Sunday, April 29, 2012

Using Student Loans to Study Economics

If you listen to politicians these days, you'd think that the greatest danger to Our Republic is the way that the other party wants to pay for an ongoing reduction in interest on Stafford Loans, the student loans presently offered by the federal government to college students. Without action from Congress, loans made after 1 July 2012 will be charged interest of 6% and change, as compared to the present rate of 3% and changed, discounted awhile back allegedly to protect the nation's students from too much student debt.

Meanwhile, a few politicians are talking about forgiving student debt, in whole or in part. That stands in pretty stark contrast to present policy, by which no one can escape paying a student loan, even through the most severe forms of bankruptcy.

All of this, of course, is exactly counterproductive to the goal of restraining the growth of student debt. Why don't they teach economics in these colleges?

How is that the case, SWNID? Isn't it better for students if they're charged less interest? And doesn't the bankruptcy provision protect lenders from students who would otherwise take out loans that they can never pay back?

The answers, of course, are no and no.

First to the interest. Let's pose the question this way: will people buy more of something if it's cheaper or more expensive. We won't bother to answer, but we'll note for those who need to hear it that the cost of a loan is its interest. Discount the interest, and you'll make more loans.

So why are students borrowing so much? Not just because college costs a ton. Some colleges are cheaper than those that many students attend. They borrow because borrowing is cheap.

Second, to the no-bankruptcy thing. Why do lenders lend so much to students, regardless of their likely ability to pay the money back? Why can someone borrow $200k to earn a degree in gender studies from a second-tier private college, knowing that the graduate will be in the same pool of educated but unskilled workers seeking to be hired in entry-level cubicles in an economy in its third year of doldrums? The answer is that the lender pretty much owns the borrower in this transaction. It doesn't matter how much or how little the borrower owes, for All Your Salaries Is Belong to Us.

Let's imagine a different world. Let's say that interest rates on student loans floated with the market for unsecured loans. That would put the interest at the level of a favorable credit card rate, maybe around gthree to four times the three-ish percent presently being charged. Would the number of students borrowing be reduced? Well, yes, of course.

Would fewer go to college? Perhaps. But some would seek more affordable options. Colleges, in turn, would have to respond by finding ways (and for most, there are ways) to reduce their costs and so charge less.

Back to the present: we act like student debt is high because college is too expensive. Maybe college is expensive and debts are high because we've underpriced student loans--by Congressional mandate.

To the bankruptcy aspect. Imagine a world in which one could escape student loan payback with bankruptcy. Would lenders, including Uncle Sugar, then lend money to students who are bad risks? Of course not. One would have to show more than an acceptance letter to qualify for a loan. Banks (and let's assume that they're making the loans in our scenario, as the government lets politics interfere with commercial transactions when it does the transactions itself) would lend on the basis of students' credit worthiness, including their grades, employment options, even their demonstration of financial planning while going to college. Is there any of that stuff that ought to be discouraged in the present environment.

SWNID doesn't think that free markets are magic. But we do think that politics, when injected into the market, tends to distort the market's ability to set realistic costs and assess real risks. In higher education as in housing, we're seeing how that can seriously foul up people's lives.

So it's time to end the charade and make student loans just like other loans: costing what they cost but not indenturing the student to the lender until death. That gives the proper caution to all sides, eliminating the awful moral hazards of the present situation, and perhaps could restore some sanity to the cost of higher education.

But at least one could say that the institutions that study and teach economics aren't run on a financial scheme that defies economics.

Postscript: We expect a few readers (those who remain devoted to this blog despite the dearth of content recently) to inquire as to how such a scheme would affect the institution to which SWNID is attached, a modestly priced but still pricey faith-based institution of higher education. We respond that our place would inevitably have to find a way to drive prices down, noting as we do that the decline in the percentage of our institution's costs borne by donors as paralleled the rising percentage assumed by government grants and loans. When Uncle Sugar pays and loans to poor students, why should I give to help  poor students? When I've got to pay Uncle Sugar what I owed him for my degree, why should I give to my alma mater?

Note well that if we thought our suggestion might be listened to by politicians (we have personally explained the economics to at least one Congressman in person, with the classic response that says "not interested in political suicide"), we would recommend its being phased in over five to ten years, allowing institutions time to adjust to the new normal.

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