Subscribe to the podcast at Bobzadek.com

The Truth About the Student Loan Crisis

Preston Cooper of FREOPP says that student loan crisis is not what we think

18 min readApr 8, 2021

Preston Cooper is a PhD student in George Mason University’s economics program and a visiting fellow at The Foundation for Research on Equal Opportunity, whose studies have led him to a number of under-publicized conclusions about the so-called student loan crisis.

FREOPP.org

Official website of The Foundation for Research on Equal Opportunity (@FREOPP), a non-profit think tank focused on…

freopp.org

First of all, blanket forgiveness of student loan debt would be far more costly than most people imagine — totaling more than all spending on antipoverty programs over the past several decades.

Second, those with the largest sums of debt are generally those who have graduated with reasonably valuable degrees, who are on their way to paying those debts down. The people most likely to be in default are those who incurred smaller debts from one or two semesters of college before dropping out, and failing to find well-paying work.

Finally, for those in this latter category, there are already programs available to alleviate the often crushing burden of student loan debt. These programs, including so-called IDR (income-driven repayment) plans,are much more helpful than the kinds of “debt forgiveness” being proposed by the Biden administration ($10,000 per student). In other words, call off the student loan debt jubilee.

Cooper joined me to discuss how we got to the point where the educational system produces so many poor debtors, and what we can do to resolve this problem going forward — without breaking the bank or benefitting the relatively privileged at the expense of the poor American taxpayer.

TRANSCRIPT

Is there a Crisis?

President Biden will not allow anybody in this administration to use the word “crisis” in discussing the border. I am now using it to discuss a related issue: student loan debt.

We have students. We have debt. Those same students owe money on their car loans. They might be even behind in their rent and owe money there. Grown ups have lots and lots of debt. Debt is an economic tool, which if used correctly, helps you organize your finances. Businesses do it. Individuals do it. Everybody does it.

Student debt is only one type of debt there are a myriad types of debt. So, why is student debt special?

The student loan debt crisis is not what you think it is. When you pick up the New York Times, you might flip to the opinion section and see a story about someone who has $100,000 in debts. What you’ll most commonly hear in the media is that person has six figures of debt. That is, actually, the person that we should be the least worried about. If you have $100,000 worth of debt, you probably have a graduate degree, a law or a medical degree, that will enable you to earn six figures a year, probably millions of dollars over the course of your life.You’re going to earn back that $100,000 you paid for the degree many times over.

“The people we really need to be worried about are the people with less than $10,000 of debt — the people who went to college for one or two semesters, who dropped out — but they don’t have the degree.”

The people we really need to be worried about are the people with less than $10,000 of debt — the people who went to college for one or two semesters, who dropped out — but they don’t have the degree. The statistics show that those people are actually much more likely to fall behind on their loans than the people who do graduate college, and who the media wants us to believe are the people who are really having trouble.

A Borrower-Centered Plan For Student Loan Relief

We can help distressed student borrowers without giving excessive taxpayer subsidies to high-earning professionals.

freopp.org

What Makes Student Debt Special?

Somebody borrowed money, which didn’t produce the revenue. The expenditure didn’t produce the revenue to pay it back, like borrowing money to buy income producing assets. They wasted their money. People waste money all the time. People make bad purchasing decisions. They buy cars that are too expensive. They buy cars they shouldn’t be buying. Many of those very same students owe money on car loans.

Why are we not talking about a national, young person’s car loan, that he’s three payments behind it? Why are we not talking about somebody who is three payments behind in their mortgage loan? Why does student loan capture the attention of people in Washington and in the media, and not other types of debt?

The average college graduate with a bachelor’s degree has about $30,000 in debt, which is about the price of a new car. So it’s not a huge sum. Where federal student loans are different is the fact that the federal government is so deeply involved with this lending market.

When you go to buy a car and you go to take out a loan for a car, they’re going to run a credit check. They might do an income check. They’re going to be able to take the car as collateral if you don’t pay back the loan.

With student debt, the federal government does absolutely none of their due diligence. They will give a loan to any 18-year-old high school graduate to go to any of our 7,000 accredited colleges that we have out there. Are they actually going to be able to graduate, get a degree, and do well in the labor market? None of that due diligence that’s happening.

“The student debt crisis is largely a product of the federal government’s irresponsible lending that we got into this mess to begin with.”

We see that student loan default rates are much higher than they are for car loans or for mortgages. I don’t want to excuse the student here because the students still did sign on the dotted line. That’s why I don’t support student loan forgiveness because if you take out a loan, you do have responsibility to pay it back. At the same time, we can’t ignore that the federal government is complicit in all this. It’s largely a product of the federal government’s irresponsible lending that we got into this mess to begin with.

