Monday, April 3, 2017

Student Loans and the Need to Abandon Ideology.

Ideology is just a cover for shallow thinking.

There are real issues associated with student loans. Once they are identified it should be possible to avoid the ideological biases that inhibit effective public policy. Yet, much of the current discussion about policy related to student loans only addresses the symptoms of the issue (e.g., defaults and the cost the taxpayers, students graduating with unmanageable debt burdens, students who don't feel any sense of responsibility for the cost of their education). It is much easier to address symptoms within the ideological framework.  It doesn't even require any thought. The ideology is all one needs. Real issues, by contrast, often present intractable problems that require thought rather than ideology.

The last posting on the topic, “The Hypocrisy Should Bother Them: Student Loans,” pointed out some of the most egregious examples of ideologically induced policy blindness. This posting will look more closely at the real issues associated with student loans and illustrates how better policy options become apparent once ideology is set aside.

As discussed in a previous posting (“Educational Loans: Dare We Ask Who Benefits from the Subsidy?”) educational loans subsidized demand rather than supply. As a consequence, they increase the price of education. Last month the General Accounting Office (GAO) estimated that the loan forgiveness provisions of the student loan program would result in a cost of at least $108 billion (that's billion with a B not million). That's a pretty big oops.

Ideologues can focus on whether college is too expensive, the loan program was mismanaged by the Department of Education, or the Obama administration intentionally deceived the public. But, lost in the ideological arguments is the fact that this massive failure suggests an over emphasis on subsidizing demand rather than supply. Perhaps we should be considering taking that $108 billion out of the student loan program and allocating it directly to supply subsidies. Granted $108 billion is probably not the right figure but at least it's focused on the right issue: what's the most effective way for the public sector to subsidized post-secondary education?

Student loans undoubtedly have a role to play in the appropriate policy mix, but under the current institutional arrangements they are bearing too much of the burden. There are three groups that benefit from the subsidy implied by government guarantees of student loans. They are the students themselves, the academic institution, and society in general. But, as economists love to say," There is no free lunch." There are costs associated with student loans that have to be borne by someone. An obvious cost is the opportunity costs. The money used for student loans could be spent on something else.

There are issues associated with how costs are distributed. Just shifting from subsidizing demand to subsidizing supply assumes that the benefit to society in general justifies the cost. However, it's unlikely that currently the cost to society of subsidizing postsecondary education is equivalent to the benefits to society. If there are allocation issues associated with the benefits to the students and the academic institutions, those allocation issues almost certainly distort the return to society from its subsidies.

The distribution of costs should relate to the benefit derived from the student loans. The government's loan guarantee program is particularly poorly designed to accomplish that objective. The government guarantees the full amount of the loan, but the government is not the exclusive beneficiary of the loan.

The government isn't the only party to the loan or benefits and costs are improperly aligned. The cost borne by the student should reflect the value of the education to the student. If that were the case, the education would increase the individual’s income enough to pay back the loan. Clearly, that's not the case to the tune of $108 billion plus all the defaults beyond the part of the debt that is forgiven. The high and rising number of ex-students who are not meeting their loan obligation attests to the fact that the $108 billion is not the full extent of the exploitation of the students.

It is easy to ignore the root of the problem if your bias allows you to blame it totally on Obama for shifting student lending to the government. People who strongly believe in the private sector versus the public sector are prone to that bias. To them the entire problem is government inefficiency. The exploitation of the students is not intentional; it is just a byproduct of inefficiency. By contrast, many supporters of shifting student lending to the government supported the move out of fear that private sector lenders would intentionally exploit students. The problem with both biases is that they ignore the fact that defaults have occurred both when the loans were done by private bankers and when they were done by the government. The problem isn't properly addressed by vilifying the lender regardless of whether the lender is government or banks. The problem is the structure of the transaction (i.e. the student loan).

Saying that students are bearing $108 billion of costs that they can’t justify is not the same as saying that the $108 billion is not justified. The $108 billion may represent benefits but not necessarily benefits that accrue to the student who borrowed the money. A posting entitled “It's a Wonderful Life: Student Loans” suggested that part of the problem is that student loans are going to individuals with no sense of responsibility. 

