The Congressional Budget Office (CBO) recently released a new assessment of the cost of the federal government’s income-driven repayment (IDR) plan for student loans. The numbers are depressing. The federal government expects to write off $207 billion in student loan debt in the next decade.
How did we get here? Back in the 1960s, based on the notion that going to college is a good investment and hoping to level the playing field for minorities and the poor to go to college, President Lyndon Johnson signed the 1965 Higher Education Act. It lets the government guarantee student loans made by private financial institutions, essentially putting all risk on the shoulders of taxpayers.
President Richard Nixon followed with the Higher Education Act of 1972, which codifies the system we have today: students can get a combination of grants and loans from the federal government to pay for college. The 1972 act also established Sallie Mae, a government-sponsored enterprise. Sallie Mae was authorized to borrow from the U.S. Treasury at below-market rates to purchase federally guaranteed student loans from banks, thus freeing capital so private banks could make even more student loans.
There is no academic criteria to prevent anyone from getting a student loan because college debt has become an entitlement available to all. There is also no concern about dropouts and the borrower’s ability to repay.
With this abundant supply of cheap taxpayer money, the demand for college went up, so colleges raised tuition and fees, which then caused Congress to increase student loan limits and grant amounts. This vicious cycle keeps repeating itself as colleges become more and more expensive and the outstanding student loan debt has increased. Pell Grants today cover less than 30 percent of college tuition and fees, even though they used to cover 80 percent in 1975.
It’s Other People’s Money, So Who Cares?
The federal student loan program has enriched Sallie Mae, private banks, and colleges, but exposed U.S. taxpayers to enormous financial risk. Undeterred, President Clinton decided to get the federal government even more involved in student lending by having the U.S. Department of Education launch a Direct Loan Program in 1993.
When President Obama came into office, he decided that a federal government takeover was the best way to fix the student loan problem. In 2010, the President signed the Health Care and Education Reconciliation Act (HCERA) Act, which kicked private lenders out and made the federal government the only issuer of all federal student loans.
We were told the federal government takeover would “put an end to wasteful subsidies to banks and used much of the more than $40 billion in savings to strengthen college access.” The CBO even projected in 2012 that the federal takeover would generate a $219 billion profit over a decade.
The HCERA Act also offered the income-driven repayment (IDR) option to help student borrowers manage repayment. The IDR capped monthly student loan repayments at 15 or 10 percent of income for borrowers after 2014, and made taxpayers pay the rest of their tab after 20 years.
President Obama sweetened the offer further by announcing a “Pay as You Earn Plan,” which allowed about 1.6 million students to take advantage of IDR as early as 2012. People who work in government jobs will see any remaining debt paid entirely by taxpayers after 10 years. Not surprisingly, the federal government takeover and the IDR were welcomed by many back then, and President Obama easily won his reelection.
A decade later, we learned the truth. Instead of generating $219 billion in profit, now the CBO projects an $11 billion loss through 2029 based on its own questionable accounting. The Wall Street Journal, based on fair value accounting that American businesses use, estimates the loss will be $263 billion by the end of this decade.
Borrowers Were Happy To Get Other People’s Money
The Obama administration grossly underestimated the number of borrowers who would sign up for the IDR. By 2016, close to six million borrowers took advantage of the IDR plan, more than the 1.6 million original estimate we were given. Borrowers are attracted to IDR because there is no concern for the value of their education or how much they can make in the future.
Actually, the IDR incentivizes borrowers to find a low-paying first job so they can keep their initial repayment low and expect a final loan payoff at the end of 10 or 20 years. CBO’s own data shows “borrowers who select income-driven plans tend to borrow more money. CBO also expects the average subsidy rate of loans in income-driven plans to be higher for loans to graduate students than loans to undergraduate students, mainly because graduate students take out larger loans, which are less likely to be paid off.”
The CBO also estimates that if there is no change in current law, the federal government will disburse $1.05 trillion in federal student loans in the next decade, out of which “undergraduate borrowers would have $40.3 billion forgiven and graduate borrowers would have $167.1 billion forgiven. The forgiven amounts are equal to 21 percent of the disbursed amount for undergraduate borrowers and 56 percent of the disbursed amount for graduate borrowers.” So even based on CBO’s questionable accounting, taxpayers will bail out more than $200 billion in student loans in the next decade.
Free College Is A Scam
The fiasco of the IDR is merely the latest episode of our nation’s student loan crisis, a crisis created by the government that has been worsened by a succession of “well-intentioned” fixes.
Today student loan borrowers collectively owe more than $1.5 trillion and an average of $34,000 per person. About 40 percent of them never even completed a degree despite accumulating mountains of debt. Some will still be paying their student loans after retirement.
Sen. Bernie Sanders’ free college proposal may seem to help current student borrowers, but does nothing to address the root cause of the rising costs of attending colleges, nor will his proposal ensure quality education. Instead, his proposal will end up costing students more in subpar education outcomes and will cost taxpayers even more unsustainable debt because there is no such thing as a “free college,” and someone still has to pay for it.
How To Stop the Madness
To fix the student loan crisis, the nation must do several things. First, the federal government must get out of the student lending business, stop lending to students and their parents, and stop guaranteeing private student debt. Let private financial institutions impose time-tested sound lending criteria such as a borrower’s ability and willingness to repay in order to minimize future losses.
Second, adults should stop promoting the idea that “borrowing money to pay college tuition is a good investment.” In an op-ed, Walter V. Wendler, president of West Texas A&M University, wrote that adults have a responsibility to inform students and their parents that not every college degree is worth whatever it costs.
Based on starting salaries by college majors, the marketplace clearly values some majors more than others. Adults also need to help students understand the pitfalls of borrowing. “Borrowing the amount you can’t afford to pay back or you have to spend a lifetime to pay back is not an investment,” wrote Wendler.
He advises prospective students not to borrow to pay college tuition because “student loan debt can have a negative, long-term effect on people financially and emotionally.” If a student must borrow, he recommends following the “60 percent Rule,” which means never borrow more than 60 percent of one’s anticipated starting salary at the first job.
You Don’t Need College to Make Your Way In Life
Adults should also let students know that not everyone needs to go to college to have a successful and fulfilling life. The most recent Deloitte Skill Gap Study shows that 2.4 million jobs will likely go unfilled over the next decade because businesses can’t find workers with the right skill sets.
Many colleges do not have the flexibility nor the resources to equip students with the most desirable and marketable skills that businesses need today. Apprenticeship and vocational schools are better investments and better alternatives for some students than college. There are also lucrative careers that don’t require a college degree at all.
Third, colleges need to have a skin in the game, which means they must invest in their students’ future success. Purdue University started an income sharing program in which the university lends money directly to students, in exchange for a share of their income for a period of time after graduation.
Students who attend the San Francisco-based online computer coding school Lambda pay nothing upfront. The school gets to claim 17 percent of their future income for two years, but only if graduates get a job making $50,000 per year.
We need more colleges to invest in their students’ success like Purdue and Lambda do. Austen Allred, the co-founder and CEO of the Lambda School, said, “If your job as a school is effectively promising a job, it doesn’t make sense that student pays you a bunch of money that doesn’t work out on the other side.” Amen to that.