The Origins of Federal Student Loans

There was a time that the federal government had almost nothing to do with this consumer lending product. When you wanted to go to college, you went to a bank, and borrowed money from the bank, or perhaps the university or the college would have a program to lend you money. It was all being done by the private sector with whatever credit standards the private sector decided to extend. It was no different than a loan for any other purpose. How did we get from that, which worked, to the feds being the only student loan creditor?

In order to understand why the federal government has such a huge role in student lending — about 90% of the new student loans come from the federal government — you have to go back to Sputnik. The Russians launched a satellite in 1957, the first manmade object in space, made headlines around the world. It caused this freakout in the United States.

They thought, “We’re falling behind in the science, technology and math race with the Soviets. We can’t allow them to beat us!”

In order to do that, we need to educate a bunch of new scientists. We need to educate a bunch of new mathematicians. So they created a student loan program for national defense. It started out small. It was just 40,000 loans in its first year, dedicated to math and science education, compared to about 45 million student loan borrowers today.

“As we all know, there is nothing so permanent as a temporary government program.”

As we all know, there is nothing so permanent as a temporary government program. Over the years, the government just started expanding the student loan program. The first time came in 1965, when we expanded this from just science and technology education to all low-income students could then get a student loan from the federal government. We kept expanding it again in the 70s, 80s, and 90s. We opened it up to all students.

A few decades later, 2021, we have over $100 billion worth of student loans going out the door every single year. We’re going to make $1.2 trillion worth of student loans over the next decade alone.

“A few decades later, 2021, we have over $100 billion worth of student loans going out the door every single year. We’re going to make $1.2 trillion worth of student loans over the next decade alone.”

The program has just slowly grown for these discretionary expansions that happen every five or 10 years into a $1.7 trillion behemoth. All because of Sputnik.

Loans are a temporary renting of money with an obligation on the part of the renter of the money to pay it back. Student loans are half of that. The money goes out, but doesn’t quite come back. It seems to be an optional repayment loan.

The government gives a 17-year-old high school graduate unlimited money to spend on any program irrespective of whether their program is going to produce revenue, on whether this 17-year-old is likely to pay it back. How would you do a credit check? The 17-year-old has no credit history and never had a job to speak of. It’s just a gift of money with a vague expectation of getting it back now.

We have unlimited money to un-creditworthy students who can spend it pretty much any way they want in any amount that they want. They’re going to go to college. Let’s look at what they are buying. Tell us about the cost side of the equation, because as tuition costs go up, the amount of the loan has to go off to keep abreast of it.

The number that we all need to know is 80%. That’s how much college costs have gone up over the past two decades after inflation. Ironically, that’s as federal government aid — grant aid and aid from the state governments — has also been going up. Taxpayers are running faster just to stay in place when it comes to college costs, because we’re putting more and more money into the system, yet the tuition keeps rising more and more. Even though students are getting much more financial aid today than they did 20 years ago, the net price that they’re paying after all that aid, is still going up.

The loans are a big piece of this. When a student goes to college, they’ll get a financial aid award letter that will say, “Here’s the headline tuition, and here’s all the grant aid, and here’s all the loans that you’re going to get.”

The college does not at all make it clear that students are taking out loans. About 70% of these award letters from colleges, did not actually say clearly that the loan was part of that package. Students were not actually aware that they were taking on loans, and the colleges were somewhat deliberately hiding that fact, because that enables them to charge higher prices.

“If you’re not fully honest about how much something is going to cost, it’s easier to raise the price of it.”

If you’re not fully honest about how much something is going to cost, it’s easier to raise the price of it. We see that 15–20% of students who have loans today don’t actually know that they have loans. This is a huge problem because if people don’t know they have loans, how are they supposed to know that they’re supposed to pay them back? That’s why I do have some sympathy with the students here because they have been somewhat bamboozled by the colleges and by the federal government into taking on loans that they didn’t necessarily know they were taking.

Other People’s Money

It has been observed by economists the two segments of our economy where the increase in costs vastly exceed the inflation rate are healthcare and in college tuition — higher ed. Those are the two dominant segments of the economy where the buyer doesn’t know and doesn’t care about the cost. The buyer is spending somebody else’s money. When government dollars drive the cost, we lose the control of the intelligent buyer shopping for the best price.

We have students who didn’t do that analysis and weren’t invited to do the analysis. The creditor doesn’t do the analysis. The government doesn’t care if the student is acquiring the income stream to pay it back. The problem is that the student who probably shouldn’t have gone to college, should have gone to a trade school or or an apprentice program, but was encouraged by society to go to college.

How much of the student loan debt goes into the pot of “not likely to be able to be paid back?”

About half of people who default on their student loans owe less than $10,000. You cannot get a college degree for $10,000. Those are people who only went to college for one or two semesters and then dropped out.

