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Want to solve the student debt crisis? Get the Government out of Student Loans

Updated: Aug 20, 2019

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The student loan debt crisis might be the biggest problem facing our nation in the years to come. The total debt sits around $1.6 trillion right now. Several politicians, including US Senator Bernie Sanders, have proposed plans to "cancel" student debt, and make all college tuition free.

There are a couple things we need to get out of the way. First off, the government has been involved in the subsidization of student loans since 1958, with the passage of the National Defense Education Act. At that time, the governments involvement was limited to college degrees including science, technology, math, or engineering. It should come as no surprise that it only took 7 years for the feds to decide they needed more than just control over the STEM fields.

In 1965, they passed the Higher Education Act. The stated goal of the HEA was to promote "greater social mobility". The HEA has been the doorway to the federal government's full involvement in college education. At that time, they were able to start subsidizing or guaranteeing all student loans.

The cost of college began to rise with the involvement of government subsidies, as we've seen in most other industries (look at a graph of medical costs following the passage of Medicare). As you would read in Basic Economics by Thomas Sowell, the artificial demand created by government stimulus resulted in a shortage of supply, leading to higher prices. Your high school economics lessons will teach you that creating a virtually unlimited demand will cause higher prices 100% of the time.

Although the cost of degrees were already on the rise, the greatest acceleration happened in 2010, when the government completely took over the student loan process with the Student Aid and Fiscal Responsibility Act. That title definitely hits the top 10 most "Ironic Congressional Act" titles in my book. It's right up the with the "Affordable Care Act," and "No Child Left Behind." Up to this point, private institutions were still involved in the lending process, but all loans given by private lenders were guaranteed by the US Government. The housing market crisis comes to mind with that last statement.

In the graphs below, you'll see the massive spike in student loan debt, corresponding with the 2010 year mark- the first year private institutions had been removed from the student loan market.

The red circle is when the government took full control over student loans

Bad Economics

If the government does one thing well, it's executing terrible economic policies. Starting before 2010, the private loans were still guaranteed by the government. In this type of economic climate, there is no incentive to drive prices down, or to make smarter lending decisions. If you go to the Casino and the Casino says "I'll repay anything you lose!" what is your incentive to make good decisions? The truth is, since you have the potential to earn a profit, but have no potential to lose money from the risk, you're very likely to make some risky bets.

We saw the same thing with the housing market crisis by the way. The government made it illegal to "red-line" districts, and set racial and economic quotas. To make it "work," they also guaranteed all the loans for the bank. So in short they said, "We'll penalize you if you don't make these risky loans, and if it goes poorly don't worry, we'll cover the loses." At that point, much like the student loan crisis, the banks only had an incentive to loan out as much money as possible regardless of the risk, since for them- the only option was to make more money.

What we're seeing now..

What we're seeing now is the failure of another government system: student loans. Right now, you can basically get a loan from the government to go to any college, for whatever amount of time you'd like. In addition, it makes no bit of difference what your career field is. The worst part of the previous statement is the absolute disregard for the career field a student is choosing.

With nearly unlimited resources, a 17-18 year old is able to make the decision to spend $100k on a "Diversity Studies" degree from Harvard.

They were closer to the mark in 1958. IF, and that's a big IF, the government is to "invest" money into a student's degree, it most certainly needs to be for a skill that is highly valued in our society. Degrees towards math, science, engineering, skilled trades, etc., would at least have the chance of returning value to the people. The government has clearly made a mistake offering low interest loans to children for a degree that will ultimately be worthless in the long run.

Free Market Solution

If you're worried about the debt crisis, you should want the government out of the loan market.

All of the above problems would be solved with a return to privatization of student loans, WITHOUT guarantees from the government. It's never a "free market" if the risk has been removed. Risk is the basis for interest rates, and fund allocation. Simply stated, a private bank that has to hold the full weight of the risk will not give out $100k for a degree that has a 20% likelihood of developing into a career, and a low-paying one, at that. The lowest interest loans are going to be available for career fields that have the highest likelihood in providing value to society. The lowest interest loans will go to the people that are going to be most likely to pay them back.

This shift alone would cause a major price decline in the cost of college. With lower demand, the prices will most definitely be driven down to meet the market price. Sure, you can get your sociology degree, but the bank is going to charge you 20% APR on that, and they are only going to allow $2k per semester. Once this is the norm, the colleges will have no choice but to lower prices. Open competition for this market will keep those free market interest rates from climbing out of control.

Why is the interest higher on student loans than rates for a car, or a house?

Student loans are uncollateralized loans. Meaning they have no "collateral" to be recouped by the bank if you fail to repay the loan. A home loan, on the other hand, has a fail-safe (the house) if the customer does not repay the debt. A car loan, likewise, has collateral in the value of the car. Both of these things make the loan a lower risk for the bank, meaning they can charge a lower interest rate. Credit cards and student loans, on the other hand, have no collateral. This means the lender is taking a much larger risk when loaning out the money.

This might sound risky, but you should be able to add your house or your car as collateral for a student loan. Since most students won't own a house or a car, you might actually see a move towards more responsible paths, like working at a job after high school to become more financially stable, before students sign the dotted line on a student loan. You might also see more parents as cosigners, when they are able to use their assets as collateral to help with the interest rates on the loan. Having more parents as cosigners would create more incentive to finish college, as well as an incentive to go towards more valuable career fields.

All of these things should push us towards a more responsible society. A society where there is a cost/benefit analysis done on the decision to attend college in the first place. The reduction in money available for college will result in the rise of trade schools, which might be a much better option for many students. The reduction in money available for student loans will result in an immediate reduction in the cost of all college degrees.

The future

In the future, I see the need for student loans to become more like an "investment" in a business. If you think about the way a business owner gathers money to fund their production, it would be interesting to think of this being used for students. What if you as a person were a corporation, and you received outside investments in the development of your skills towards a future life of valuable productivity. Sounds like I'm envisioning a future where you are owned by whoever loaned you the money, but that's basically the case now anyway. A percentage of your future earnings will go towards repaying your lender. I'm just looking at a structure that would incentivize "smart money" to be used in the student loan market. This, in theory, would push people towards more value-based degrees, and a more responsible "college experience."

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