Student Loan Debt
What is to be done?
US student loan debt outstanding now exceeds $1.7 trillion and has doubled in the past decade, growing at a much faster rate than the US economy. Over 43mm Americans have outstanding student loans, with an average amount owed of close to $40,000. The average amount borrowed by graduate students is over $70,000 and is twice that for law students, three times that for medical students and four times that for dental students. Over 5% of all outstanding student loans are now in default and over 25% of those student borrowers who entered college in 2003-4 have now defaulted, with the rate continuing to climb. Default rates are particularly high among first-generation college students and students who attend for-profit schools. Student loan debt has become a crushing financial burden for millions of American students and their families, despite temporary government funded covid relief programs implemented over the past two years.
But what if anything should we as a society do about this situation?
The proposals on what to do with student loan debt range from “do nothing” to “cancel the debt” to “privatize student loans”, with a wide range of more moderate proposals from both Democrats and Republicans. Given the current political situation in Washington, there is little prospect for radical reform of the current student loan programs. The reasons are many, ranging from rigid partisanship to ideological differences regarding the role of the state in funding university-level education. And voter views are not consistent either; those with high loan amounts tend to favor some form of debt relief, but others who did not take out loans (or have paid them back) don’t see things quite the same way.
But the size of the problem keeps growing and at some point the question of student loan relief or reform will be back on page one of the political news. And when that happens I would like us all to be prepared to engage intelligently in the debate.
I have written before about student loan debt from both a personal finance and public policy perspective, as in my July posts Financially Hobbled for Life and Grad School Economics. But I didn’t really address the question of what to do about student loan debt, other than to advise students to think twice before incurring large loans to finance graduate programs with dodgy economic prospects. Today I would like to take this discussion a step further and raise a few fundamental questions for us all to consider, before coming back to specific reform proposals in subsequent blog posts.
To begin, however, let’s make sure we all understand at least the highlights of the principal US federal government student loan program(s). The vast majority (over 90%) of annual student loan funding is now provided directly by the US government, with the balance (less than 10%) coming from private lenders. The US federal government lends about $100bn a year directly to students and their parents through three principal programs: Subsidized Loans for Undergraduates(18% of the total); Unsubsidized Loans for Undergraduates and Graduates (35%); and Unsubsidized Graduate Student and Parent PLUS Loans (12%). The balance of oustanding federal student loans consists primarily of Federal Consolidation Loans (35%). The federal government also guarantees smaller amounts of outstanding private student loans made years ago under the now defunct Federal Family Education Loan Program (FFELP).
Subsidized loans are need-based loans which provide students with up to $5,500 annually: unsubsidized loans are not based on need and provide up to $20,000 per year (less the amount of any subsidized loans). Undergraduate students can borrow less money under the federal programs than can graduate students. The total amount of federal student loan debt is capped at around $31,000 for dependent undergrads, $58,000 for independent undergrads, and $138,000 for grad students. However students and their parents can and do borrow amounts in excess of these limits using federal PLUS loans, private student loans and other forms of debt.
The interest rate on federal student loans varies with the loan program and currently ranges from 3.7% (subsidized loans) to 6.3% (PLUS loans). All interest rates are fixed for the life of the loan, with interest accruing from day one for unsubsidized loans but deferred until 6-months after graduation for subsidized loans. Loan principal amounts are typically amortized over a 10 or 20-year period, with fixed monthly payments consisting of varying amounts of interest plus principle (similar to a traditional amortizing mortgage loan).
Eligible borrowers who have trouble repaying their loan may take advantage of various payment deferral, income-based repayment and consolidation programs, and students working in certain public service careers may be eligible to have some or all of their debt forgiven after a period of time (typically 10-years). Over the past two years, the Covid CARES Act relief package provided temporary student loan forbearance for an estimated 35mm borrowers, but this relief is now coming to an end.
Now back to my original question: What is to be done about the US student loan debt problem? I really don’t know and I would prefer to wait for specific actionable proposals before commenting further. But for now here are some of the fundamental public policy questions that I am wrestling with, which may help trigger further thinking on your part as well:
What is the rationale for any government funding of post-secondary education, whatever form it takes? Is this a case of private market failure, social goods, addressing inequality or inequity, or something else entirely? I get the case for funding early education but why post-secondary education and specifically university education? Keep in mind here the substantial empirical evidence of high private financial returns from investing in a university education for many or most students. Why can’t or shouldn’t this be funded privately?
