By Jackson Toby
No modern-day Paul Revere is taking a midnight ride to warn about this, but the defaults are coming. Many are already here. They are coming from student loans given to the wrong students for the wrong reasons. The portfolio of federally guaranteed student loans passed the one trillion dollar mark in early 2012, and it continues to grow. The portfolio consists not only of loans for students from low-income families currently in college but also of hundreds of millions of dollars of education loans taken out by students who graduated from college or quit before graduating that have not been fully repaid. Such loans were extended either by the Department of Education directly or by financial institutions like Sallie Mae and banks and guaranteed by the United States Treasury. The total size of this loan portfolio exceeds the total credit card debt of the American population.
Former students will eventually default on a considerable portion of these loans--a reasonable estimate is 40 per cent--or die before paying them off. This means that student debt is likely to be a permanent drain on taxpayers, as defaults add to the ballooning federal debt. Defaulters suffer too; they need not fear debtor's prisons, which no longer exist, but their credit standings will be ruined for years. Even some graduates of professional schools cannot find jobs in the professions they borrowed large amounts of money to train for -- and cannot repay their loans. Nine graduates of New York Law School accused their alma mater of misleading them about their postgraduate employment prospects and sued. Melvin L. Schweitzer, a New York Supreme Court judge, dismissed their lawsuit. While expressing some sympathy for the students' plight, Justice Schweitzer said the suit had no merit and was essentially a case of caveat emptor -- let the buyer of a legal education beware.
Unsustainable and Imprudent Loans
This pessimistic prognosis for student loans assumes that that the existing student loan program has become unsustainable, as the sub-prime mortgage-lending program was unsustainable, because of imprudent risks. Sub-prime mortgages were at least based on property, albeit overvalued property; student loans are based on nothing more tangible than the earning prospects of students after completing their educations. The student-loan risks were imprudent because of at least two aspects of a trillion-dollar misunderstanding:
- The failure of many students to understand the difference between grants, such as Pell grants, which are taxpayer gifts awarded to college students who can demonstrate financial need, and loans, which must eventually be repaid - with interest. Contributing to this misunderstanding is that both types of federal financial aid are funneled though campus departments usually called the "Office of Financial Aid." These offices assemble a financial "package" covering current college expenses including parental contributions, student earnings, grants, and loans. The time when repayment of the loans must begin is six months after graduation - for many students, in the almost unimaginable future. Students didn't realize that the burden of large student loans could be justified only if they have a realistic chance of high future earnings.
- The assumption of most parents and politicians that higher education is an investment in future careers. Many students regard a college education that way also, but for a large minority of students college is not investment but consumption: four fun-filled years before they have to settle down to a life of adult drudgery. That is why many enroll in courses they hear are easy, fail to do the required reading, and come late to class and leave early when they attend the class at all. For such students, college is a time-out or in the words of psychiatrist Erik Erikson, a "psychosocial moratorium." Do students, parents, and lawmakers really want students to incur burdensome loans that must be repaid later - or defaulted on -- to finance a psychosocial moratorium?
True, it is not possible to predict precisely which students are likely to repay their student loans and how quickly they can do it. But ignoring the likelihood of students being able to repay their loans invites similar problems to those attributable--at least partly--to bankers who did not require applicants for mortgage loans to make down payments, have good credit histories, and produce evidence of earnings from employment. What evidence is there that bankers are capable of distinguishing students likely to pay up from students likely to default? The most compelling evidence is the experience of banks. The history of banking over many centuries - and the profitably of most banks - attests to the ability of loan officers to distinguish good risks from bad ones.
Here's what the Department of Education does now: it gives Direct Loans to every college student who demonstrates financial need, without examining evidence of academic ability and other criteria of credit-worthiness. From the liberal standpoint, this policy provides crucial educational opportunities to young people from low-income families. Liberals are willing to have taxpayers pay for the higher default rate in exchange for the increased educational opportunities for children from low-income families.
Why Are Taxpayers Ultimately Responsible?
This policy position recalls the confusion of grants and loans. Children from low-income families already receive Pell grants as well as other need-based scholarships that do not require evidence of good credit ratings or superior academic performance. In 2009-2010, Congress appropriated $25.3 billion for Pell grants for 7.74 million American students. True, the maximum grant was only $5,350 per year and the average grant $3,646, not enough for the rising tuition rates at most colleges and universities. Keep in mind though that these are taxpayer gifts that do not have to be repaid, and the Pell grant program has been an expensive drain on the budget that continues to grow. For 2010-2011 Congress appropriated $32.9 billion for 8.87 million American students; the average grant had risen to $4,115 and the maximum grant to $5,550.
Congress established a loan program in addition to the grant program because it seemed politically untenable to provide grants large enough to cover the educational expenses of the millions of students who wanted to attend college, regardless of scholastic preparation or serious interest in education. The logic of loans was to give students some responsibility for the cost of their post-secondary educations. It was only partial responsibility, however, because federal guarantees of repayment of the loans made taxpayers ultimately responsible.
The three possible approaches to the student loan problem are as follows:
- Turn all the loans into grants so that taxpayers rather than students are responsible for repayment.
- Continue to provide student loans to all students who demonstrate financial need, regardless of whether many default - thus allowing similar disadvantages both to students and taxpayers as happened with sub-prime mortgages.
- Insert a risk-assessment component into all future student loans that includes credit-worthiness and past academic performance, in order to maximize the likelihood of loan repayment and minimize defaults that add to the national debt.
Possibility 1 is unlikely to attract the support of the voting public and therefore of Congress or even of President Obama in view of current concerns with budget deficits and the overhang of the large national debt. Possibility 2 is almost as bad; the trillion dollars of student debt that has already accumulated will grow and the defaults will increase. That leaves Possibility 3 as America's only chance for keeping student debt under control. The best argument against it is that some students who would ultimately pay back their loans will not receive them because they don't appear to be good risks to the screeners and, on the other hand, that some students who look like good risks to the screeners ultimately default. In short, the human beings who assess the risks of would be student-borrowers, being fallible human beings, make imperfect judgments. Of course, in a decentralized system of loan allocation, students denied a loan in one bank might receive it in another. Although mistakes will be made, the question is: Is a student loan system that attempts to control the risk of default better than one that gives loans promiscuously to all college applicants? Reasonable voters would say that it is.
Moreover, attempting to control the risk of student defaults has an important advantage, as I argued at length in the final chapter of my book, The Lowering of Higher Education in America: Dangling the prospect of getting needed student loans before students and their parents constitutes an incentive for college students and would-be college students to behave more responsibly. They will be more likely to pay attention in class and do assigned reading, less likely to spend long weekends drunk or on "recreational" drugs, and less likely to accumulate a bad credit rating by maxing out their limits on several credit cards on balances that they cannot pay. In short, a side effect of the risk-assessment approach to student loans is to nudge the student cultures of college campuses in the direction of making responsible adult behavior more attractive - even respectable.Well, why not?
Jackson Toby is professor of sociology emeritus at Rutgers University and an adjunct scholar at the American Enterprise Institute. The paperback edition of his book, The Lowering of Higher Education in America: Why Student Loans Should Be Based on Credit Worthiness, will be published in April 2012 by Transaction Publishers.