was a decade ago or that the price of gold is up well over 40 percent since Election Day 2008?

We don't need more federal student grants, even ones disguised as loans. The big access problem is not money, as Bob Zemsky kept telling me years ago when we wrnagled in a friendly fashion on the Spellings Commission.

The reason why Hispanics and blacks and low income whites don't get college degrees is vastly more connected to family background and behaviors, poor academic training, and, in some cases affirmative action programs that push students into inappropriate learning environments. Attrition rates are higher among lower income students, even ones with generous financial support.

We are dealing with symptoms, not the disease. The disease is the fact that the cost of college is rising faster than people's income, which is unsustainable in the long run. Obama is trying to keep the Titanic from sinking rather than build a new ship. No one has the guts to force the higher ed establishment to change its ways --which the politicians have the power to do via the money spigot. Until my three I's of innovation are dealt with --incentives information, and and innovation -- the Law of No Consequences rules in higher ed --nothing much happens to you no matter how irresponsible your behavior. Making loan programs more generous is setting us up for another financial crisis, albeit on a smaller scale, like that occuring in the housing market. My sidekick Andrew Gillen has been talking about a tuition bubble, with good reason.

Too many kids are going to college, borrowing too much money, enabling too many universities to employ too many people, do too many non-academic things, enjoy too large economic rents, etc. etc. Stopping the expansion of student loans would force either a mini-crisis of a financial nature that will lead to true reforms, or significant enrollment declines that are needed if the cost explosion is to be contained.

President Obama is, in his heart, a socialist in the German Social Democratic party tradition. He wants to kill off private lending, thinking that the government is more efficient than private lenders, that profits are exploitation of students, etc. The evidence is clear that both students and the colleges themselves like having the private lending system, and have been slow to voluntarily move to the Obama student loan model. Moreover, the U.S. Senate has not adopted a plan that would end private lending and likely will not in this election year. I suspect something is at work here similar to health care -Americans are not wild about private insurance companies and other aspects of the current system, but they are against radical change that increase the government's role. Moderate Democrats valuing job security along with a newly empowered Senate Republican minority can keep the Obama plan from happening this year, which may mean, keep it from happening forever. Long live the voters of Massachusetts!


Ben Miller said...

Dr. Vedder,
I think your presentation of the public service and income-based loan repayment programs is a bit off target. Here are the positions that qualify for the 10-year forgiveness benefit (emphasis mine):

Public service jobs include, among other positions, emergency management, government (excluding time served as a member of Congress), military service, public safety and law enforcement (police and fire), public health (including nurses, nurse practitioners, nurses in a clinical setting, and full-time professionals engaged in health care practitioner occupations and health care support occupations), public education, early childhood education (including licensed or regulated childcare, Head Start, and State-funded prekindergarten), social work in a public child or family service agency, public services for individuals with disabilities or the elderly, public interest legal services (including prosecutors, public defenders and legal advocacy on behalf of low-income communities at a nonprofit organization), public librarians, school librarians and other school-based services, and employees of tax exempt 501(c)(3) organizations. Full-time faculty at tribal colleges and universities, as well as faculty teaching in high-need subject areas and shortage areas (including nurse faculty, foreign language faculty, and part-time faculty at community colleges), also qualify.

Including 501(c)(3) employees, which I would assume includes CCAP, means that there certainly are private sector people who will benefit from this program. And that says nothing of nurses, health care practitioners, etc., who work in public service jobs but are not actually part of the public sector. Moreover, everyone else in the program does get loan forgiveness, but it would take place after either 20 or 25 years, so they just have to wait a bit longer. It's certainly fine to argue the merits of whether or not the program is a good idea, but it is not as black and white as you present it.

Unknown said...

It is imperitive that studen loans are tied to income and/or productivity. Education should be seen as an "investment". The lender (ideally the school) "invests" in a student. Their ability to collect on their investment should be tied to how well they prepare the student for the real world... In the current system, there is no incentive to "create" productive students. A school can set whatever curriculum they see fit at a cost they choose with no real tie to real world forces.... They charge an outrageous fee and wipe their hands clean when the student graduates. Rather, in an ideal situation, if a student graduates and can not find a job and is ill prepared - the school will not collect on their full investment and they will need to rethink how they prepare students...

Daniel L. Bennett said...

Ian -
I think that you have a very interesting idea. Colleges should be held accountable for the success (or failure) of the product that they provide. Tying their financial success to the outcomes of their graduates would force them to create the most value for their students and to control their costs.

Please feel free to contact me. I would like to discuss this idea more with you.

Unknown said...

I read your other posts and it sounds like you've put a lot more thought in than I have to this topic. I wholely agree with your position on this though and would definitely be interested to hear more of your thoughts and interest in this topic (

My own interests come mostly from my struggles with a mountain of school debt that i am realizing is not tied to my income and ability to pay it back.

Though I benefit from Obama's push for the new requirements of the Income Based Repayment plan I am pulled both ways on it...

On the one side i am put in a more managable financial situation.

On the other hand - as you allude to in your other post - government pumping more funds to bail me out addresses a symptom and not a root problem... It funds an out of control system, allowing it the breathing room to grow further....