People who strongly believe in the private sector versus the public sector are prone to see that as a major source of the problem. By abandoning the loan standards of the private sector the government failed to take into account the character of the borrowers. The problem with that argument is that the loan itself may be the source of the failure of the individual to meet their responsibility. Further, while the abandoning of private sector loan standards by the Obama administration may explain the exponential growth in student loan defaults, defaults are not restricted to individuals who borrowed since the responsibility for lending was shifted the government.

The problem with the student loan market is that it is burdened with government imposed distortions. Those distortions were imposed in order to achieve the social objective of having a broadly educated population. But, that objective can’t be optimized unless the distortions are either eliminated or taken into account. 

Currently the risk associated with the loan is borne by the student and taxpayers. The government guarantee of the loan puts taxpayers on the hook for a substantial portion of the cost of the inefficiency produced by this misallocation of the risk associated with student loans. Because as guaranteed by the government, the student can borrow more money for longer periods of time than would be the case if there were no guarantee. At the same time, in order to protect the taxpayers the government has given student loans what might be referred to as super priority in bankruptcy. In fact, student loans can't be dismissed in bankruptcy. As a consequence, student loans appear to have very little risk: they’re guaranteed by the government and can't be dismissed in bankruptcy. Thus, market forces can't be relied upon.

Eliminating the government guarantees and treating student loans like any unsecured loan in bankruptcy would eliminate the distortions and allow the market to function. A functioning market isn't an objective in-and-of-itself. However, the existence of a properly functioning market for student loans would position the government to more rationally address the issue of what is the proper way to subsidized post-secondary education. Currently, the government has to respond to the distorted demand for student loans that result from distortions they've introduced into the market.

People with an inherent distrust of markets will oppose this solution regardless of its potential benefits. That will be the case especially if, like academic institutions, they are major beneficiaries of the distortions in the market. People more favorably disposed toward markets may view correcting the distortions as all that is required. Neither is correct; illuminating the distortions still leaves the issue of how much society should subsidize post-secondary education. That's a social decision independent of the market result. There are social benefits to an educated population and economists are quick to point out that when there are such externalities the market does not generate an optimal result.

Externalities can surface in a variety of ways. By definition they involve a benefit or cost to a non-market participant. In the case of student loans the participants are the government as the guarantor of the loan (or its proxy if banks are doing the actual lending for the government) and the student. That brings us to the third beneficiary of student loans. The academic institutions benefit from student loans because they increase the demand for the services of the institutions, but they don't directly participate in the loan.

Academic institutions may prefer to avoid responsibility for their refusal to refrain from abusing the trust students and taxpayers have placed in them. However, the abuse has been so bad that politicians of many persuasions have called for a response. Often the response focuses on the symptom rather than the cause. The responses often focus on trying to take back the financial benefit (e.g., finding the institution) or forbidding the institution from responding to the incentive (e. g., insisting on limits on tuitions). They don't generally address the incentives that the government has created.

Further, ideology can influence the perception of the symptom. To illustrate, the Obama administration in 2014 created rules to punish educational programs that graduated large numbers of students with high debt burdens relative to what they could earn upon leaving school. Rightly they focused on whether students were repaying their debt as a way to identify schools that should be punished. The rules are an acknowledgment that there are benefits flowing to the academic institutions beyond those earned by providing benefit to the students.

Even with that acknowledgment there was an inability to recognize that the problem is with the student loan program. Rather, the Obama administration went looking for villains. Naturally, given its ideological bias they found them in the profit motive or at least tried to present it that way. First, they identified hundreds of for-profit colleges as subject to the rules. Then, they discovered that they grossly underestimated the number of students who were not paying back their loans. Once they corrected for the underestimation they discovered that the problem related much more to the composition of the student body than whether the institution was a state institution, a private nonprofit, or a for-profit institution.

Unfortunately, the intentional or unintended mishandling of the Obama administration's efforts to recapture the externalities created by the student loan program led those less inclined to distrust anything private sector to focus on the mishandling by the public sector. They could view it as an issue of regulatory overreach and government effort to pick winners and losers.

The simple expediency of having the educational institution take some responsibility for the loan can be avoided as long as one's prejudice allows one to ignore the fact that the educational institution is the free rider.

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