Lessons from the Student Debt Crisis

About a year ago, I heard a local Republican Congressman respond to a question about student loan debt at a small forum. Given that he was talking to a Republican audience, he felt comfortable relating a discussion he had with an incoming freshman at Carnegie Mellon University who complained that she would be drowning in the debt by the time she graduated from the university with her art degree and without financial aid. The congressman, exacerbated by the self-imposed silliness of her situation, went on to proudly explain to us how he set her straight, telling her that she had made a terribly foolish decision and that she should obviously go to an in-state public university. As I heard this, I made two observations. One: whoever this student’s high-school guidance counselor was should be terminated immediately for advising her that taking out a high-interest $200,000 loan for an art degree was a good idea (or, assuming this guidance counselor has already been granted tenure under his public-sector union contract, he or she should be made to wear a dunce cap for the rest of his or her career). Second, I observed that the congressman slightly missed the point.

Normally, when one goes to take out a loan, he or she goes to the bank. Not so with student loans. When the aforementioned student wanted to take out a loan, she almost certainly went to a government lender. On the other hand, if this student walked into a Wells Fargo bank and ask for such a loan, she could have expected one of two responses. One, she might have been given the loan with an unconscionably high accompanying rate, or two, she would be laughed out of the building. Why? Because a private lending institution understands that this student has almost no realistic chance of ever repaying this loan. Sallie Mae has no such concerns.

By inserting itself into the student loan market, the federal government effectively removed the last line of defense against a catastrophic financial decision: the private lenders themselves.

The student loan market is not unique among government initiatives in this respect, however. In fact, the current student loan crisis is troublingly similar to the 2007-2008 Subprime Mortgage Crisis.

For those of you, who, like myself were only twelve years old during this crisis, let’s have a quick review.

In 2007-2008, the long burgeoning housing bubble burst. As housing prices declined, millions of Americans who had been given subprime loans were trapped in their homes, caught off guard by the sudden decline in housing prices which prevented them from refinancing. Additionally, without the ability to refinance, many of these borrowers were no longer able to make their mortgage payments. When this occured, financial institutions which had for several years been stockpiling mortgage backed securities suddenly found that, as a result of declining mortgage payments, these mortgage backed securities had become toxic assets. This sudden decline in the value of these investments crippled many financial institutions, and the Great Recession followed.

Exciting stuff, huh?

In all the talk about Wall Street greed from our friends on the Left, however, some important facts are at risk of being lost to history. In particular, the progressive policies meant to increase homeownership among lower income families were the primary culprit behind this crisis, namely a forgotten but still existent little gem of a program called the Community Reinvestment Act (CRA). Those of you who are familiar with progressive policies will know doubt see warning signs in the name alone.

The CRA was begun in 1977 under the Carter administration. (In hindsight, this should have been the first sign that something would go horribly wrong!) It was not until the Clinton administration, however, when regulations were tightened, that the program really took flight.

The aim of the program was essentially to use regulations and regulators to increase low-income home ownership by pressuring banks to give home loans to low-income borrowers. Banks were pressured to meet CRA lending targets or risk less favorable treatment from regulators in opening new banks or merging with existing ones. As a result, banks began to dramatically lower lending standards to meet CRA compliance. Additionally, the banks that made more CRA loans were allowed, by virtue of special treatment from regulators, to expand at a far greater rate.

Inevitably, this government action led to an influx in subprime mortgages, and the creation of the disastrous housing bubble.

What this situation, and the millions of cases like it, illustrate, is the tendency of government programs and initiatives to create a litany of additional problems in the process of trying to solve a single problem.

I fear that we may be seeing something similar in the case of the rapidly growing student loan bubble.

As of the start of 2016, total student debt was $1.2 trillion. That’s up from just over $200 billion in 2003. As that number continues to rise sharply, there is a more concerning figure: over 40% of borrowers are not making payments on their student loans as of April. Given the weak job prospects for college graduates and persistent economic sluggishness in the US economy (growth was only 1.2% in the second quarter),  it is unlikely that we can expect any improvement in this number anytime soon.

The problem with this current situation is twofold. One, the federal government, through its student loan program, is giving out loans to students who have a low likelihood of successfully repaying the loan, which ties them down with debt for life. And two, if the job opportunities for many students continue to dry up, especially in the event of a recession, the taxpayers will be left holding the bag once again.

Naturally, the Left has been busy brainstorming brilliant new plans to deal to use massive government intervention to solve the latest problem that government intervention created. Hillary Clinton’s plan will allow students to refinance student loans at current interest rates, caps interest payments at 10%, and will allow students to attend public schools for a fraction of what they currently pay. Bernie Sanders, for his part, offered similar proposals with the addition of his plan to make all public college education “free.” Hillary and Bernie’s plans would, according to projections, cost $350 and $750 billion over a 10 year period. What a steal!

The price tag, of course, is far from the only problem with such proposals. The main issue is that, in classic progressive fashion, they completely ignore the actual cause of the problem and, in fact, exacerbate it. Such plans only work to subsidize the existing problem and make the student loan bubble bigger by shifting the cost to taxpayers. It’s rather like pitying an addict’s withdrawal and deciding to help by given him hundreds of dollars to buy drugs. Is the addict still experiencing withdrawal? No. But that wasn’t the real problem, the problem was that he was addicted to drugs and, thanks to the “help,” is now more addicted and at greater risk than ever.

The real solution, as is so often the case, lies in removing the federal government from the problem entirely. In this case, returning the business of student loans to private banks would all but end the kind of financial malpractice we see all too often from poorly advised student borrowers by forcing them to make fiscally responsible decisions. As for the issue of rising tuition rates, it seems obvious to this writer that a return to fiscally prudent borrowing would force colleges and universities to compete financially for the flood of new, price-conscious students.

Until that day comes, however, the student loan crisis, like the subprime mortgage crisis before it, stands as a testament to the federal government’s perpetual inability to affect any kind of positive change without royally screwing up. As Ronald Reagan famously said, “The nine most terrifying words in the English language are, ‘I’m from the government, and I’m here to help’”.

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