Is Student Debt Too Great? Becker

 

Students from richer and some middle class families have their college education financed by their parents and other relatives. Students from poorer families may gain a lot from going to college, but they have trouble raising the tuition and financing their living expenses while in college. It is difficult to get outside financing for college education because education becomes part of the individuals with the education, and hence cannot be offered as collateral for commecial loans from banks. Government-sponsored student loans have enabled many students from less privileged backgrounds to finance a college education.

This inability to offer human capital investments- in particular, college education- as collateral for commercial loans on these investment even when the returns are excellent is the fundamental “externality” behind the case for government support of student loans. This externality could justify governmental provision of student loans, although whether the government should guarantee student loans is questionable.

Student loans have increased the supply of young persons who go to college. In a competitive higher education market-which describes the American situation where thousands of colleges compete for students- a greater number of college students induces increases in tuition. However, the increased supply of places for college students moderates the increases in tuition.

The fraction of American students who take out loans from the government or private lenders has increased since the early 1990s to about 65% from under 40% at that time. Outstanding student loans now amount to about $1 trillion. The proximate cause of the increase in student loans has been the sharp rise in tuition at both state and private colleges during this time period.

Although students and their parents complain a lot about the rise in college tuition, since the early 1980s monetary and other benefits from college have risen even faster than tuition and other college costs. As a result, the rate of return on college education in the United States – benefits net of all costs- grew greatly during the past 30 years. The increased net return to college, despite the increase in tuition, explains why a larger, not smaller, fraction of young persons are going to college than did prior to the sustained rise in tuition.

That monetary gains from college increased faster than tuition does not mean that higher tuition and greater student loans are not financial burdens. These loans are still a burden, but it is easier to repay them when college earnings are much higher. According to the NYTimes of May 12, in 2011 the average student loan debt was about $23,000, but 10% owed more than $50,000, and a small percent owed more than $100,000. Since typical graduates of 4-year colleges or from postgraduate studies earn on average over $30,000 per year more than typical high school graduates, these graduates could completely repay a $50,000 student loan in under 2 years from the greater earnings they get from their education. Students who contract debt that exceeds $100, 000 usually have gone to medical, law, or business school, or have received PHD degrees, and they earn far in excess of $30,000 per year more than high school graduates. Hence they too usually can finance their larger student debts without much hardship.

Of course, as Posner indicates, the prolonged recession has hurt the earnings prospects of young college graduates. Many of them need to be given, and are receiving, greater flexibility in repaying their student loans until economic conditions return to more normal levels. Others with student loans do not earn much because they went to bad schools, or they dropped out of school before acquiring much in the way of useable skills, or they went into occupations that do not pay well. Doing away with federal guarantees of student loans would discourage college from trying to foster excessive debt on students with these unpromising economic futures. Moreover, especially if federal guarantees were eliminated, student loans should become dischargeable through personal bankruptcy, the way most other loans are dischargeable.

One might also want to experiment with student loans that are like equities; that is, where the amount to be repaid depends on earnings. These equity-type student loans have their own problems, but they might be a useful complement to the present system where loans are given with fixed rather than effectively variable interest rates.

Young families with mortgages that exceed $100,000 under normal circumstances are not considered to be in dire economic straits, even though their homes can be taken if they fail to meet their mortgage payments, and they are only investing in more comfortable living arrangements. Young couples that contracted a similar level of debt when they were students have invested in raising their earning power, usually by a lot. So I find it difficult to comprehend why sizable mortgages are accepted while there are political and media outcries over comparable student loans that are based on usually highly productive investments in human capital.

 

Comments

[Jim]

of course not... loan habit starts small and rises up to heights of Himalayas..
i have seen people spending all their lives under the burden of loans where i believe its better to stay in a rented house earn less and live happily rather that struggling to earn more, buying mortgage, buying other luxuries on loan...

[Austen]

I would be interested in hearing your thoughts on the increasing split in financial aid between the richest, highest-ranked colleges and everyone else, and their subsequent effect on income inequality. As an incoming college freshman to Chicago that isn't paying much of anything, I watched many of my friends plan to take out ~$25,000/year loans for our local university because they don't have alternate savings. While those loans allowed them to attend, the debt afterword seems at this age to be impossible to repay.

[Richard Belloff]

Actually Austin, as Becker correctly points out, a $100,000 student loan is NOT impossible for most folks to pay off.

[Jimbino]

Though I have advanced degrees gained when higher education was either cheap or free, if I were a young man now, I would forgo higher education, as Gates, Jobs, Dell and Zuckerberg did.

A young man who takes out a loan to get a degree qualifying for a job will face a labor market much worse than the one I faced in 1969. First of all, he will endure drug screenings, waste away in a cubicle, pay compulsory insurance premiums that finance all the women and breeding around him, be denied family leave that he pays for, and suffer income tax penalties to support all the marrieds and breeders.

The way to avoid all those hassles and expenses is to learn to use a hammer, to design and build homes, or work on an oil rig in the Middle East, or something else (even programming) that requires no college degree.

