Approaching Crunch Time on the Student Loan Debacle

For a number of years now, a number of critics of the American system of higher education have rightly insisted that there is a "bubble" in the system, with more and more students running up loans in amounts they will find difficult to pay back.  This bubble has been fueled by the federal government's lavish subsidization of the student loan program (which was nationalized four years ago), in a way similar to how the housing bubble was fueled by government agencies pushing subprime mortgages.

This extensive government largess has produced a number of unintended -- though not necessarily unforeseeable -- negative consequences.  First, it has dramatically driven up the tuition and fees charged by colleges, which in turn has forced more students to take out loans.  This should have been easy to foresee, since the agents running the colleges would know that their clients had access to government-backed loans and so would jack up tuition quickly to extract that money.

Second, this flood of money has only encouraged administrative bloat, which in turn has increased college costs with no increase in the quality of education.  Again, this should have been foreseeable.  The administration would be rationally well-informed about the new honey-pot of taxpayer-backed loans, and the self-interested administrators are the ones who decide where to spend the money, so you don't need to guess where they will (and did) spend it.

Third, the rising price of college tends to erase the potential returns of a college education for students of only average ability.  In effect, like homeowners who refinance their homes only to squander the increased equity, many students are spending more (and borrowing more) of whatever future extra earnings their college educations will bring.

Two recent studies suggest that this bubble is indeed real and is beginning to burst.  The first is the recent Department of Education report on student loan default rates.  The report shows that the two-year default rate rose from 8.8% in FY (fiscal year) 2009 to 9.1% in FY 2010.  This marks the fifth year of increases in the two-year default rates -- indeed, the two-year rate is nearly double what it was in FY 2005.  This means that the number of borrowers whose first payments were due between 10/01/2009 and 9/30/2010 and who defaulted before 09/30/2011 went up dramatically -- numbering 375,000 in all, on a base of 4.1 million borrowers entering repayment.  Remember -- all these loans are ultimately guaranteed by the government.

The FY 2009 three-year default rates -- which the Department views as more indicative of ultimate defaults -- was 13.4%, essentially the same as the 13.8% for the FY 2008 cohort.  In private non-profit institutions, the three-year default rate was 7.5%, at public institutions it was 11%, and at private for-profit colleges it hit 22.7%.

There were 218 schools that actually managed to produce students who had three-year default rates of over 30%, and 37 schools that had rates over 40%!

As bad as these stats are, remember that they do not count borrowers who were allowed to postpone payments due to unemployment or other hardships.

Given that over half of all recent college grads are unemployed (or employed only at jobs not requiring a college education), we can expect those default rates to rapidly rise.

The second study is the Pew Research Center's report on student debt levels.  It notes that in 2010, fully 19% (i.e., nearly one fifth) of American households had student loan debt, which is up considerably from the 15% level that obtained in 2007 and is more than double the percentage that obtained in 1990.

The percentage of households headed by someone younger than 35 that had student loan debt is an astounding 40%.

Compared to other household debts (such as for automobiles, credit cards, installment loans, and mortgages), student loan debt is still minor.  It is only 5% of all household debt as of 2010.  But this is not quite comforting, because just three years ago it was only 3% of all debts, and worse, unlike the other forms of debt, taxpayer-backed student loans are not dischargeable in bankruptcy.

The Pew Study also reports other unpleasant news.  First, the average outstanding student loan balance is growing rapidly -- up 14% from $23,349 in 2007 to $26,682 in 2010.  And those most deeply in debt are getting deeper in the hole: while 10% of debtors in 2007 owed more than $54,238, 10% of debtors in 2010 owed more than $61,894 (in constant 2011 dollars).

Second, the amount of student loan debt relative to other household income or assets is highest among households at the bottom fifth of the income scale.

In fine, the student loan program, meaning the use of taxpayer guarantees to fuel the rapid growth in college loans, has been a textbook illustration of moral hazard.  It has induced often marginal students to rack up debts to get often marginal degrees (or none at all), and has induced colleges to expand often pointless administration and useless programs (victims studies, anyone?).

Remember, under recently adopted rules, payment on student loans will be capped at only 10% of the borrower's "discretionary" income, and the balance "forgiven" after twenty years.  What this means is that more and more massive amounts of bad student loan debt will be saddled on the backs of taxpayers, many of whom never got to go to college in the first place!

This is a program that desperately needs reform before it simply melts down -- like the mortgage market did not long ago.

Philosopher Gary Jason is a senior editor of Liberty and author of the recent book Dangerous Thoughts.

