What Is Driving the Student-Debt Crisis?
Financing equal access to higher education largely through student loans has resulted in $1.3 trillion in debt, exceeding auto loans, credit card balances, and home-equity loans. Twenty-seven percent of loans in repayment are delinquent, and most of them are expected ultimately to default, threatening hundreds of billions of dollars in taxpayer losses and creating millions of financial basket cases for our consumer-based economy.
Early attempted remedies mainly involved increased student grants-in-aid (but much less than the cost of college); limited access to student-loan programs in extreme cases of institutional abuse (such as astronomical default rates or almost-total reliance on federal aid); and changes in borrower interest rates (not always advantageous to students). Then, income-driven repayment plans, or IDRPs, extended repayment up to 30 years, reduced installments based on borrower incomes (but with increased interest accruals, often at unconscionable profits), and forgave unpaid balances at maturity (but with uncertain income-tax consequences).
Recently, the U.S. Department of Education mandated the publication of consumer information (but without teeth) and expanded the use of its statutory authority to forgive student loans in cases of institutional fraud (but is mostly delayed by negotiated rule-making until after the next presidential election).
Pain relievers may make life more bearable; they do not cure the underlying illness. Indeed, increased federal financial aid to college students may actually fuel institutional spending, shifting much of the added burden to taxpayers. The write-offs in IDRPs even fall outside the government's 10-year budget-scoring window, adding to the national debt without any fiscal accountability.
Rather than providing analgesics, we urgently need to address the underlying problem: the skyrocketing cost of higher education. Its magnitude is growing too rapidly for our economy to absorb, no matter how distributed. As with the Titanic, there are insufficient lifeboats to save all the passengers, but the real problem is that the ship is sinking.
This is not just a problem of for-profit schools. From 1949 to 2012, the total enrollment of all degree-granting institutions roughly octupled, but their total annual expenditures increased 2½ times faster (in constant dollars). A substantial contributor to this disproportionate increase is a zero-sum competition among nonprofits to increase enrollments and/or prestige/rankings with tuition-funded research and such marketing enticements as merit-based scholarships; palatial dormitories, dining halls, and student life centers; and even lazy-river pools. Neither they nor burgeoning noninstructional personnel costs bear much relation to student learning.
With federal grants-in-aid lagging, state governments substantially reducing their support, and only college endowments growing comparably, families have filled the gap with more and more borrowed money. So, we have the $1.3 trillion student-debt crisis as the symptom of the underlying problem.
Higher education does open doors to financial futures, but while higher education costs have skyrocketed, the average income of its graduates has stagnated (in constant dollars). And averages obscure the increasingly bipolar distribution of income in our society. For too many youngsters, crossing the baccalaureate threshold is no longer worth the price of admission. Even when the investment still does make sense, its financial advantage has been eroded by the narrowing spread between educational cost and future rewards.
This is not just a problem for students. The decline in higher education's real net value has substantial macroeconomic consequences for our entire consumer-based economy. Even the increasing number of borrowers using IDRPs will have little discretionary income after application of the 150 percent of the poverty-level guideline allowed for their expenses.
Moreover, student debt burdens all borrowers. The ability to repay their loans over a standard 10-year term does not necessarily mean that they will have much left over for truly discretionary expenses. Economists already question when future graduates will be able to buy their first house or automobile. Our consumer-based economy may drown in student loans well before rising oceans engulf our shores. The economics behind the student-debt crisis could be our financial "inconvenient truth."
Delaying attempted solutions to this problem until repayment is like trying to protect the public from massive floods with sandbags. Effective flood control requires reducing the flow of water at its source by damming, not just trying to tame a raging torrent after the forces of nature (or economics) have already vastly increased its intensity.
Higher education expenses should be reduced at their source by aligning institutional and student interests. Our institutions of higher education house some of the best minds in our country. Why not draft them to work on the problem by giving their institutions some "skin in the game," by incentivizing them to concentrate on cost-effectiveness, rather than the current pursuit of ever-increasing expenditures to obtain more applicants and higher rankings? This would be a much better approach than another set of potentially heavy-handed, inflexible government regulations, which should always be the last resort.
We do not need to look far afield for a model structure to put institutional "skin" into federal student loans. That was precisely the structure of the recently expired, low-interest, and forgiving Federal Perkins Loan Program.
In Perkins, institutions made the loans, but the government provided two-thirds of the capital and took equivalent risk. Largely because institutions had to fill the gaps themselves, participation was highly skewed to public and private nonprofit baccalaureate institutions. And the program was tiny in comparison to the principal federal-loan programs, affording insufficient incentive to increase attention on program suitability or cost reduction. Nevertheless, Perkins would be a good model.
Risk-sharing in Perkins was not based solely on defaults, like most current proposals for its extension to other loan programs. Loan defaults alone do not provide a sufficient incentive to reduce costs for all students, are subject to manipulation, occur too far in the future, and frequently become "excessive" only when the institution is already unable to meet its financial obligations. Moreover, their validity as a risk-sharing metric will decline substantially as IDRPs transform them into loan forgiveness.
With total portfolio performance from Perkins as the risk-sharing metric, the government or other lenders would supply all the loan capital, but the institution would be responsible for its share of all final nonpayments by borrowers, whether by default, forgiveness, or discharge. Exceptions would be appropriate, however, for nonpayments unrelated to educational quality, such as the borrower's death. And, absent adoption of current proposals to provide some minimal level of higher education at public expense, the risk-sharing formula should be adjusted to support the higher-risk community college segment, which is often legally required to offer open enrollment.
Because final nonpayments would be so far in the future, however, institutional reserve funds to cover delinquent loans should be required. This broader metric would much more likely ignite the creativity of higher education to find new ways to provide quality education at lower costs. It would also provide some simplicity to loan programs that are far too complex.
Making "college affordable for every American," as President Barack Obama urged in his final State of the Union address, is a shared national goal. Sen. Lamar Alexander, R-Tenn., as well as other members of the Senate education committee from both sides of the aisle, now support the concept of institutional risk-sharing in principle, as did former U.S. Secretary of Education Arne Duncan. Incorporating it into reauthorization of the Higher Education Act would be the proper macroeconomic approach to the student-debt college-cost crisis, but specification on an effective risk-sharing formula remains the devil in the details.
Vol. 35, Issue 18, Page 24Published in Print: January 20, 2016, as The 'Inconvenient Truth' of Student Debt