If you default on your student loans, the government is still probably going to lose 20–25 cents on the dollar. Where are taxpayers taking the biggest hit is when people enroll in repayment plans called income driven repayment — this allows them to tie their loan payments to their income, so their loan payments are never above a service of a certain income. They’ll get all remaining debt forgiven after 20 years.

This is supposed to be a safety net program that’s supposed to help the people who went to college for one or two semesters dropped out and defaulted. But actually the people who are using this most are the people with the graduate degrees, the people with the law degrees, the people with the MBAs. They’re paying a small share of their income for 20 years, and then they’re going to get the rest of their loans forgiven. Because you can borrow an unlimited amount from the federal government. If you’re a graduate student, then the marginal dollar that you borrow is effectively free because of this program.

People running up huge debts if $100,000, $200,000 are promised that most of this is going to get forgiven. The education department did an analysis of how much we are going to lose on this thing. They realize that about $435 billion are going to be lost on this program. That had bounced to about one quarter of all outstanding federal student loans right now. We don’t necessarily need student loan forgiveness because a bunch of it is going to get forgiven anyways because of the way the system is set up right now.

Debt Forgiveness for the Wrong Constituents

We have a bad program, IDRs, which is in place and nobody is talking about. Let’s repeal it. What is the crisis that the government thinks has to be fixed?

The cynical answer is that it has to do with constituencies. In the 2020 election, Democrats got a very high share of the college educated vote. Maybe they say, we want to do something for them now. People in Washington DC who are proposing student loan forgiveness have a skewed view of what student loans actually are because the people that they know with student debt are the people who have $100,000 in debt from law school. They don’t like paying their student loans. They’re not happy about it, but they’ve also got the high salary that will probably make their student loans not that big an issue for them.

When actually the data shows that it’s people at the other end of the spectrum who are having the biggest issue — the people who went to school who took on debt for a couple semesters who dropped out who still have the debt, but they don’t have the degree they don’t have any of the benefits of the degree.

I would be okay with your reallocating some of the help that we’re currently giving to law students and med students to help the people who went to college for a couple semesters and dropped out, because they were tricked by the federal government and colleges to taking on more debt than then they were able to. Right now, the student loan discussion as it’s being played out in Washington is very much focused around these people with very high debts, but also very high incomes, who really do not need help from the federal government.

Federal Collection

Student loan debt cannot be generally discharged in bankruptcy. It’s a special kind of debt. You’re really stuck with it for a very long time, because you owe it to the federal government for the most part. If we did nothing, what bad things will we be reading about in 5 or 10 years that we’re not reading about today?

The federal government can really make their life a living hell when borrowers get themselves into that situation. It’s very much unlike private loans. The federal government can garnish your wages. They can take up to 15% of your paycheck. They can take your Social Security benefits if you happen to be older. They can take your tax refunds. They can add thousands of dollars in fees just to your balance. None of this is transparent.

“This is the story that the media is ignoring about student debt — it’s not the people with $100,000 — it’s the people with very little student debt with this problem.”

The government doesn’t send you a letter saying we’re adding fees to your balance. They just do it. The borrower doesn’t even know sometimes that thousands of dollars of fees are being added, more interest is being added, because the government is just not transparent about it.

This is the story that the media is ignoring about student debt — it’s not the people with $100,000 — it’s the people with very little student debt with this problem. Rather than trying to do good policy debt to help them out and get them to start paying their loans again, the federal government is just really bringing down the hammer and doing a lot of things to them that regulators would never tolerate with a private bank. That’s what I worry about what we’ll be reading about five years from now. I’m not sure that we necessarily would be reading about that crisis because we’re not reading about that now even though 27% of student borrowers are going to default at some point. That crisis is going to be no less real. It’s not going to go away.

The Biden Plan

Debt collection practices get a lot of legislative attention when it’s the private sector doing the collecting, and yet the federal government is the world’s worst debt collector. It’s hypocritical that the federal government feels it necessary about regulating debt collection, but they haven’t cleaned up their own debt collection practices. What is Biden proposing to fix the problem?

Biden’s proposal is just an across the board forgiveness of $10,000 per borrower. He’ll just take $10,000 off of everyone’s balance. Senators Schumer and Warren say that doesn’t go far enough. They say, we should take $50,000 off of everybody’s balance. The $10,000 proposal would cost about $370 billion according to by calculations, the $50,000 proposal would cost about $1 trillion.

The problem with both of these is they don’t address the fact that the federal government is going to make more than a trillion dollars in new loans over the next decade. You get rid of people’s debt today. Tomorrow, you’re still sending more loans out. If you haven’t made any fundamental changes to the way that we’re making student loans, you’re just kicking the can down the road. You’re still going to have people defaulting on their loans next year and the year after that. You’re still going to have people getting into trouble. You’re still going to have the federal government going after people with a fury that a private debt collector would never even dream of doing. All these problems are still going to exist.

