Wednesday, January 4, 2017

The Hypocrisy Should Bother Them: Student Loans

Or perhaps they're not so smart

This is the third posting on student loans. The first two postings focused upon how we could organize student lending to achieve greater social benefit. They reflect the general philosophy that it is more productive to focus on potential improvements than to concentrate on failures of the current environment.

Unfortunately, many people are so wedded to rigid ideologies that they are blind to alternatives. Others lack the imagination, intelligence, and open-mindedness to see any alternative other than what exists. Either many people formulating policy are tremendously hypocritical or they just aren't smart enough to see alternatives to the disaster they are creating.

So, critique of the current system may be a prerequisite for getting people to address its deficiencies. However, it would be totally unproductive to just critique the current system without at least providing the outline of a viable alternative. With that in mind, this posting begins with a brief summary of the general outline of the major conclusions from the previous two postings.

An alternative approach.

The previous two postings suggested an approach that involves having the government discontinue most subsidies of demand for post-secondary education and shift resources to subsidizing supply. Academic institutions should be forced to bear some risk associated with the product they deliver by making them partially responsible for the risks that individuals incur in order to finance education. The risk that individuals bear by borrowing to finance education should be treated the same way as the risk associated with any loan. Student loans should be treated in bankruptcy like any other consumer loan.

The previous postings.

The first posting done on October 27, 2015 was entitled "Educational Loans: Dare We Ask Who Benefits from the Subsidy? Sometimes it pays to ask the right question.” It focused on questions related to what should be the proper objective of subsidies to post-secondary education. It acknowledged the need for subsidies and discussed how the benefits of subsidies end up being distributed.

It pointed out that the appropriate objective for public subsidies to post-secondary education is a level of post-secondary education that is justified in terms of the benefits it provides to society. That definition of an objective implies an assumption that post-secondary education provides social benefits. Put differently, it assumes that we all benefit from an educated population. However, it also points out that while that social benefit exists, its magnitude is open to debate. Thus, the posting emphasizes methods for ensuring the socially desirable level of post-secondary education without specifically defining the magnitude of the social benefit.

To achieve that objective, most public subsidies should focus on increasing the supply rather than increasing the demand for education.  Public subsidies of student loans may actually be counterproductive in terms of the public policy objective. There is considerable evidence that the educational establishment from the lowest instructor through the administrative apparatus, including the Department of Education, has positioned itself to capture the benefits of subsidies to demand. Any supplier of a good has an incentive to respond to increased demand by increasing price and constraining supply. The educational establishment is no different.

At the same time, student loans are a necessary component to making access to post-secondary education available to the entire population, another desirable social objective. The benefits to the individual from post-secondary education accrue at a different time from the cost. Not all families and individuals are in a position to finance that difference in timing. Educational loans can fill that void, but since that benefit accrues to the individual, it does not need to be subsidized by public entities. Demand subsidies, such as government guaranteed student loans, increase the price of post-secondary education and thus make it less available to those with limited financial resources.

The difference in efficient methods appropriate to achieving these two social objectives has tripped up those responsible for formulating policy. The problem is not new.  As the posting states, “When addressing subsidies for post-secondary education, policy makers should first compare who benefits from post-secondary educational loans to who bears the risk of those loans.

If they did, they would realize that analyzing who benefits is a prerequisite to addressing the appropriate level of expenditures for education” (i.e., combined public and private expenditures on education) “and the appropriate participation of the public sector” (i.e., a public subsidy that reflects the social benefit of an educated population). The distribution of benefits has to be addressed because if student loans result in benefits that are captured by the educational establishment, it follows that “The US will never get the right level of investment in education and a justified public subsidy to post-secondary education...”

 “They would also realize that it is clear that the educational establishment should be bearing some of the risk” (i.e., the risk that the student is bearing by taking on debt under the assumption that the education will produce an adequate positive return to pay back the debt). In short, educational establishments should have to bear some of the risk associated with student loans.

The misplaced incentives created by the current system are widely recognized.  For example, Mr. Duncan, a former secretary of the Department of Education, has noted the problem and stated: “Government, at both the federal and state level, along with accreditors and Congress, need to flip the current incentives in higher education,” Mr. Duncan said. “In the current system, only students, their families and taxpayers lose when students do not succeed. That simply doesn’t make sense.” 

Having educational institutions bear some of the risk for student loans would be a very efficient way to force them to ensure that education delivers a benefit to the student that justifies the loan. The alternative of having students sue the school, professors, and the faculty unions whenever their education is disappointing would be far less efficient. Further, it is unlikely that the government will sue academic institutions when their graduates are unable to repay their loans, although government suits would be more efficient than individual student suits.

The second posting on student loans was on December 28, 2016. It was entitled "It's a Wonderful Life: Student Loans: It isn't whether you win or lose but…." It focuses on the impact of student loans on individuals and families.

It points out that:   “If the government is taken out of the role of the student lender or guarantor of student loans, the basic structure of the student loans is no different from any other loan. The government may provide a subsidy in a form other than a loan guarantee, but there's no reason why that subsidy has to dictate the terms of the loan.”

The failure of the current system

WALL STREET JOURNAL on December 27 ran an article entitled “Student-Loan Market Warms Up: Trump administration is seen as making the sector friendlier to private lenders.” It illustrates how ideology can blind observer to options. It treats government lending or private lending, primarily bank lending, as if they are the only alternatives.

