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01/09/2005

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Corey

There is an extremely critical factor that this
analysis overlooks that will be immediately obvious to anyone under 40 who has borrowed unsecured in the last 20 years.

There are NO consumer protections on private, unsecured debt. There are NO caps on fees or interest rates. The credit card companies are all located in states that repealed their consumer protecting usury laws. Federally insured students loans DO have capped interest and limits on fees.
This is their primary appeal to students vs. private loans.

Over the last decade, credit card companies have mailed literally billions of low-interest credit card offers. My generation has borrowed to a greater extent than any other. But guess what happens when you are a day late on any payment on any of these cards... you get hit with a $40 fee and soon ALL your lenders jack your interest rate to 29%. Ever try to pay off a debt at 29%?

People at the early stages of their careers hit speedbumps, and now that layoffs without cause are systemic, you never know when your 70K a year lifestyle will go to ZeroK in one week flat. But the bills don't stop, you miss a payment. 29% interest! FROM THEN ON.

So with tuition increasing at 3-4 times inflation, and average debt loads per degree at 100K, the single most important feature of the Federal Stafford loan is the INTEREST RATE CAP.

Unless a private student loan system is implemented with a interest rate cap, and in this administrative climate it will most certainly NOT be, then advocating such a plan is simply shilling for the moneylenders. Don't believe the hype, Citi has enough of your money.

Jim S

I have to say that part of your post is hilarious. Well, OK, more than one part. First, the idea that the financial markets would produce student loans at not much more than current mortgage rates. It's more likely that the rates would be at least twice current mortgage rates. Why? Because they could. Because they have stockholders who want not simply good but great performance. I suggest that you look more closely at the really weak excuses that banks currently make for consumer interest rates in many areas. You attempt to imply that people would still find enough value to justify paying the greater amounts that non-subsidized loans would involve. Why? In a world where teachers aren't paid that well, nurses are becoming contract labor so hospitals and other health care corporations can avoid providing benefits, and IT professionals are telling their children not to even think of entering the field in no small part because of outsourcing why do you think the future will be like the past? One aspect of the decision making process that you are ignoring as many economists do is the effect of predictability and anticipation of security on this type of decision making process.

The thoughts go something like this: "OK, I can borrow many thousands of dollars and be in massive debt the day I leave school for an education that will not protect me in the slightest from layoffs, extended unemployment (See the length of unemployment in today's recession versus historical ones.) or help me have benefits. Even if I get a good job I can lose it in a heartbeat and be out of work for a year and still be held liable for the loan.". What is their logical motivation again? In spite of the paeans to the willingness to take risk that is part and parcel of modern conservative thought, most people want security. If they're going to walk the tightrope they want a net. You want to take the net away in the name of free market ideology.

Jim S

I see that Corey spotted the same flaw and put it more succintly. It seems that Mr. Becker has forgotten that most of those involved in the business of loans have sold their souls. He thinks that they are simply rational beings involved in market transactions that actually involve something resembling competition. Please note, Mr. Becker, where Corey points out how ONE late payment results in every debt holder immediately jacking up your interest rate up to amazing levels for the rest of your life no matter what you may do in the following decades. Sounds like non-competitive collusion to me, but the "markets" have their own excuses and false labeling.

bjr@yahoo.com

Both B and P assume that education is valuaable, but it seems like you hide the problem in the details: the borrowers least able to benefit are the most likely to be saddled with a debt they can't pay off. Plenty of jobs that don't require higher ed nevertheless select for it in hiring simply because they assume that any reasonably hard working and intelligent person has a college education. If you reduce the subsidy for college, the hiring prospects for high school grads would go up. And if you subsidize something, doesn't that make it more expensive?

DanT

Privatization of student loans would cause some significant market corrections in the education market. The entrenched interests will act to prevent such privitization.

Some college degrees, like engineering, help ensure higher salaries for its graduates and jobs which are far less prone to elimination during economic downturns. Other college degrees, like history, do not convey these economic benefits. That is not denegrating history degrees, but they do not convey an ecomonic return in the marketplace of jobs as much as engineering.

To colleges and universities, all students pay tuition so all degrees are valuable. The colleges and universities have the established infrastructure (departments, professors, classrooms, libraries, etc.) to supply both engineering and history degrees.

