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Some Thoughts on the Student Loan Debt Problem

posted by Adam Levitin

The student loan issue is increasingly coming the front-burner, both domestically and abroad. I haven't blogged about it before (and it's worth noting how little scholarship there is on student loans compared with say mortgages or credit cards). So here are some initial thoughts by way of encouraging a less muddled conversation on student loan debt.  

1.  Student Loan Debt vs. Cost of Education. We need to distinguish between the problem of student loan debt and the cost of higher education. They are intimately related, of course, but as far as I can tell, the problem is less anything about the structure of student loan debt than its amount, which is a function of the cost of higher education. There's no question that education costs have and continue to grow faster than inflation. Why is more complicated. Before we prescribe austerity in higher education as the solution, however, let's recall that US higher education is the envy of the rest of the world. Foreign students come here for their advanced degrees, not vice-versa. There's huge social value produced by having outstanding domestic higher education. There's also a lot of unnecessary expense (I'll name names when I'm good and ready, though, as that isn't really the issue here).  

2.  U.S. student loan debt is often structured differently from other consumer debt.  It's important to recognize that student loan debt is quite different than other types of consumer debt. A lot of student loan debt can be deferred for substantial periods and can be repaid over extended terms.  All of this is to say that student loan debt is unlikely to cause a sharp liquidity problem for a consumer by itself. When combined with other debt and impairment of income, the story is different. 

3. Student loan debt isn't especially expensive.  OK, let me start with some caveats.  That's a first impression from eyeballing some loans, and it doesn't apply to for-profit lenders.  But as far as I can tell, the bulk of student loan debt isn't crazily expensive in terms of interest rates. It's large dollar debt, rather than high rate debt, and of course it doesn't go away easily. The low rates are at least partially because of government subsidization, but the low rate, large amount issue that goes back to the first point--our problem is more the cost of education than the cost of the debt.

4. International variation. We need to recognize that there is HUGE variation internationally in how education is financed and the structure of student loans. We should be looking very hard at how other countries finance student loans.  

5.  Legacy Debt vs. Future Education Costs. We need to distinguish between the question of what to do with the existing stock of student loan debt and what the education financing system should look like going forward.  Even if we make higher education completely affordable henceforth, we have a massive stock of student loan debt.

To this end, I don't see reforms like changing the bankruptcy dischargeability of student loan debt as being real gamechangers. In a totally efficient world, nondischargeability should have translated into lower credit costs and thus into higher tuition rates. (Bankrup'cy Bob and I are all over this issue, right Bob?) 

6.  Why not equity financing? Why we are financing education via debt? It's not obvious that we have to do so, and that's the easiest way to avoid leverage going forward. Milton Friedman proposed equity financing some years back, meaning that the school got a % of future income, rather than a fixed amount. It could be as progressive or regressive as a school wanted.  

Yale tried such an experiment in the 1970s, but with poor results--the alumni didn't pay.  Yale didn't want to sue its alums, and let them convert to debt at a favorable rate. But that's an easily surrmountable problem--we could have education payments rolled into tax bills and collected by the IRS, which would then remit to the schools.  Non-payment isn't stiffing the school.  It's stiffing Uncle Sam, who is much better at collecting.  It's not such a radical idea--Australia collects student loans via its tax service.

There's an entrenched education bureaucracy that would have a lot of trouble changing to an equity financed system (alumni fundraising would surely suffer, for example). But it would mean that people take the jobs they want, rather than the jobs that pay the student loans. That might be a very good thing for society, even if it would certainly hurt some employers (think those who pay recent graduates outsized "hazard pay").     

Comments

I've always found it really interesting that interest rates on student loans are not tied to the student's grades or degree program. This is most certainly because of the government's involvement in the market, but it still seems crazy to me that a student who is getting C's as a communications major can obtain credit at the same rate as one who is pulling A's in an engineering degree.

But imagine the pressure on professors to give higher grades if loans pricing was grade sensitive. Grade inflation is bad enough as it is.

My sense is that grades have only a marginal impact on most students' earning potential. The school itself is the primary factor. Why loan rates aren't school sensitive is more of a puzzle, I think. I would lend much more freely to students at most top tier law schools than to students at lower tier schools. If we had school sensitive pricing, it would help discipline school cost-value ratios better.

