SHORT TAKES


December 12, 2012

Obama Bails Out the Students

Cross Posted From Open Market 

I've written before about perverse federal financial aid policies that encourage colleges to jack up tuition. Recently, the Obama administration came up with something even worse. It announced a new financial aid policy that will effectively bail out low-quality, high-tuition colleges and especially law schools at taxpayer expense, and encourage colleges and professional schools to increase tuition even more. These changes are the product of a revised income-based federal student loan repayment program that will go into effect starting December 21.

The revised "Pay as You Earn" program will allow eligible student-loan borrowers to cap monthly payments at 10 percent of discretionary income, and have their federal student loans forgiven after 20 years -- or just 10 years, if they go to work for the government. An earlier version of the program capped payments at 15 percent and offered forgiveness after 25 years. For students who foolishly attended third-rate but expensive colleges and law schools, this could wipe out part of their debt, at taxpayer expense, since their salaries in the low-paying jobs they end up with will be insufficient to pay off all of their massive debt in 20 years if they pay only 10 percent of their leftover income on repaying their student loans. Thus third-rate law schools stand to disproportionately benefit from this bailout.

This taxpayer subsidy for low-tier low schools is especially unfortunate, because such law schools are in many respects economically harmful, and many law schools teach their students so few practical skills (as a few candid law professors have admitted) that students would be better off studying for the bar exam on their own, rather than attending such law schools. Alas, the option isn't available.

In the short run, this will primarily benefit those students. But in the long run, the primary beneficiaries will be low-quality but expensive colleges and law schools, which will be able to raise college tuition through the roof, since no matter how much debt their students run up in college, it will be written off after 20 years. That will eliminate market-based price discipline for those colleges, resulting in even more rapid increases in tuition.

Of course the losers in this new arrangement will be American taxpayers, who will be on the hook for the unpaid balances. Recently, college loan debt passed credit card debt as the largest, non-mortgage, source of debt in the United States. If college students were willing to rack up this much debt under the assumption they would have to actually pay it back, imagine how much debt they will be willing to amass now that they realize they do not?  As a result, expect college tuition increases to not only continue but to accelerate.

Under the Obama administration's new program, the federal government will write off most of these foolish law students' loans, and they will not even have to repay what they are capable of paying, since their payments will be limited to less than 10 percent of their income. (By contrast, prudent students who attended cheaper or better law schools will not receive the same benefit, since their loan payments are generally already smaller compared to their incomes.) These law schools will respond by increasing tuition even faster, since the increased tuition will simply be paid by the American taxpayers when the borrowed tuition is later written off.

Colleges have been able to increase tuition faster than inflation, year after year, secure in the knowledge that they can rake in ever-rising government subsidies and skyrocketing tuition. College students are learning less and less even as education spending has risen. Meanwhile, the Obama administration has de-emphasized the teaching of practical skills needed in manufacturing.

Using faulty math, the Obama administration has given this costly income-based repayment program a ridiculously low price tag of just a few billion. Time will undoubtedly prove them wrong. 

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