If the government ceased backing funding for degrees what would occur?
Private lending institutions would certainly fund education which increased the probablity for financial return - e.g. engineering.
For degrees without such possible financial return, interest rates equivalent to unsecured personal loans would be changed - e.g. history.
As a result, many history students would not be able to afford such loans and would not attend an educational institution.

Educational institutions would need to significantly retool. The infrastructure for high-return low-risk degrees like engineering would be maintained or increased while low/negative-return high-risk degrees like history would be mostly eliminated for lack of paying participants.

This massive restructuring of education infrastructure would be blocked by most, if not all, colleges and universities. If they wanted to offer only engineering degrees, they would be doing so already. They like having the government ensure a steady customer base.

In the end, the government backing of student loans ensures the US continues to produce more graduates with financially-marginal or even financially-negaive degrees.

There are other benefits. College degrees of almost any type make one a better citizen: less likely to commit crimes, more likely to vote, more likely to own a house. The federal government has a role in promoting improvements in citizenship, so for non-economic reasons I support this.

It would certainly be more economically efficient for the market to provide education loans, but our current president (History degree from Yale, 1965) is unlikely to act on this.

Paul Zrimsek

If degrees are really becoming as useless as Jim S's rather pat declinism says they are, then why is discouraging kids from going into debt to get those useless degrees supposed to be such a bad thing?

Mike

A couple of points...
1. I'm not really sure that we can make a claim that college makes for better citizens. We have no way of understanding the direction of causality between things like voting and having a college degree. I think there is also quite a bit of room to question the current value of a lot of degrees and programs. In particular I would question degrees from some of the more politicized departments.

2. The argument that loans are needed because of the rate of tuition increases probably should be carefully considered. In the absence of subsidization policies the schools might actually have an incentive to control costs.

3. These points are of course related. Perhaps the more politicized departments could benefit to being subject to some market forces.

Tom

An intersting point was raised about re: private financing for less economically viable careers. I would suspect that a student would we able to finance a history degree under the private system, but it may very well be that the rates are higher than for a more economically viable profession. This would result, I think, in unwanted steering of students away from liberal arts, which do have a values that aren't monetary for society.

It would be particularly interesting for professions like law too. Since there is no undergraduate major for law (and any B.A. or B.S. will do) it might make sense to major in the field with the best financing available. This would result in less diversity in terms of course of study among people who become lawyers, which would be a negative overall for the profession and for consumers.

Also, I don't think Becker ever really said why collateral wasn't needed for student loans.

Kurt Johnson

As DanT and Tom have already noted, privatizing student financing would likely result in lower borrowing costs for high income/technical professions. This seems like a fair application of the market's cost of risk - loans to low income non-professional/technical degrees carry a higher default risk that the lender should be compensated for. If government determines that there is a non-economic benefit to having liberal arts majors the government should rebate some of these higher borrowing costs in the form of grants rather than indiscriminately subsidizing all study areas.

I also take the view that most of the additional aid that is granted to students ultimately becomes a wealth transfer to college administrations as they raise their prices to absorb most of the additional aid (given a lag of a few years). Thus the "real" ex-aid cost of education to end users will remain roughly the same regardless of the aid level. This is the fundamental reason that colleges will oppose removing loan subsidies.

Finally, American colleges and governments have already made education cheap and accessible enough that affordability is no longer a rational excuse for the serious student. To oversimplify this, assume that census data indicates the value of a college education at $1,000,000 of incremental lifetime income and requires debt financing of $25,000. How many students that would have taken this opportunity at a 3% finance cost but will turn it down at 6%? To any rational consumer it's a slam dunk at either price.

spade

Interesting post. I'm also interested in whether a roll back of the federal subsidy would decrease tuition. When mortgage rates are lowered, sellers raise the price; it seems the same for tuition. The cost of college tuition in the last generation has well out-paced the Consumer Price Index.

strunkl

Is there not an argument that a better-educated populace is a public good? Consider:

Ensuring a greater aggregate level of education among the American work force increases productivity, thus allowing continued economic growth.

That statistics show a correlation between high education levels and low crime rates, suggesting that any person who lives near the well-educated might be less likely to be a victim of crime, at least at home (though this argument can, of course, be taken too far).