Good point about the grades. Tying rates to grades is likely a bad idea.

Still, my general point was just that loan rates are not tied to a student's potential to pay back the loan in any way. The school itself clearly matters a lot, but does does what one studies, I think. Just like you would be more willing to lend to a law student at a top school, I would be more willing to lend to a student who is studying engineering than one who is studying puppetry. Nothing against puppetry, but it's probably not going to pay the bills. Making the loans sensitive to what one studies should also help discipline school cost-value. Of course, to do that, the government has to let the market determine the rates.

The Income-Based Repayment program for Federal loans makes the payments manageable as a percentage of income and wipes out any remaining debt owed after 25 years at most, and after 10 years if the debtor is working for a public service entity continuously for the 10 years. Doesn't this program go a long way toward relieving the debt burden, at least for Federal loans?

Randy, when I consolidated my federal loans after I finished my MBA I wanted a payment that was around 15% of my take home income at the time. Budget-wise, 15% of net pay left me in a position to fund my 401k and put money into savings. They wanted 15% of my gross income.

Another factor to consider may be that the kids with these loans probably pay relatively high tax rates because we often don't have spouses, kids, or houses yet. Last year my federal income tax was 13.7% of gross income and my state income tax added another 5%. I've already paid more student loan interest in 2012 than the max deduction.

All that said, I'm not complaining (at least not about the loans - the tax part doesn't seem very fair when I just wrote the check). I knew the ROI before I started and I've gained 3x my loan payments in additional salary.

I am amazed at the COST of education in a world where information is virtually free. The educational world has managed to keep its product priced at a very high level relative to actual value, and this shows no real signs of abating. If student loans were eliminated entirely, the system would suddenly "discover" internet based education, and the entire system would change in a few years. There is some light at the end of the tunnel, in that Stanford is now experimenting with "noncredit" internet courses taught by respected professors. The simple fact is that brick and mortar institutions are simply not needed to obtain quality education, with laboratory-type classes/degrees excepted. Hopefully it won't be too long before the world changes to think in terms of delivering education at its true cost.
Steve Bradley.
M.Div, Th.M (so you know I'm not "outside the system," but inside it)...

Amazing how many trade/Business schools that catered to GED drop outs and late bloomers suddenly became accredited universities.... Their tuition's that were generally affordable all of a sudden became guaranteed loans for far more money than they used to cost....How convenient too that our "All VOLUNTEER" armed forces would pick up the bloated tab if they just sign the dotted line.. The system is so rigged against our kids its ridiculous. Its Shameful to continue to raise the bar to the point where a masters degree in education is a dime a dozen but the bill, even if you never get the job is not dischargeable.. Shameful.

Adam, lots of thoughts here so bear with me.

1. Student Loan Debt vs. Cost of Education.
To take your argument from the GSEs to swing their weight around a bit. Why doesn't the federal government step in and put some additional conditions on granting federal student loan aid and guarantees? This would certainly stop the 2x the inflation rate increase in college pricing wouldn't it? However, this may slow down faculty pay raises and the building around campuses across the country. We are rapidly approaching the point financial point of indifference between going to college and accruing debt vs. not going to college. That's probably a place we don't want to be as a society, but I fear we are headed.

2. U.S. student loan debt is often structured differently from other consumer debt
Yes, federal student loan debt can be deferred, extended, and some have unique parameters, but that does not extend to all private loans. Since federal loans caps have not grown with the total student college bill we have seen the necessity of parents to take out their own loans (both education, PLUS, and non-education-related, 2nd mortgages, HELOC, etc.) and additional private loans for students themselves. These debt vehicles frequently don't enjoy those luxuries; however, they make up the entire bill.

"All of this is to say that student loan debt is unlikely to cause a sharp liquidity problem for a consumer by itself. When combined with other debt and impairment of income, the story is different."