The Moral Hazard of Loan Forgiveness

What do you say to the student who went to college for a semester and a half, ran up $15,000 in debt, left college, and is now earning a living — perhaps has a family — and has over the past year, at great sacrifice, paid off the student debt. That hypothetical dropout was a sucker. Had he not paid off his debt in the 18 months right before the forgiveness was given, he would be $10,000 better off. The moral lesson that the country is giving is “Don’t pay your debts.”

The federal government decided to put a suspension on student loan payments for 18 months because of the pandemic. Right now, student loan payments are due to resume in October. We’re going to have tens of millions of borrowers who are suddenly going to have to start paying their loans again. If you as a borrower think that there might be $50,000 of forgiveness coming down the pipeline later, how likely are you to start repaying your loans again on October 1?

We’re creating an incentive not to pay back your loans. In the long term, we’re also creating incentive to borrow more in the future. Student loan forgiveness proposals don’t make any fundamental changes to the way we do student loans. We’re still going to be making as many loans tomorrow as we did yesterday. If you’re a student seeing that these loans are getting forgiven because the outstanding stock of debt got to $1.7 trillion, you say they forgive student loans once they’re probably going to forgive student loans again. So why wouldn’t I take out more debt today because I think that some of it is going to get forgiven down the road? The colleges will look at that and say, the borrowers know that they can borrow more. So why don’t we raise our prices?

“It’s a massive moral hazard, comparable to what we saw during the mortgage crisis.”

It’s a massive moral hazard, comparable to what we saw during the mortgage crisis, where the federal government said, we’re going to bail out banks, we’re going to bail out mortgage companies. So the bank said, “why don’t we make a bunch of bad loans because we’re going to get bailed out no matter what.” I really see history repeating itself if we go down the road of student loan forgiveness.

What would be a more economically sensible approach that’s more consistent with the values we want to instill in students?

I call it a student loan relief plan that doesn’t center around forgiveness. Part of it is making sure that the borrowers who are in distress, with less than $10,000, have a way to get back into a safety net program like income driven repayment, so that they’re able to easily afford their loans. They’re not going to slip back into defaults.

We have to have some accountability on the colleges that are taking part in the student loan program right now, and are getting off scot-free by forcing students to take on tens of thousands of dollars of debt, often not giving them any support. So they just drop out, often having crappy programs that aren’t worth very much in the labor market.

“If you’re running a college that’s a dropout factory, we’re going to penalize you.”

The borrowers have the debt. The taxpayers suffer the losses. The colleges don’t have any accountability. My plan, in order to help out those people with sub-$10,000 debts is pay for the cost with a new penalty on bad colleges.— That’s going to cost some money, not as much as forgiveness, but some money. If you’re running a college that’s a dropout factory, you’re leaving a lot of people unable to pay their debts, you’re leaving taxpayers on the hook for all these debts that students can afford to pay, we’re going to penalize you, and we’re going to make sure that you can’t just take advantage of the generosity of taxpayers without paying some penalty when your education doesn’t prove its worth.

Why don’t the colleges make the loans or otherwise take the entire credit risk? They would be evaluating students, as they do now, if they do based upon likelihood of succeeding the way they do with college admissions today. Wouldn’t that put the onus exactly where it belongs? The federal government has no business in being in the student loan business.

I think in the longer term, that is exactly the approach we need. Right now, student loans create exactly the wrong incentives for colleges. The colleges’ incentive right now is to raise as much money from the federal government as possible, take in all the grants and loans. And then once you have that money, just kick the student out on the streets.

What we need really is an approach that aligns the incentives between the students and the college so that if the college is the one actually making the loan, and the student paying it back, the college is not going to get paid unless the student actually repays the loan. And the students are not going to repay the loan, unless they actually get a good job, unless they have a degree that has useful skills that are valuable in the labor market, that will enable them to get middle class job and upper middle class job, that will actually enable them to pay back the loan, the college isn’t going to get paid unless they do that under your system, which I think is a good one.

There are actually some colleges that are trying out this model. One is Purdue University, one of Governor Mitch Daniels. He took over as president of Purdue University in Indiana after he left politics. He instituted this model where students in lieu of the federal student loan. They would be able to take out a certain amount of financing from the university itself, and then pay that back in proportion to their earnings over the next 8 or 10 years. Purdue actually does have an incentive to make sure that the education is up to snuff and make sure that it actually has value in the labor market. They’re going to pay in proportion to how much they earn. The college’s fortunes rise and fall with this with the students earnings, which is exactly the kind of alignment of incentives we need.