Indeed, any persuasive argument for mandatory education through high school can be extended to cover some greater form of education. Making college subsidized but not mandatory merely recognizes that the government should no be able to exercise its will so completely over adults as it does over minors.

Other 'public good' arguments abound, though not all such arguments justify all higher education. One might conclude that subsidizing higher education merely redistributes some of the cost of that good across the tax-paying public. In this sense, the subsidy is merely a solution to the classic free-rider problem.

Frank

The public good argument is already mentioned.

Looking at it from a social-liberal viewpoint intead of the libertarian/capitalist view, you can create the following argument -

As the education would be considered a public good it is justifiable that it would be financed with taxes. As there would be a strong relation between education and income it would be justifiable to use progressive taxes.

On the other hand, old fashioned motivation does need to play a role. Thus student loans, backed by the government, are a good way to make sure that a student takes on a personal financial responsability.

And it is the balance that makes good policy.

dsquared

I think this is a perfect opportunity to take a Ronald Coase moment, step away from the blackboard and ask what real-world problem we are attempting to solve here.

Is there any evidence that US citizens are buying too much education? I think the opposite; the USA is a massive net importer of graduates.

The problem is that there is an information problem on the demand side as well as the supply side. Prospective students are young adults with little wealth and no income ...

(parenthetically, I don't think it's good economic analysis or good politics to call education subsidies a subsidy to the middle class simply because the parents of students are often rich. Adult students have no enforceable claim on their parents' wealth, and ought to be counted as citizens in their own right, not as pawns of their families. There may be public policy reasons for deciding to increase the age of financial majority by four years, but I swear I can't think of a single one).

... and there is no market in which they can exchange the increment to their likely earning pwoer which might come from a college education for its certainty equivalent. Furthermore, they can't sign binding contracts with their university about the quality of education they are going to receive (relative to other job applicants) and there is no real way of testing the suitability of that product for their own situation without buying it.

They are therefore facing a situation in which they are being asked to take a large, undiversifiable risk with a very material proportion (probably a multiple) of their total wealth, with greatly attenuated bankruptcy protection if this investment goes wrong. It doesn't seem at all strange to me to say that this is a proper situation in which there is an argument for partly socialising the risk by subsidising education loans.

Pastabagel

This is an excellent website, by the way. Thank you both for taking the time.

I'd like to echo spade's comments that a reduciton or elimination of subsidized student loans would probably lead to a decrease in tuition.

In my estimation, the subsized student loan program has effectively increased the money supply in this one particular area only, thereby triggering inflation in the only 'good' that subsidized loans can buy, namely education.

To further this point, if the student loan program has raised the price of tuition, then it stands to reason that it has also caused new suppliers to enter the market to provide education.

The problem is that the market obviously does not value all college educations equally. We import graduates in technical fields because we don't produce those grads in sufficient quantities here despite the increasing number of colleges and degree-granting institutions.

Thus, we have a situtation where the federal government is subsidizing the education of vast numbers of students that are unable to get the high paying jobs the conventional wisdom believes the college degree promises. In other words, we are committing scarce resources to producing human capital that the market, to a significant extent, does not value highly.

Thus, in my opinion, the system at least needs tuning if not a cutback. Take the example of the importing of grads in technical fields.

If the U.S. economy demands technical grads, then the government's resources should be shifted there to incentive students to enter those fields and to incentivize students to pursue advanced degrees in those fields. It is very difficult to persuade technical undergrads to accept a meager grad student stipend and pursue a PhD when companies are offering those same undergrads $70,000 a year, for example.

tom

re: Pastabagel comment. As a couple of poster said above, college graduates, no matter what their field, are good for society. So, it makes sense for the US to encourage college enrollment, regardless of the real world need for those skills.

If the US really needs more tech grads, it should subsidize tech students. I don't think any student in America views his/her student loan as a subsidy, even if it is one.

I would actually really like to hear Becker and Posner's comments about why the market isn't correcting for American born tech grads and why college students aren't choosing majors which transition into well-paying careers (if, that is in fact, true).

Corey

The US does not need more tech grads. Unemployment is higher among Electrical Engineers, Computer Scientists, and IT Professionals than in other fields and it has been that way since 2001. Next time you are at Home Depot ask some of the older guys who work there what they used to do before. There currently is an elevated demand for Bio-tech workers due to the focus on health caused by the aging of the baby-boom generation.