No, student loan debt is not the dagger to the body of let's say a credit card repricing, but for many it’s the equivalent of a good size home mortgage when they leave school now. I know 22 year olds who are spending over a $1000 a month on student loans and will be doing so for years to come. In my mind, this is the exact equivalent of writing mortgages to folks who had no way of ever paying them. I wonder why when it comes to home mortgages, cram down and modifications are talked about but when its student loans somehow everybody begins talking about personal responsibility. A college student can't get a credit card with a $250 credit limit now but can sign up for the equivalent of a home mortgage without so much as knowing WHAT they will be doing in four years let alone HOW much they will be making once they graduate and 15 years from now when conceivably the debt will pay off. Despite this that student loan debt will be carried to its duration, and if a serious credit event occurs: death, medical impairment, divorce, or loss of job it cannot be written off. This to me is a complete blind spot of research in academia and one that needs to be addressed.

3. Student loan debt isn't especially expensive.
Student loan debt (federally backed) is not expensive from a rate standpoint because it is subsidized and there is no repayment risk as there is no way to discharge it. As someone who sits on the lending side of the house, I'll make that loan all day long with an attractive interest rate. All I need is capital.

4. International variation
Many countries around the world do not charge their students to attend universities; students can go freely. Of course, given finite resources the government can only afford so many slots and only a few universities. That means we must begin restricting access and all that entails.

5. Legacy Debt vs. Future Education Costs
Agreed, they are two separate issues. Legacy isn't going anywhere; the real issue is what to do going forward. As for dischargeability, I think you might be very surprised how the market would react to the loss of that now in a post-Lehman world, post-Fannie/Freddie world. As far as your efficient/inefficient market argument on dischargeability, you have stated many times in the past that surcharging (in your discussions on interchange and use of rewards cards) forces behavior change, why would eliminating the creditor perk of non-dischargeability in bankruptcy not work the same way? Lender costs would directly increase and therefore drive up credit costs thus lowering tuition rates.

6. Equity Financing
Equity Financing has a few problems:
a. What do the contract terms look like i.e. how much are you taking vs how much are you giving.
Do you give a free ride for 2%, are you exchanging 50% paid school admissions for 5% of the salary (mix of debt and equity). Do you negotiate each student separate or have a take it / leave it offer? Is this pre or post tax? When is payment made? Is there a buyout? Who collects? Are there audit rights? What's the length of term?
These are just some of a few of the terms that might be contemplated and you are asking a university to administer them and a 19 year old to agree to them.

b. Cohort Build-up
VCs know that they only need a few winners to pay off for the losses. The problem with universities today unlike VCs, universities have a tremendous amount of overhead, (those flowers don't plant themselves). Assuming 30 years of cohorts you could not institute this program right away and begin having it pay for itself. Equity financing would have to gradually build up over time (maybe 10 – 15 years before seeing real cash flow generation).

c. Adverse Selection
Unless some sort of corresponding perks were associated with it (entre into Goldman Sachs, McKinsey) or individualized deals (teachers get one rate, business school students get another). I suspect your best students would hold on to equity vs your future teachers, nurses, social workers, artists, etc who would gladly exchange it. As a societal good; it may be the absolute right thing to do, but as a business decision in terms of paying faculty, building upkeep, and keeping the lights on it might not make a lot of sense.

A lot of food for thought here.

The presumption here is that education is a personal choice, i.e. an investment in an individual's future. There's a substantial argument that transcends this position, that a society is nowhere without educated citizens, especially a democracy, and therefore society is well-advised to make an investment in its future and provide affordable if not free education.

Making interest rates sensitive to the individual school could be considered to be discriminatory under the "disparate impact" theory. See, e.g., Rodriguez v. Sallie Mae, http://chronicle.com/article/Borrowers-Accuse-Sallie-Mae-of/40281.

Thank you for a thoughtful post. I agree the problem is cost of education and not the debt per se.

The cost is a function of a monopoly position that higher education occupies - partly due to laws that impede alternatives and reinforce it, partly due to failure to fund alternatives, such as apprecenticeships, partly due to social status factors.

I think we should impose a four or five year tuition freeze and require higher education to restructure itself in that period, particularly to diversify away from 19th century methods of teaching and also to develop degree paths that don't take four years - e.g., a degree that doesn't require distributional requirements at all. You want just an English degree, for instance, and an English degree requires 32 credits, you get one for the cost of 32 English course credits, not 120 diversified credits. You want a more expensive diversified degree, fine, but you're not limited to it.

