Trillion-Dollar Misunderstanding: The 7 Sins of Federal Student Loans

Charles Miller, chair of the Spellings Commission, reminded me the other day that that panel in its report referred to the federal financial aid system as “dysfunctional.” I think I (as a member of the commission) picked the word and Charles seized upon it. More than five years have passed, and the system now has been promoted to “uber dysfunctional.”

Let me outline seven problems or “sins” with the program, some of which I outlined earlier in a piece for National Review Online.

1. The low interest rates (3.4 percent currently, and likely to continue) on federal subsidized Stafford loans are set by the political process, not market forces. Loose Federal Reserve monetary policy along with irresponsible lending by such government subsidized agencies as Fannie Mae and Freddie Mac contributed hugely to the housing bubble and 2008 financial crisis, and federal student loans today are having a smaller but still sizable detrimental effect in higher education.

2. Loan terms are invariant–the wealthy, bright kid almost certain to graduate from Cal Tech in engineering into a high paying job gets the same loan terms as the risky student of marginal educational background attending a school with a high dropout rate, and who majors in ethnic studies, English, social work, or education–subjects whose graduates usually get relatively low-paying jobs. Thus, subsidies are implicitly greater for mediocre students than good ones,  and the same is true for majors that are less valued in the job market.

3.  There is good evidence that the student-loan explosion has contributed to the tuition explosion of the past three decades or so; cheap loans increase the demand for higher education and reduce the supply in a way that raises the cost of attending school. Former Secretary Bill Bennett hypothesized this relationship in 1987, and it is even truer today than 25 years ago.

4. That said, the net effect of student loans is to increase enrollments, leading to dual problems. First, the quality of the incremental students on average is probably lower than those who would have attended in the absence of loans, leading to more mediocre students, a dumbing down of material, an easing of student expectations–all of which has happened (read Arum and Roksa’s Academically Adrift). Also, the number of graduates now far exceeds the number of traditional college-graduate entry level jobs. Hence we are now in the era where well over 100,000 janitors have college degrees. This has contributed to the anger and angst over servicing over $1-trillion in student loan debt.

5. As currently run, the U.S. government has become essentially a monopoly provider of student loans, robbing students of the variation in options and competition between  private providers, etc. Just as the U.S. Postal Service and the Bureau of Motor Vehicles will never win awards for customer satisfaction, the same can be said of the U.S. government’s loan program.

6. The student loan and related federal grant programs have spawned the infamous Fafasa form, hated historically for its complexity (over 100 questions) and the fact that it is a significant barrier to application, especially among low-income persons not used to completing long government bureaucratic documents. It also allows the colleges to engage in price discrimination of its customers to a degree that no other providers of services can.

7. The problem above, along with the tuition price explosion, has led to a smaller percentage of low-income recent college graduates today than was true in, say, 1970, before loan programs were as large as now. A program designed originally to promote equal educational and economic opportunity may well have contributed to rising, not falling, income equality in the United States.

The Congress and the President are tinkering with a failed system, giving it a Band-Aid in the form of essentially zero-interest (in inflation adjusted terms) loans until after the election, if things go as predicted in the Senate and House-Senate Conference. It is time to start from scratch with a newer, more innovative, approach. I hope to discuss this more in subsequent epistles.

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