It ignores important aspects of the issue. For example, should the government be guarantee student loans at all? Should bankruptcy proceedings include student loans along with other types of debt? At the same time, the article is to be commended for pointing out that student debt has become an issue with over $100 billion (by government estimates) that the government plans to forgive. Also, the article is a report rather than an editorial, and thus, can be forgiven for just reporting on the two sides taken by various policy advocates. The real critique is that none of the policy advocates has the imagination to see that the either/or decision they're posing is a blueprint for failure regardless of who wins.

The article points out the expectation that some change will take place. The Republican Party’s platform called for a return of private lenders. “The federal government should not be in the business of originating student loans. In order to bring down college costs and give students access to a multitude of financing options, private-sector participation in student financing should be restored.”
It fails to knowledge how government guarantees on any loans can cause the loans to be mispriced. 

Regardless of whether the government or banks make the loans, if there is a government guarantee, the loans will be mispriced because the value of the risk in the loan has been shifted to the taxpayers. Consequently, many individuals will be encouraged to take on larger loans with longer payment periods than is appropriate. The fact that we currently have some people on Social Security who are still paying back their student loans clearly indicates that the issue of government versus bank loans only addresses part of the problem.

But those who are ideologically blinded to the true issue because of their commitment to private-sector financing aren't the only ones at fault. The magnitude and crisis nature of the ballooning student loan burden goes way beyond the results of mispricing. The problems that the private sector can create when government guarantees distort loan risk pale compared to the mess that can be created if the government takes responsibility for actually doing the lending. It is very hard to come up with any conceivable justification for the exponential growth of the student debt burden under the Obama administration.

The Obama administration has either been totally blind to the mess they created or extremely hypocritical in its handling of the student loan issue. Giving the Obama administration the benefit of the doubt, one can only conclude that they were not smart enough to see the disaster they created. As the article points out, under President Barack Obama, responsibility for student lending “was transferred entirely to the U.S. government, already the dominant force in the market.”

The move was designed to lower lending costs for the government….” They were wearing complete ideological blinders if they really believed that taking on increased responsibility for mispriced loans would lower cost. The WALL STREET JOURNAL article points out that they “wanted to redirect savings to student grants and to offset costs associated with the Affordable Care Act.” Whether one endorses those objectives or not, the mechanism by which they tried to accomplish them just wasn't smart. (In passing, it is worth noting that the previous postings endorsed their objective of increasing student grants as an alternative to mispriced lending).

The article notes that: “The result has been a student-loan market run almost entirely by the federal government— and for which taxpayers are ultimately on the hook.” By government estimates that hook is already over $100 billion, and there are numerous reasons to think it will grow.

The article goes on: “An added concern: Most of this federal debt was extended to borrowers without checking their credit scores. When the government totally ignores the benefits of the market allocation of credit, loans go from just being mispriced to being mispriced and distributed in ways that are irrational.   How could anyone imagine that it benefits anyone to lend to individuals without any regard to their ability and likelihood to repay the loan? The borrower ends up with a debt burden they can't pay and the lender loses their money.

Clearly, the policies of the Obama administration were going to saddle some students with an unbearable loan burden. The hopelessness of the situation that the government was putting them in was clearly going to undermine their future. Many students have no hope of ever being able to demonstrate the responsible behavior that would allow them access to the financial resources they'll need later in life. Even if the loans are forgiven, that failure to repay their debt is going to undermine their sense of financial responsibility for their behavior. It's almost as if the Obama administration is pursuing a policy designed to undermine students’ sense of achievement and sense of responsibility.

The full extent of the hypocrisy of the Obama administration can be appreciated when one considers some of the steps the Obama administration took to ensure that it had control of all student lending. As the article points out: “Regulatory scrutiny of private lenders also intensified after the Consumer Financial Protection Bureau opened in 2011.”

Keep in mind that the Consumer Financial Protection Bureau is supposed to protect consumers from predatory lending. Even a cursory examination of student loan debt burdens and default rates make it clear that the predatory lender in the student loan market is not private lenders. It is the government. Yet, the Consumer Financial Protection Bureau has not initiated any steps to rein in the abusive lending practices of the Department of Education. It is the epitome of hypocrisy for the Consumer Financial Protection Bureau to ignore predatory lending by government agencies.

Technically one could argue that the Consumer Financial Protection Bureau is an independent agency that is not a part of the Obama administration. In fact, it is an agency that is responsible to no one. But that would be extremely disingenuous given that it was created as a result of the Dodd-Frank financial reforms and that the Democratic party has refused to acknowledge that Dodd-Frank could be less-than-perfect.

If we don't address the deficiencies in the student loan market, taxpayers, many of whom never had the benefit of college, will be saddled with the bill for hundreds of billions of dollars. Unfortunately, the result of that tax will not be a responsible educated population. Forgiving the debt of students who can't repay it will cultivate the selfish attitude that they, the college-educated students, have no responsibility for returning the resources to society that society put into their education.

Summary

Students taking on a post-secondary education deserve every opportunity to start adult life with a sense of accomplishment, an appreciation of the importance of responsibility, and a chance to demonstrate responsible behavior. They should be able to graduate with a sense of pride rather than responsibility for government insured loans that do nothing but guarantee that some of them will experience financial failure.


A major benefit of the approach outlined in the previous two blogs is that if the “Student loans could then be treated like other loans, and if it’s impossible to repay them, they could be dismissed in bankruptcy. Thus, students who borrow and then repay or that finance the education within the family, as in the “It's a Wonderful Life,” will demonstrate how to play the game: take responsibility, be grateful for the opportunity, be thankful for the subsidy that would replace the loan guarantee, and do the best you can. Win or lose that seems like a better route to wonderful life than living with the illusion that others are responsible for your future.” 

1 comment:

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