I also think the US should develop an optional national service program that would give kids an alternative way to find something to do to build a resume post-secondary school.

First, rates on student loan debt are pretty damn high for completely nondischargeable debt. 8% on loans from the government (GRAD PLUS loans), when the government borrows that money at <1%. That is not "low," when the debt cannot be escaped from, and, combined with a high dollar amount of loans, additional debt accrues at a wild pace.

Second, educational institutions, law schools in particular, charge an absurd amount of money with very little attention paid to the employability of their graduates.

My solution: keep the current system, but a) make the debt dischargeable, or at least adjustable to your income (IBR is a step in the right direction), and last for a maximum of 5 years; and b) put the school on the hook for the difference between the loan amount and the amount repaid in the repayment period.

Similar to the "equity" idea, but it would not require nearly as much change in how things currently work.

Equity financing would provide institutional incentives to put students into “high earning” programs and to restrict or eliminate others. I doubt students would feel free to choose fields with limited earning opportunities.

Equity financing for medical students and licensure-based programs that produce high-earners might be a reasonable tradeoff for the distortions produced by government enforced credentialing in many lucrative fields. If applied institution-wide, it would quickly drive out many socially useful programs.

There’s no getting around the need for all parties to have skin in the student debt game. Lenders, students, and institutions should share the pain of default. This would cut education funding but the biggest losers would be in the for-profit sector and others with high default rates. Cutting their air supply might not be all bad.

I’ve posted some additional thoughts. Would New Financing Models Drive Useful Higher Education Reforms?

Great issue to discuss. I couldn't help but think how in some countries, kids don't have to loan to get the basic right to education because the government pays on it. The trade-off is high taxes but it's well worth it.

Thanks for all of your commentary. I don't necessarily agree that student loans are not a major problem, but my comment seeks to raise awareness of a totally separate issue with student loans. Currently Dept of Education is having a MAJOR problem both collecting payments via garnishments (not my concern) and completing people's rehabilitation of defaulted Federal Direct Loans/Pell loans/etc (this is a MAJOR issue).

I'm sure lots of people here are familiar but for those who aren't, if you default on a federal student loan (>270 days late) you are declared to be in default and your account is sent to one of many dept of education-contracted collection agencies. They give you one chance to rehabilitate the loan before you get administrative wage garnishments/etc. I won't go into the details of how payments are determined but let's just say that the payments are typically substantial and often include a lump sum "down payment" of up to $1k-5k (this is before monthly payments even start). After you complete 9 on-time payments within a 10-month period your loan is sold back into the normally serviced loan pool and it is "rehabilitated." The benefit of this rehab is that the loan default marks come off your credit report. At that point you are also eligible to re-apply for hardship/deferment/income-based repayment/income-contingent repayment plans. Even before the rehab is complete (after 4 or 5 months of payments) you are once again eligible for more student loans/VA home loans and all that good stuff.

The problem is that because of the new software that dept of ed is using (or should I say "trying to use") they have been unable to, as I said, complete any individual formal loan rehabilitation or initiate any wage garnishment.

This is where I come in. My wife makes $15k per year and defaulted on $45k of student loans. After we got married we've been slowly cleaning up her financial past (bankruptcy, student loan rehabs and starting her with a credit-agency reporting secured credit card...). She has been paying over $500 per month, totaling well over 1/3 of her pre-tax income (I have been paying the vast majority of other bills in order to accommodate this). Tomorrow she completes her 9th payment and about a month ago I started looking into the formal completion of this drawn-out saga (this whole time we've been referring to it as our "debt baby" because of the 9 months of development).

There are tens of thousands of people who have been waiting for their formal loan rehabilitation to be completed and have found out since last October that dept of ed has them in a permanent holding pattern. Dept of ed as well as the collections agencies just tell them to keep on paying the (LARGE) payments indefinitely until the situation is resolved. I have read many accounts of people just giving up because they have gone into the 13 and 14th month of repayment, originally thinking that they would be in for 9 to a maximum of 12 months, only to be told week after week for 5-6 months now that "the problem should be resolved shortly".