Does the public policy rationale for government support apply equally to all levels and types of post-secondary education? How strong is the public policy case for government funding of the cost of attending different types of post-secondary educational institutions? How should we think about the relative merits of community colleges and trade schools vs 4-year colleges and universities? Public vs private vs for-profit institutions? Undergrad vs graduate-level programs? For all courses of study?
What is the rationale for providing federal funding in the form of student loans rather than student grants? A number of well-off universities are making an effort to replace student loans with endowment-funded grants, but the vast majority of schools cannot afford to do this. Should the federal government do something similar? What would be the costs and the benefits?
Why does the federal government make student loans without conducting any sort of credit analysis to confirm likelihood of repayment? Private lenders only lend money to those they expect will be able to repay. Private lenders don’t always get it right, but they do have lower default rates and loan losses as a result. Why shouldn’t the federal government do this as well? There may be good reasons, but what are they?
How big are the expected losses currently embedded in the federal government’s student loan portfolio and how might this influence our thinking about various proposed courses of action? Recent studies have suggested that as much as 30% of the amount currently owed by student loan borrowers to the federal government may never be repaid. If true this represents a potential loss of over $400bn on a portfolio of around $1.4bn (at the time of the study), which would put the quality of the federal government’s student loans on a par with (or below that of) sub-prime mortgage loans made during the run up to the 2008 financial crisis. But is this an indication of a poorly run federal student loan program or one which is doing exactly what it is supposed to do, providing educational funding to those who could not otherwise afford it?
What are the economic gains to be realized from cancelling or restructuring student loan debt? Various commentators cite the large negative impact to the economy imposed by the current level of student loan debt. But what exactly are these economic impacts and how can we quantify them? Is it clear that student loan debt cancellation or restructuring will in fact generate net benefits for the economy as a whole and not just private benefits for those individuals who have their debt burdens reduced?
What are the equities associated with student loan debt relief? Is it “fair” or “just” to cancel debt for some but not all student loan borrowers? Conversely why should taxpayers pick up the tab for debt relief to borrowers who are able to pay in full? And what about those students and their families who have already repaid their student loans or who scrimped and saved so that they did not have to borrow as much in the first place? How would the philosopher John Rawls think about this?
Do we really have a student loan debt problem or is it something else entirely? We often refer to the global financial crisis earlier this century as the “sub-prime mortgage crisis”. But putting the blame for the global financial crisis—or even the related but distinct US housing crisis— entirely on US sub-prime mortgage lending is not entirely correct. The fundamental underlying problem in US housing during the late 1990s and early 2000s was in large part one of over-investment in high-priced housing by individuals who could not afford to maintain ownership of their newly purchased houses and the rapidly rising of house prices which ensued. Yes this was facilitated by excessively lax mortgage lending standards (primarily from private lenders), but the root cause of the problem was one of bad investment and excessive speculation, not just the wrong funding structure. And perhaps something similar is going on in the market for post-secondary education, with too much investment in over-priced or low-quality educational programs aggressively promoted to ill-prepared students. This investment may have been facilitated by generous federal student loan programs, but how we address the current situation depends heavily on whether we think the real problem lies with the structure or terms of student loan funding or more fundamentally with the nature and quality of the underlying educational investment per se.
We often talk of owning a home as the “American Dream” but for many people in this country the bigger dream is a college degree for themselves or their children. And this is understandable and even laudable. But it seems that for millions of Americans this educational dream has turned into a financial nightmare. And so we need to figure out together what the problem is and what if anything we should do about it, for the benefit of those currently in trouble but also for the generations of students (and taxpayers) to come.
Links
Student Loan Debt Statistics: Education Data Initiative, November 2021
Student Loan Debt Statistics, NerdWallet March 2021
Five Facts about Student Loans, Pew Research Center, August 2019
Why Washington Won’t Fix the Student Loan Debt Problem, December 2021
More Schools Rethink Student Loans, Washington Post, 11 December 2021
Student Loan Losses Estimated at $400bn, WSJ, 21 November 2020