If a change in student loan policy lowers tuition, it will only be because the higher interest rates have decreased the supply of students willing to take on 100K in debt. As I have pointed out on the Posner side of this blog, those students who do chose not to go will be disproportionately from the lower income brackets.

Lowering prices by changing policies in a way that discriminates on class is a horrible idea.
Federal education loans represent a choice by our society for encouraging equal access to higher education.

Diana

Three points: First, the loan limits for subsidized loans has yet to increase to match the drastic increases in student tuition. The usual tactic to make up for this lack of funding is to have parents sign for PLUS loans (private loans that are placed under the parent's name).

This brings me to my second point. Wouldn't it be logical that once the student is out of school the PLUS loan that was taken out for them could be consolidated with their other student loans. Apparently not as I've found out.

I'm trying to be the dutiful daughter by taking over the payments my parents made while I was in school. I'm willing and able now that I have a job of my own. But with the system currently in place, I'm not able to transfer that loan to my name or package it with my other loans. Very frustrating, and costly.

Third point: when is the age guidelines for dependent students going to change? Currently if you are under 25 and not in graduate school you are considered dependent on your parents' income and have to include their income on your FAFSA which will count against you when figuring your expected family contribution. For those of us who did not receive any financial support from parents other than cosigning loans this is a real kick in the ass. Not only is my family lower middle-class and unable to contribute to my education, but the government will tell me that they expected them to contribute and will punish me by lowering my available loans total.

The federal education loan system is in major need of overhaul!

Halcyon West

College costs have risen at a rate about double the CPI since 1968. I think that student loans have been a big factor in allowing colleges to have runaway budgets and almost total disregard for any cost/value return to the students. With 12 credit hours being considered full-time status for students applying for loans, it is pretty obvious that colleges exist to maximize revenue, not turn out grads.
Were student loans curtailed altogether, or in the least charging a market interest rate, then colleges would have to be as competitive as automakers in trying to attract students and sell their programs.
The job market used to do a good job at putting a market value on a college degree. That's why a Harvard grad in 1960 had a better job offer than a grad from say Kent State.

Jim S

Markets aren't capable of solving everything. One of the primary reasons that more students don't go into the technical fields is that an American K-12 education doesn't prepare any but the most motivated students well enough for the demanding highly abstract thought processes required by a college level technical education. They've gotten by without working very hard in school and no one really pushed them towards the technical arena because while the medical field was viewed as high income the other technical areas weren't when compared to law or business.

dsquared

By the way, the "often-suggested system whereby interest rates on student loans would not be fixed, but would rise with the eventual earnings of borrowers" is pie in the sky because of an obvious moral hazard problem. If there is a choice between this kind of loan and one with a fixed payment, then the only people who would apply for the income-contingent loan would be people who you wouldn't want to lend to on this basis.

John David Galt

Several of Becker's comments seem to miss the mark. I hope it's not taken as insulting when I point out that things have changed a lot in the 50 years or so since he went to college. The secure job has become a thing of the past; and a college degree does not make you part of an "economic elite", it is merely expected and required to get anything approaching a good job, much as a high school diploma was expected 50 years ago.

As soon as I got into college I was offered credit cards. This, I think, makes clear that banks are already quite willing to lend to students, even without "bankruptcy-proof" status. However, Corey's comment that the banks will gouge the highest interest rates they can get is well taken. I don't see this as a problem, but I do see it as a good reason NOT to make student loans bankruptcy-proof; it would be an unacceptable burden on those who aren't lucky enough to get and hold onto one of the shrinking supply of good jobs after graduating.

I tend to believe that there would be fewer bankruptcies among student borrowers than today anyway. I know people who were unable to keep up the payments on their student loans; when they tried to renegotiate terms with the banks, the banks refused. Which made perfect sense from the bank's point of view; by forcing the student to default, they were able to collect the full amount immediately by means of the federal guarantee. The fact that this put an un-called-for bankruptcy on that student's record didn't bother the bank. Take away the federal guarantees behind the loans and the banks will have to go back to negotiating in good faith with the borrowers when this problem arises.

