Federal student loan model brokenBy Cruise Hall | 07/09/2014 12:43am
Currently, the Department of Education issues loans to students at a flat interest rate that is set by Congress, and students cannot be denied based on their ability to repay the loan. In fact, larger loans are often made available to financially disadvantaged students.
This model is fundamentally broken because it suppresses all of the natural signals that help borrowers and lenders make wise financial decisions. Whenever these signals are concealed, lenders and borrowers cannot make good decisions, and the results are invariably destructive.
The recent mortgage crisis provides a textbook example. For decades, under the banner of making housing affordable, the federal government pressured banks to approve mortgages for applicants with less-than-fantastic credit scores. In this way, the government skewed the signals that shape the real estate market, and the real estate market was skewed in turn. The easy money climate inflated real estate prices as more Americans were able to buy more expensive houses that they otherwise couldn’t afford. Ultimately, when the market bubble burst, the taxpayer was left holding the bag.
Today, the government is playing a similar game, promising to make higher education affordable, and it’s cutting out the middle man. Instead of pressuring banks to loan money to high risk borrowers, the federal government has taken it upon itself to indiscriminately dispense debt to millions of college students nationwide. The government doesn’t blink an eye when it lends thousands of dollars to a 19-year-old with no career path or a seventh-year-senior double majoring in art history and kinesiology. The phenomenon of the subprime student loan knows no limit.
Furthermore, just as easy mortgages inflated home prices, the federal government inflated the cost of tuition by guaranteeing every student’s ability to pay, however high the cost. And since the federal student loan program offers no incentives for students to pursue profitable degrees in a timely fashion, colleges are happy to allow students to chase their dead end majors for four years and beyond.
These trends can be reversed if we allow the student loan system to reflect risks and opportunities that exist in the real world. The best way to restore sensibility to the student loan market is to eject the federal government from the business altogether.
When profit-minded institutions determine eligibility and interest rates, greater consideration is given to the each student’s ability to repay. With loans tied to graduation rates and profitability, colleges would have a stake in the financial success of its graduates and would shape their programs accordingly. Likewise, students who demonstrate professional competence, whether through good grades or on-the-job experience, would enjoy lower interest rates. In this way, privatized student loans would empower students to make better decisions in college and would shape higher education to the benefit of our economic future.
Cruise Hall is a senior majoring in mechanical engineering.