These are typically people who are broke as it is and are desperate to rehab their credit and get their loans on the up and up. They all were in default and have done the right thing to pay back their debts in a pre-arranged agreement according to a standardized dept of education student loan rehab program. They all lived up to their end of the agreement and after thousands of dollars in payment they find out that the goalposts not only keep moving away from them, they have vanished all together.

I have read that this has all happened because dept of education accepted FREE software instead of using a competitive bid process and on the date last October that the software was supposed to go live they basically turned the switch and nothing happened. So, for going on 7 months now good, honest, hard working people are getting screwed in violation of the agreements that they made with dept of ed to rehab their loans. If they stop making payments their efforts are all for not (you are only allowed to miss one payment during the rehab period, which for many like my wife has been extended indefinitely).

Just like abused prisoners in a jail, there are few people fighting to protect the victims of this failed dept of education software glitch. After all "these people defaulted, did they not"? is the common refrain.

If anyone is interested in pursuing this, here are a few links:

---------------------
Sribed document linked to section for dept of ed collection agencies to process loan rehabs:
http://www.scribd.com/doc/51551017/46/DIRECT-LOAN-REHABILITATION

Loan rehab law:
http://www.law.cornell.edu/cfr/text/34/682.405

:Operation problems at Dept of Ed":
http://www.studentloanborrowerassistance.org/2012/01/26/operational-problems-at-the-department-of-education-what-is-going-on/

Loan rehab background (2009):
http://www.studentloanborrowerassistance.org/2009/06/26/loan-rehabilitation-relief-finally-on-the-way/

Unrepaired Education Department System Leaves Thousands Stuck in Default:
http://chronicle.com/article/Unrepaired-Education-Dept/131605/

Department’s New Debt-Management System Leaves Some Students Stuck in Default
http://www.wikilawschool.org/justice-glossary/departments-new-debt-management-system-leaves-some-students-stuck-in-default
---------------------

There are tens of thousands of people out there basically being extorted out of their agreed-upon payments and being told that they are free to stop paying but then if they want to rehab their loan they will start from base one. It's like the movie "the money pit" where Tom Hanks keeps asking when the house will be done and is told for months if not years "two weeks".

Dept of ed keeps on saying the agreements will finally be honored and rehabilitations will be granted in... "two weeks" while behind the scenes for 5 months they've been saying it and nothing changes. Meanwhile, the collection agencies happily keep collecting their fees each month from desperate people while dept of education tells both parties that "maybe next month" things will work themselves out.

What kind of bureaucratic banana republic madness is this? Obviously the right high-profile person has not been impacted by this yet because as it stands, no one cares and no one does anything except tell the victims to wait it out and keep cutting checks.

unbelievable.

/rant


A few thoughts as a debtor's lawyer and 2007 law grad with a hearty student loan payment.

1. With regard to graduates, the loan payments are more of a micro-economic issue than a macro-economic issue that are tied up with relative income and the capitalization cost of either deferral or forbearance. Depending on your degree, your field of study, and your job, $500 - $1,000 for 30 years is a huge difference for two otherwise equally situated 26 year old recent grads.

Depending on the loan and whether you are in forbearance or deferment, the loans can capitalize. If you defer a $100,000 loan for 3 years and it capitalizes at 8% annually, you've added almost $26,000 to the principal balance.

I started a law practice, deferred for two years, ate a little bit of capitalization and four years later regard the additional principal as a cost of starting the business. I would be in a vastly different situation if I had a PhD in History and could only find adjunct professorships that paid $25K a year.

Nonetheless, Mr. Levitin is still welcome to make my loan payments for me.

2. Credit decisions need to take into account the degree and the school. Overall a masters in English from Stanford is worth more than a masters in English from Podunk University, but is still worth less than a MBA from Harvard. Not all degrees and all degree programs are created equally. It's irresponsible lend to students without any regard for the likelihood that they'll derive any economic benefit from the degree.

3. High schools need to prepare students based on their interests and abilities, not on the assumption that college is right for everyone. Many students would be better served using their free public education to learn some academic skills but focus on classes that prepare them for jobs they are interested in and able to do. Instead we have 4 year colleges with staggering freshman drop out rates and students getting loans for community college courses that used to be taught in high schools.