In this as in other areas of government fiscal policy, the government has got to stop assuming that anyone who needs a job can go out and get one. The jobs simply aren't there anymore, and people are getting screwed by that assumption.

kputnam

The underlying question is whether students should be a protected class of borrowers either through low-rate federal loans or through a statutory cap on the rates that lenders can charge above the prime rate. As previously mentioned, it is unlikely that lenders would restrain themselves from interest-gouging.

Does an 18 year-old funding her education deserve a better rate than an 18 year-old running up her first credit card? Arguably both are purchasing things they expect to make them happier.

Human accomplishment continues onward in times of strife as well as in times of peace. It builds upon itself, however, in areas where there is a high density of educated persons. Not only is it intuitive, but there is emperical evidence to suggest that a highly educated population propels human accomplishment, and as such, promoting education through protecting students from prohibitive interest rates is desirable.

The young person running up her credit card, however, reflect a growing cultural divide between lifestyles Americans can afford and the lifestyle lenders are paying for. The United States' decline in personal savings rates from the highest rate to near the lowest may have spurred consumerism and the economy, but it has also created a nation of individuals in debt up to their eyeballs in order to fund their lifestyles. This type of behavior is less socially desirable.


Additionally, we should not forget that the glut of highly educated professionals is a symptom of our aging population. A large number of near-retirees are not only staying at their jobs longer due to improved health care, but also they are at the height of their pay scales and are securing golden parachutes for retirement. In the next decade a great number of much sought professional positions should begin to open for the smaller, younger population. Removing protections for students partially in response to the currently glutted market may be ill-advised.

patrick

I don't understand what y'all mean by interest gougeing? I think the lending market is very competitive, so, given the ease of shopping around for the best rate, it seems like student loan interest rate should be bid down to a minimally profitable level. See, for example, mortgage rates. Credit card interest rates are "high" only relative to mortgage rates because, as mentioned in the post, it's really hard to get any collateral that you can reposses in case of default. If you had some provision for wage garnishments for defaulted student loans, it seems they would be relatively low-risk loans which would lead to a commensurately low interest rate.

Corey

The reason you are having trouble with the idea of interest-gouging is that you are thinking of an interest rate as something that is negotiated up front based on borrower's status. This is true for all home loans, but is most certainly NOT
true for credit card loans.

Read your credit card contract sometime and note how they reserve the right to CHANGE interest rates at any time for any reason. As a practical matter, there is about a 30 day lag time between an event which modifies your FICO score (i.e. a late payment or even long term non-use of the card) and a nice letter from Citi informing you that your interest rate has been raised to 19.9% (or 29.9% in extreme cases)

In other words, should a layoff or sudden illness that falls outside your depreciated health insurance coverage put you in a temporary position of financial instability, your friendly credit card companies will raise your FICO-based risk level and boost your interest rate (and minimum payments). This of course makes your financial situation even worse.

So the basic question is, were student loans to be privatized, would banks follow the fixed rate home loan model, or the kick-them-when-they-are-down unsecured credit card model? I think anyone who has any sense of reality about the policies of our current government would see that the latter would be their clear choice. Remember that MBNA is both the largest credit card company and one of the largest corporate political donors.

Patrick

I think the difference has to do with the term-length of the lending. Credit Card loans are different in kind from most other types of credit in that there isn't really a fixed term for the loan. Well, there is in a sense, but that term is 30 days, at the end of which the credit card company can renegotiate. As you note, most do. If you don't like the new terms, pay off the balance and take your business somewhere else. If you can't do that, I still suspect there are other refinancing offers around which beat 19.9%.


The real point, though, is that a student loan isn't the sort of thing that gets renegotiated every 30 days. It's for a fixed term, and gets paid off, with interest, over a fixed period (barring any refinancing). It seems likely that, just like in car loans and home loans, a variety of lenders will offer a variety of options: fixed rates, variable rate (tied to prime), semi-variable rates, etc. They will do this because there is money to be made in making the best offer.

The role for the government, then, is not to say "this is the sort of loan you must offer," but rather to outline fair rules for collection in the case of default. Wage-garnishing has been used in the past, and seems a likely rout. As cited above, allowing no way of recovery (since human capital is non-appropriable) would drive interest rates through the roof (though probably not up to 29.9%), but full federal insurance of loans provides all the wrong incentives for lenders (and borrowers).

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