Franke: The Student Debt Crisis

June 20, 2018

by Mark Franke

The Wall Street Journal recently ran a front-page article about a dentist in Utah who was in debt over his graduate school student loans to the extent of $1,060,945. Yes, $1,060,945, and he is just one of 101 who owe more than a million dollars.

This man had attended the school of dentistry at the University of Southern California, a private institution among the priciest of U.S. universities. One year of dental studies at USC costs $137,000 including living expenses. Tuition alone is $91,000.

Our dentist twice took advantage of government programs to consolidate his outstanding loans and to capitalize unpaid interest. This resulted in his original $601,506 in loans becoming $882,300. Since going into what he described as a corporate dental practice, he earns $225,000 in salary but only pays $1,590 per month on his debt. This doesn’t even cover the monthly accrued interest, so his balance keeps increasing. Hence the million plus still owed.

Granted, this man is an outlier. The national average of outstanding debt for a graduate is about $40,000, not an unreasonable amount when discounted against the higher earning potential over a 40-year career, that is for many but not all college degrees. But this average is for bachelor’s degrees and doesn’t take into account the significantly higher loan balances for graduate and professional students like our dentist. And it completely ignores loans taken by students who never graduate.

(In the interest of full disclosure, I spent several years of my career in higher education administration working in student financial aid. I have lived this issue for years and am familiar with the arguments on all sides.)

The total student loan debt is nearly $1,500,000,000. That’s one and a half trillion dollars, second only to mortgages and more than double owed on credit cards. Most of this debt is held by the U. S. government, thanks to a 2010 law pushed by the Obama administration to drive private lenders out of the market. This left the government, in other words the taxpayer, responsible for the full risk of default as well as the provider of the capital necessary to fund the loans.

Fortunately the government regularly runs a huge budget surplus it can tap, right? No, the government must borrow the funds in the bond market to cover much of the one hundred billion dollars in new loans made each year. Since the Obama administration drove the commercial lenders out of the market, the federal government has increased its direct student loan portfolio by three-quarters of a trillion dollars. This is all done off-budget so it tends not get much attention when the annual federal budget deficit is reported.

Government accounting, by which I mean non-standard accounting practices, claims that student loans will turn a $37-billion profit over the next 10 years. After using standard discounting methodology, which takes into account the time value of money and risk of loss, this turns into a net loss of $170 billion according to a recent Forbes article.

Another piece of misinformation about the student loan program is the publicly reported default rate. The published rate is 11.5 percent, enough to force any commercial lender into receivership. But the base in this calculation includes only students who went into first time repayment three years ago and have not made a payment for at least 270 days during past three years. It does not include defaults after three years when in fact most occur.

Now, the student loan program surely helps students get access to college when otherwise they couldn’t afford it. It also allows middle class students to trade up, to choose a more expensive private college instead of the state university or community college. Access and choice are matters of faith to the financial aid profession and these professionals certainly see themselves as doing good even as most realize the dangers of excessive borrowing. Remember, I was one of them early in my career.

There is an understandable argument for higher education as important for economic productivity and therefore should be considered at least a quasi-public good. What is less understandable is the stridency of higher education lobbyists when they argue that unlimited access to government student loans does not affect the price colleges charge their students. Public good or not, something has to restrain pricing if the market is handicapped in doing so.

How about the law of supply and demand? This fundamental law of economics instructs us that if billions of dollars of artificial purchasing power are injected into a market, the price will inevitably rise. To the point colleges have raised their tuition by 3.2 percent-4.4 percent over the rate of general inflation in each of the last three decades, as reported by the College Board which collects this data annually.

To simplify the math on this, just assume each of the last 30 years colleges raised their tuition charges by 3.8 percent (the midpoint of the above range) each year over the rate of general inflation. This means that college tuition is three times higher today than 30 years ago . . . after accounting for inflation. This is the statistical equivalent of paying $7 per gallon for gasoline today. And nobody is patting Big Oil on the back for moderating prices at the pump.

Take away subsidized borrowing and see what happens to tuition rates. Colleges will either need to cut costs, something they are genetically incapable of seriously doing, or accept lower enrollments. We will have a lot fewer colleges left after the market fallout, to be sure.