For a number of years now, a number of critics of the American system of higher education have rightly insisted that there is a "bubble" in the system, with more and more students running up loans in amounts they will find difficult to pay back.  This bubble has been fueled by the federal government's lavish subsidization of the student loan program (which was nationalized four years ago), in a way similar to how the housing bubble was fueled by government agencies pushing subprime mortgages.

This extensive government largess has produced a number of unintended -- though not necessarily unforeseeable -- negative consequences.  First, it has dramatically driven up the tuition and fees charged by colleges, which in turn has forced more students to take out loans.  This should have been easy to foresee, since the agents running the colleges would know that their clients had access to government-backed loans and so would jack up tuition quickly to extract that money.

Second, this flood of money has only encouraged administrative bloat, which in turn has increased college costs with no increase in the quality of education.  Again, this should have been foreseeable.  The administration would be rationally well-informed about the new honey-pot of taxpayer-backed loans, and the self-interested administrators are the ones who decide where to spend the money, so you don't need to guess where they will (and did) spend it.

Third, the rising price of college tends to erase the potential returns of a college education for students of only average ability.  In effect, like homeowners who refinance their homes only to squander the increased equity, many students are spending more (and borrowing more) of whatever future extra earnings their college educations will bring.

Two recent studies suggest that this bubble is indeed real and is beginning to burst.  The first is the recent Department of Education report on student loan default rates.  The report shows that the two-year default rate rose from 8.8% in FY (fiscal year) 2009 to 9.1% in FY 2010.  This marks the fifth year of increases in the two-year default rates -- indeed, the two-year rate is nearly double what it was in FY 2005.  This means that the number of borrowers whose first payments were due between 10/01/2009 and 9/30/2010 and who defaulted before 09/30/2011 went up dramatically -- numbering 375,000 in all, on a base of 4.1 million borrowers entering repayment.  Remember -- all these loans are ultimately guaranteed by the government.

The FY 2009 three-year default rates -- which the Department views as more indicative of ultimate defaults -- was 13.4%, essentially the same as the 13.8% for the FY 2008 cohort.  In private non-profit institutions, the three-year default rate was 7.5%, at public institutions it was 11%, and at private for-profit colleges it hit 22.7%.

There were 218 schools that actually managed to produce students who had three-year default rates of over 30%, and 37 schools that had rates over 40%!

As bad as these stats are, remember that they do not count borrowers who were allowed to postpone payments due to unemployment or other hardships.

Given that over half of all recent college grads are unemployed (or employed only at jobs not requiring a college education), we can expect those default rates to rapidly rise.

The second study is the Pew Research Center's report on student debt levels.  It notes that in 2010, fully 19% (i.e., nearly one fifth) of American households had student loan debt, which is up considerably from the 15% level that obtained in 2007 and is more than double the percentage that obtained in 1990.

The percentage of households headed by someone younger than 35 that had student loan debt is an astounding 40%.

Compared to other household debts (such as for automobiles, credit cards, installment loans, and mortgages), student loan debt is still minor.  It is only 5% of all household debt as of 2010.  But this is not quite comforting, because just three years ago it was only 3% of all debts, and worse, unlike the other forms of debt, taxpayer-backed student loans are not dischargeable in bankruptcy.

The Pew Study also reports other unpleasant news.  First, the average outstanding student loan balance is growing rapidly -- up 14% from $23,349 in 2007 to $26,682 in 2010.  And those most deeply in debt are getting deeper in the hole: while 10% of debtors in 2007 owed more than $54,238, 10% of debtors in 2010 owed more than $61,894 (in constant 2011 dollars).

Second, the amount of student loan debt relative to other household income or assets is highest among households at the bottom fifth of the income scale.

In fine, the student loan program, meaning the use of taxpayer guarantees to fuel the rapid growth in college loans, has been a textbook illustration of moral hazard.  It has induced often marginal students to rack up debts to get often marginal degrees (or none at all), and has induced colleges to expand often pointless administration and useless programs (victims studies, anyone?).

Remember, under recently adopted rules, payment on student loans will be capped at only 10% of the borrower's "discretionary" income, and the balance "forgiven" after twenty years.  What this means is that more and more massive amounts of bad student loan debt will be saddled on the backs of taxpayers, many of whom never got to go to college in the first place!

This is a program that desperately needs reform before it simply melts down -- like the mortgage market did not long ago.

Philosopher Gary Jason is a senior editor of Liberty and author of the recent book Dangerous Thoughts.

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