The Student Debt Crisis: An Entitlement Debacle

Jul 6th, 2019 | By | Category: Featured Issues, Politics & Current Events

The American higher education system has become totally dependent on its students amassing huge debt to finance a college degree.  It is now a system in crisis.  The basic statistics explain the nature of the crisis.  Josh Mitchell of the Wall Street Journal explains that borrowers owe more than $1.5 trillion in student loans, an average of $34,000 per person.  Over two million of them have defaulted on their loans in the past six years, and that number grows by 1,400 each day.  “After years of projecting big profits from student lending, the federal government now acknowledges that taxpayers stand to lose $31.5 billion on the program over the next decade, and the losses are growing rapidly.”

The debt crisis is compounded by the shifting attitudes Americans have about college and the phenomenal increase in tuition rates at American colleges.  Mitchell reports that college tuition has soared 1,375% since 1978, more than four times the rate of overall inflation.  “The US now spends more on higher education than any other developed country (except Luxembourg)—about $30,000 a student.”  Most specialists have concluded that the current higher education system is inefficient, too costly and increasingly dependent on the US government.  The key component of this inefficient system is the loans students take out to finance their college education.  That student loan system, now administered by the US government, has become another entitlement program, making a significant portion of the US population further dependent on the state.

How did the student loan system come about?  This loan system was built in the 1960s “on the overarching belief that higher education is a safe and worthy investment for both society and the individual.”  After World War II, the boomer generation began to enter college at increasing rates.  As the American economy become more knowledge-based, education became a requirement for entering the labor force.  “Education became a key factor behind the nation’s impressive economic growth and rising living standards, to say nothing of its standing as a global superpower.”  A series of historical developments provided the foundation for the student loan program:

  • With Lyndon B. Johnson’s Great Society vision, the desire emerged to level the playing field by making it possible for anyone who desired to go to college to be able to do so. The US government would not pay the tuition but it would facilitate loans for those seeking a college degree.  “Banks were reluctant to make loans to students, who were viewed as risky prospects,” so the Higher Education Act of 1965 provided funding for the US government to guarantee student loans made by banks, shifting the risk to the US taxpayer.  [Hence, the Guaranteed Student Loan program.]
  • The question now was should the money go directly to the higher education institutions or directly to the student? Both the Congress and the administration agreed to appoint a task force to offer advice on the best way to proceed.  In late 1960s, Alice Rivlin, a young economist, headed this task force.  “The Rivlin panel,” as it became known, recommended direct aid to the students via a voucher system “in which the federal government gives students a combination of loans and grants [e.g., the Pell grants].  Student loans became an entitlement, like Social Security, which students were free to spend at the school of their choice.”  Rivlin argued that “Companies can borrow to buy equipment.  People ought to be able to invest in themselves.”  The Nixon administration basically followed the Rivlin report of 1969 and passed the Higher Education Act of 1972.  “That act made permanent the government’s role in guaranteeing student loans made by private banks.  It also created Sallie Mae, a quasi-public entity designed to jump-start the student loan market.  Sallie Mae borrowed from the Treasury at low rates and used the money to buy student loans from banks, thus freeing up banks to make even more loans to students.”

What were the results of the Guaranteed Student Loan program?

  1. “Schools of all types, banks, nonprofit guarantee agencies and Wall Street investors competed for federal student-loan dollars. In particular, the system gave colleges an incentive to maximize the tuition they extracted from students and the federal taxpayer by boosting fees and enrollment, which meant relaxing admissions standards.”
  2. Nationally, the idea emerged that anyone who wished to attend college should be able to do so.
  3. This voucher system, “combined with a lack of government oversight,” resulted in rather perverse incentives: “Colleges could raise money quickly by admitting academically suspect students while suffering little or no consequences if their students dropped out and defaulted on their loans.”
  4. Colleges continued to raise tuition and fees and Congress continued to increase loan limits and grants. “This cycle continued throughout the 1980s and 1990s, as Sallie Mae and private banks that fronted students the money for the federal student loan program made big profits—and schools collected more money.”
  5. As the US entered the 21st century, this system was now in crisis.

Therefore, President Barack Obama and his administration attempted to reform the system:

  1. Obama put in place regulations to force for-profit trade schools to shut down if too many students defaulted on their loans.
  2. Obama killed the Guaranteed Student Loan program by instituting the direct loan program, whereby the money came directly from the US Treasury.
  3. Obama also “heavily promoted income-based repayment programs, which set borrowers’ monthly payments at 10% of their discretionary income and then forgave a portion of their debt after 20 to 25 years of payments. This severed the link between the value of students’ education and how much they could borrow, providing a huge incentive for schools to raise tuition, since taxpayers would pick-up more of the tab.  Enrollment in these programs is one big reason that the government’s costs for student loans are exploding.”

Therefore, the current political culture has generated rather radical solutions to the student debt crisis in America.  Two are worth mentioning:

  1. Some in the Democratic Party are proposing the idea of free college (e.g., Elizabeth Warren and Bernie Sanders). The cost of such a proposal would be astronomical and would necessarily mean that “schools would become subject to even more political control, potentially undermining the quality of the educational experience.  Costs would continue to rise and strain government budgets.”
  2. Some in the Republican Party advocate shifting student-loan financing to the private sector. Mitch Daniels, president of Purdue University, has proposed income share agreements, in which students receive funding from investors in exchange for a share of their income for a period of time after graduation.  The positive aspect of such a proposal is that “Investors would presumably advance students money only for schools that were doing a decent job of teaching them.”  But the risks are that borrowers may end up paying even more than the current plan and that investors might not lend to students they consider too risky.

The student loan system now in crisis has had several measurable positive results.  The number of full-time workers with Bachelor’s degrees has risen from 7.6 million in 1980 to 19.5 million today.  “The share of Americans age 25 and older with a bachelor’s degree reached 34.2% in 2017, double what it was in 1980.”  As an investment for the future, higher education does seem to pay off:  “The college premium—the amount graduates earn over workers without degrees—remains at an all-time high.  About 40% of all student debt goes to finance graduate degrees, including law and medical degrees, which typically lead to high salaries.”

However, the current program created by the Johnson and Nixon administrations and modified by the Obama administration is hopelessly broken and needs major reform.  It cannot continue as is.  Recently, Mitchell had a conversation with Alice Rivlin and he asked her about the program she helped create 50 years ago.  She exclaimed, “We unleashed a monster.”  Is free college the answer?  It might solve the student debt crisis but it will simply create another massive entitlement program fostering even greater dependence on the state.    The income share agreement idea has potential but needs much more analysis.  But perhaps the overarching question is will the political culture of a polarized nation even permit reasonable, balanced consideration of alternative ways for financing a college education.  At this point, it is difficult for me to be optimistic.  The student debt crisis is another example of the increasingly dysfunctional nature of the US government.

See Josh Mitchell, “The Long Road to the Student Debt Crisis” in the Wall Street Journal (8-9 June 2019).

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