So back to the original question of assigning blame. Are the students at fault for taking advantage of what looks to them like free money? A fundamental principle of economics is that people act rationally in their own interest, though not necessarily intelligently when viewed by others. And nearly one-third of these former students have acted rationally to take advantage of government loan forgiveness. Thank you, U. S. taxpayers.

Can you really blame the colleges for raising tuition as high as the market will bear? Again, aren’t they simply acting in their own best interest, if only in the short term? I played the Cassandra on my college president’s cabinet whenever tuition increases were discussed, arguing that we were rapidly pricing ourselves beyond the reach of the middle class. We shifted the blame to the state legislature for not giving us as much money as we asked for, so I’m sure we all slept well at night.

It does not take a trained economist to realize that there are two major industries in our nation that do not have sustainable financial models—health care and higher education. Each believes it offers a superior good, one that can successfully overcharge its customers. But each also has a pricing model that is highly driven by negotiated pricing, called net tuition discount in higher education. Consumer Reports gave this as nearly 50 percent for the 2016 freshman class at private colleges. This means that, on average, a college freshman could expect to pay half of the published tuition rate. But we all know what averages mean. In health care the power of Medicare and large insurance groups can reduce charges to dimes on the dollar for its members while other under-insureds pay full price. Likewise in higher education. Some students in that average pay nothing while a few unfortunate others pay sticker price. These must rely heavily on student loans to pay the bursar’s bill.

Do colleges bear any responsibility for this impending crisis? Most would probably say no. According to the WSJ article cited at the beginning of this essay, a USC official was quoted as saying, “These are choices. We’re not coercing. You know exactly what you are getting into.” Fair enough. Our society is riddled with victimhood and lack of personal responsibility and I don’t propose to append this case to an already interminable list.

Would these defenders of colleges, however, take the same attitude about tobacco companies and absolve them of the health-related problems originating with smoking? How about gun-makers and the mentally ill mass murderers who use guns?

I’m not trivializing by any means the horrible suffering caused families by people who smoke or decide to kill everyone in sight. I’ve already mentioned oil companies which have been accused of everything from price-gouging to benefiting from “unearned profits,” to quote another economically illiterate president. Nor am I raising unjustifiable tuition levels to the level of mass murder or cancer.

But think about how many start college and don’t finish, usually because they don’t belong there in the first place due to inadequate preparation or lack of motivation. They leave no more employable than when they began but with loans to be repaid.

Like most public policy issues, no silver bullet is obvious. Many, perhaps too many, proposals have been put forth to address the symptoms but I’ve not seen any that get to the fundamental root of the problem. No doubt this is due to the number of sacred cows that might get slaughtered if everything were to be put on the table. I also don’t doubt that those truly responsible for the impending crisis will do their utmost to focus the light elsewhere.

I leave the readers with the following philosophical questions to ponder:

How many young people can truly benefit from traditional four-year college attendance? Sociologist Charles Murray suggests about 40 percent maximum.

To what extent does government stimulation of demand through student loan programs distort the market for post-secondary degrees? Who ultimately pays the cost for this market manipulation? Think not only of our dentist with his million-dollar debt but also the many unemployed owing tens of thousands in loan balances.

If the government already knows it will lose about 30 percent of the balances in income-driven repayment plans, is this really the best use of federal education subsidy funding aimed at helping students afford college? Since about 40 percent of student loans go to graduate and professional students, are we as taxpayers subsidizing them at the expense of low-income students in two- and four-year programs? Many student financial aid professionals argue that these funds would be spent more wisely increasing Pell Grants for the lowest income students.

Quis custodiet ipsos custodes? When government, federal and state, represents the greatest power in the marketplace, who will call it to account for bad outcomes? When Barack Obama was Blamer-in-Chief, he targeted the for-profit schools and tried to drive them out of business. This deflection of scrutiny has apparently worked, at least for a while, until the public and private colleges finally realize they are next on the block.

If student loan debt in fact becomes recognized as a financial crisis, can we trust the government to honestly assess its own role? Remember the mortgage crisis? Did Freddie Mac and Fannie Mae take the hit, or just commercial banks? If anyone can remember a time when Congress admitted responsibility for the law of unintended consequences after it passed a law with disastrous results, please let me know forthwith.

Mark Franke, an adjunct scholar of the Indiana Policy Review, is formerly an associate vice chancellor at Indiana University-Purdue University Fort Wayne.​


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