Poll Results and Federal Student Loans

Hey all, thanks for voting in the polls.  I was surprised not to see more votes for Twix (yummy!), but was even more surprised that the top vote was for a post on federal student loans rather than DIY or financial scary stories.  OK, here goes…

So student loans are the bane of many young peoples’ existence, loans are so hard to pay off, college is so expensive, blah blah blah.  To begin to understand the problem and its possible solutions, it’s good to know: how did all this insanity get started?

Interesting story really: as of 1940, only about 15% of college-age kids went to college, and they did so either with family wealth or, I suppose, limited private bank loans.  I don’t think there were many public or community colleges back then.

Then in 1958 the Federal Government started providing student loans through the National Defense Education Act, to turn more kids into scientists so we could win the Cold War.  I don’t know what kind of lending the Federal Government already did at that point, but this already sounds unusual to me (while patriotic) because I do not understand how a government comes to be in the banking business unless the Constitution calls for it.  But the Constitution is kind of open-ended as they say, so who knows.

Anyway, the government lent more and more money, and this led to a subsidizing effect, rather than mitigating, as William Bennett first noted in 1987 and reiterated last year.  The Federal Government provides large student loans at low interest rates, relative to the more limited, higher-interest rate private bank loans.  So this has enabled more kids to go to college, leading colleges to just charge more.  And we pay up, because we all have to go to college and don’t particularly worry about loans (as you see with the proliferation of car loans and house loans).

The question is what to do about it, assuming the market of hopeful college entrants does not make an organic decision that a fancy college is not worth debt, and does not ensure ROI via a job once in the working world.  But this does not seem like it will happen: these are teenagers we are talking about.  I had an opportunity to finish school a semester early but I convinced my parents that I was not done “having the college experience.”  Oy.  College is a big fun vacation for kids and assurance of success for the parents.  We are all hooked on it; the colleges are taking advantage of us AND the government enables the abuse, if you ask me, with loads of free money.

Plenty of people have plans for fixing this market-driven craze:

  1. Elizabeth Warren has an amusing, sometimes frightening list of reforms including punishing colleges whose graduates have a high loan default rate by extracting the payments from the college, and giving the money to other colleges that “keep costs low.”  I don’t understand the constitutionality of that idea, and imagine it would cost billions of dollars just to get the Committee organized to carry out that Robin Hood nightmare.  I think her heart is in the right place, but her ideas create too many loopholes in favor of students which would just shift the burden to taxpayers (such as dischargeability in bankruptcy – which I am sure propertyless, broke graduates would love to abuse).  And I do not see how most of the ideas would directly help students not accrue so many loans in the first place.
  2. Suze Orman, whose advice I mostly appreciate, suggested recently that student loans should have a 0% interest rate, to help students out.  I have no idea how this makes business sense for any lender.
  3. President Obama wants a government board to rate schools based on 1st year graduate employment rates (a nice idea for transparency, but ripe for corruption all the way around), and then tailor amount of federal student loans accordingly.  This also does not seem Constitutional.  I do not recall an Article in which the government helps us choose a college.

These ideas all make the federal lending system less profitable or more complex, which I see as inevitably adding corruption, taxpayer cost, or both.  My interpretation of William Bennett’s analysis is that the federal government’s vast and almost judgement-free lending has inserted a variable into the mix which is throwing off the free market order.  Usually loans require qualification and are limited and financed according to the customer’s qualification.  And college kids are a horrible investment who should not particularly be trusted.  But that is because banks are interested in making money; I am not sure what the federal government’s interest is.

If the government were to get out of the loan scene, colleges would stand to lose a huge customer base that would have otherwise paid with huge federal loans, and would have to lower prices or offer more scholarships to the quality applicants whose patronage they really want.  College applications would almost certainly shift toward public and community colleges, further compelling elite private colleges to attract students of merit with financial offers.  And the Federal Government could stop paying to administer this system.  And the loan bubble, as articles tend to refer to it, might actually taper a little.  It would be rough and might take a few years to balance out, but ecosystems seem to do better with the withdrawal of a predator than the introduction of cages.

That’s my $0.02 since you asked for it.


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