Student loans can have positive or negative effects on students. The system works for students who can benefit from a college education but cannot afford to enroll without a loan. These are likely the majority of borrowers.
However, many borrowers are left worse off after taking out student loans. These borrowers usually fall into one of two buckets: drop-outs and “not worth its.â€
College drop-outs can accumulate student loan debt, but without the earnings bump that graduates typically receive, even modest debt can be a substantial financial burden. The “not worth it†bucket comprises those who graduated but where the costs outweighed the benefits. Around 25% of graduates regret going to college, and around a third of them are underemployed, working in jobs requiring less education than they possess.
An effective student loan system would enable and encourage student loans that facilitate worthwhile educational investments while avoiding mal-investment (education that isn’t worth the cost). Our system fails at this, primarily because the federal government is the lender. The government offers loans to everyone on the same terms. It is content to lose massive amounts of money — 19 cents for every dollar lent.
However, ending federal lending and replacing it with private lenders could lead to improvements for students and taxpayers.
The most significant benefit for students would come from price signals indicating the riskiness of various educational choices. For example, while the government is content with lending to unprepared students attending ineffective colleges and majoring in fields with high unemployment, private lenders would avoid making such loans. This would help students avoid the drop-out and underemployment problems that stalk many unsuspecting borrowers.
Price differences would be helpful even for good students attending good colleges. For example, the interest rate on a loan for any student majoring in nursing would likely be lower than a loan for the same student majoring in psychology since there are plentiful nursing jobs but not many for psychology majors. These price differences would nudge students into safer choices about which college to attend and what major to pursue.
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Would students lose the 19-cent subsidy if they switched to private lenders? No, for two reasons.
First, students who graduate from college and get a good job generally repay their loans, so they account for very little of the subsidy. The bulk of the subsidy is from loans that are not repaid, which is typically due to drop-outs and “not worth its.†In other words, our current system doesn’t provide much subsidy to students investing in worthwhile education, but it showers students who are mal-investing with enormous subsidies.
Second, there is strong evidence that colleges raise tuition when loans are available. For instance, recent research finds that colleges raise prices by 64 cents for every new lending dollar. This means that colleges, not students, are the primary beneficiary of the student loan subsidy.
Taxpayers would also benefit from switching from government-as-lender to private lending. The 19-cents-per-dollar-lent loss translates into losses for taxpayers of $212 billion over the next 10 years. Moving to a system that relies on private lenders would eliminate these losses.
There are a few dangers in switching to a system of private lending. Fortunately, a defunct loan program, the Federal Family Education Loan program, “provides almost a perfect roadmap of mistakes to avoid when designing a private lending system.†Efforts to include loan guarantees (bailouts for lenders), price fixing (government setting interest rates), interest rate subsidies, or limiting competition among lenders would be huge red flags signaling that the effort is being “hijacked by crony capitalists.†These red flags are relatively easy to spot and avoid.
In sum, the massive benefits for students and taxpayers should provide the new Congress and president with all the reasons they need to switch from a government-as-lender system to one that relies on private lenders.