On sale of a principle residence, $250,000 in gain is tax-free, and that can be repeated every two years. Even if not a principle residence, the maximum tax is 15% compared to the roughly 50% tax rate suffered by a Silicon Valley programmer. A young man with a hammer can make a good living in sunshine, traveling around.

There is really no excuse for an enterprising person to seek work in Amerika. Much less to go into debt to "qualify" for it. A young man who is not bright or enterprising still may need a college education, I suppose.

[Austen]

Richard,

It seems from the article that Becker was interpreting the data to mean that people with over 100k in debt usually come out the other end with PhDs; my point was that it's not all just graduate degree holders. People do end up with similar debts and no more then a BA, where that much debt becomes extremely risky. I agree that 100k, 200k, or even 300k in debt for medical school is almost always a good investment, but because student loans cannot be discharged in bankruptcy and an individual's income is not like a stock portfolio that can be tailored to track the S&P 500 and deliver consistent and predictable results near the market mean, the possibility that one will fall below "average" in earnings is a terrifying one.

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I think it might be a mistake to focus on the debt held by students rather than total tuition costs. Some student hold lower debt than others because their parents made up the difference, but that causes its own set of problems for them.

[Max]

Stop assuming that people have the average debt of $30,000. Many of us with undergraduate degrees have way more than that and can barely keep up. To throw out numbers like $25,000 or $30,000 is to argue with a straw man.

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[TANSTAAFL]

Evidently the widespread availability of student loans has fostered yet another entitlement mentality among the putative beneficiaries of such financing. A very common mindset nowadays is that students can borrow their way through 4 years of fun in college, rather than working their way through in 5, 6, or 7 years, most likely with a lot less time for fun, then complain because the bankruptcy law makes student loans nondischargeable.

Bah.

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[NEH]

affl, Has or does the GI Bill fostered your "entitlement mentality" or the actions of other individuals on Government sponsored Loans who only wish to better themselves intellectually? Me thinks this is just another case of envy and the desire to keep the "Hoi Poloi" in their place. How about, "Let them eat cake"!

As for myself, I worked my way through College, both prior to and during (cleaning out the chicken barns at the University Research Egg&Husbandry Farm to be sent be sent to Cambell's Soup to be converted to Chicken Soup is always a fond memory)and also had an Academic Scholarship. Completing my degree program in the alotted four years. And Yes, I/We did have fun...

[TANSTAAFL]

NEH -- that's funny. I worked my way through college, in part, by raising chickens and selling fresh eggs to my professors. Also mucked out horse stables, punched cattle, and busted knuckles doing all sorts of construction work. And I borrowed not one penny, and never filled out one of those damn intrusive FAFSA forms.

The entitlement mentality I refer to in the case of student loan programs today is a far cry from the expectations fostered by the GI Bill. The GI Bill rewarded those who served their country in the armed forces. Today's profligate student loan programs, by and large, merely perpetuate the nanny state for high school grads for another four years, whereupon they awaken and realize the tab must be paid.

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[NEH]

affl, Hopefully, those eggs were from Rhode Island Reds or genetically modified chickens that has tripled egg laying capacity or feed that allows for increased output. Not too mention advanced Ag. mechanization. As for the egg output, "ours" went into the University Food Services. As for the "Nanny State", it's all an attempt by a "select" few to return full circle to the 16th Century where only the Aristocracy attended school. Something this Nation has been trying to get away from for the last two hundred years...

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[Tom Henry]

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[Merrill]

Both Becker and Posner assume that college ed *causes* the increased income of grads but correlation is not causation. It could be that those who go to college are brighter and more persistent to begin with and *that* is what causes higher earnings. The illegality of aptitude testing by employers may cause them to require degrees (from universities that relentlessly aptitude-test)as proxies at enormous extra expense for employees and society. Another potential cause for higher earnings that correlates with college but is not caused by it is the formation of social networks with other future high-earners that come in useful for finding clients, deals, etc. There could be cheaper subsitutes for this as well.

Finally, neither Becker nor Posner quantify the supposed externality to society of the education. Becker confuses this with the inabilitity to collateralize education but that is not a benefit. How do we know the extra benefit, if any, is not entirely absorbed by the extra income to the individual?

[Eric Rasmusen]

The last paragraph could be the entire blog post: it blows away 90% of what's said on this topic:

"Young families with mortgages that exceed $100,000 under normal circumstances are not considered to be in dire economic straits, even though their homes can be taken if they fail to meet their mortgage payments, and they are only investing in more comfortable living arrangements. Young couples that contracted a similar level of debt when they were students have invested in raising their earning power, usually by a lot. So I find it difficult to comprehend why sizable mortgages are accepted while there are political and media outcries over comparable student loans that are based on usually highly productive investments in human capital."

[jrcarter]

there is a great website for college loans. alltuition.com.

The college financing process is probably too muddy for a blogpost. But, I think that the economic incentives of four year schools are mismatched to the market. There are enough externalities and barriers to entry to try and fix that problem that is remains unsolved.

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Doing away with federal guarantees of student loans would discourage college from trying to foster excessive debt on students with these unpromising economic futures.

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