4. No public funds for for-profit colleges. Period. Every single one of my student loan discharge cases has been for someone with a for-profit degree. One for national profit university advertises BAs and MAs in Education on Seattle TV, without disclosing anywhere that the WA Department of Education does not accept that degree or those credits for state certification. I have a client with a MBA from a national for profit university who applied to Amazon's entry level management program and now works in an Amazon fulfillment center filling boxes, because Amazon doesn't accept MBA from that school.

5. As an aside, I have a friend from Finland who has a PhD, didn't pay for any of it, including books and a year of study abroad in Scotland. In exchange, he spent a year in the army and has to do a couple of weekends every few years until he is 50. He was an artilleryman; drank a lot of army issue vodka (I tried some, terrible but effective); and has a great story - with pictures - about a cabin in Lapland, some army buddies, their girlfriends, lots of vodka, possibly a bear; and some hand grenades.

"Before we prescribe austerity in higher education as the solution, however, let's recall that US higher education is the envy of the rest of the world. Foreign students come here for their advanced degrees, not vice-versa. There's huge social value produced by having outstanding domestic higher education."

This is a novel defense of the expensive U.S. higher education system, that we export advanced degrees. The problem though is that these are subsidized exports, and just because the rest of the world wants it doesn't mean it's worth the cost for foreigners either. Someone has to pay for the subsidy.

I can see this argument serving the defense of elite graduate programs, e.g. engineering or physics programs, but many millions of Americans have college degrees but the question no one has asked is: how many underwater degrees are there in the U.S., or worse, how many radioactive degrees are there--that is, degrees that merely indenture the graduate but provided no real labor market value? The number is many millions, which indicates that austerity in higher education would provide more benefits than costs. Note this doesn't even get to the tens of millions of dropouts.

1. I agree there should be NO government-backed loans for for-profit institutions. These places are mills that are exacerbating the over-degree problem without really bringing anything to the table to compensate. This is not new. The for-profits were already part of the problem a quarter-century ago and no one has done a thing to fix it. Why are we subsidizing for-profits?

2. You can make a policy argument for government-backed loans being nondischargeable, but there is no reason to make unbacked loans nondischargeable. Lenders should have to take their chances.

3. Service-in-lieu is a good idea. We have it in some areas and need it in more. We let people work off fines, why not education costs?

4. It's long past time that we decided what we want to accomplish with these education subsidies. We want a few art historians around, but no lender will make that loan without a guarantee. On the other hand, a nation of unemployable art history majors is counter-productive. The system requires a massive overhaul.

5. #4 will be far more difficult than people think, and not just because of vested interests. Determining the societal value of degrees is less simple than many would have it. Just how useful is that business degree for actually running a business? Many successful entrepreneurs have those "worthless" communications and psychology degrees. Just how useful is it to dump so many JDs onto the market every year? And how radioactive is a JD outside the legal field (Hint: hotter than Hanford)? Even hard tech fields have issues. Check with civil engineers and geologists about career issues in their fields. And just for snark's sake, how much do we want to keep subsidizing engineering schools is they're going to keep giving us graduates with Heinlein's Disease (i.e. people who believe that, because they can do Fourier transforms and differential equations, they know more about law, economics, politics, religion, and pretty much everything else than pretty much anyone else)?

6. I'm glad Mr. Fuller has been able to get his practice off the ground. The problem we're facing is that the overwhelming majority of grads are far too undercapitalized to open their own shops, and with all that nondischargeable debt hanging over them, they can't borrow the necessary start-up capital. They're stuck, and ultimately we're all stuck because of the wasted talents and skills.

I AM NOT SURE IF I AM DOING THIS CORRECTLY. I REALLY LIKED THE COMMENTS ABOUT THE S. LOANS. I HAVE A COMLICATED LOAN SITUATION AND DON'T QUITE KNOW WHAT TO DO.

"We need to recognize that there is HUGE variation internationally in how education is financed and the structure of student loans." Very true. When I first moved to the states I was amazed by how young parents were saving for their children college education from day one, that was something I wasn't used to see. From were I come, most of the students are financing their selves throughout college, and the loans are much more tricky and alluring than the ones we see here.

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