By Jackson Toby
When Victor Hugo claimed that all the world's armies are powerless against an idea whose time has come, he probably had in mind good ideas. But the time can come for a bad idea also. Low-cost student loans, embraced by President Obama, Governor Romney, and Congressional leaders of both parties, is a bad idea. Students and prospective students love the prospect of paying less for college, and so do their parents. Moreover, some economists say that investing more in educating youngsters from low-income families will increase the ability of American workers to compete in the global marketplace.
But students don't need cheaper loans. What they need are loans that give them an incentive to get good enough college educations to qualify for jobs - well-paying jobs that enable them to pay off their loans. The flaw in the federal guaranteed student-loan program - from its beginning in 1965 - has been its exclusive concern with whether or not students came from families with low-incomes, not whether loans would help launch careers.
Consequently, to reform the federal student-loan program, the Department of Education should start targeting student loans: giving cheaper loans, not to every student from low-income families, but to needy students with good prospects for repaying the loans they take out. Some loans should continue at a 6.8 per cent interest rate, as Congress originally planned in a 2007 law; some will charge 3.4 per cent or even less. Differential loan rates have two advantages. First, they would reduce student defaults and thereby reduce not only the credit problems that defaulting students get into (but also the cost of these defaults to American taxpayers). More importantly, a side effect of targeted loans would be to improve the educational atmosphere of American colleges.
The Helpful Side Effects of Good Loans
When students know that the interest rates on their student-loans are at stake every year, they are more likely to choose to pay attention in class and do assigned reading, less likely to spend long weekends drunk or taking "recreational" drugs, and less likely to accumulate bad credit ratings by maxing out their limits on several credit cards on balances they cannot pay. Financial incentives surely will concentrate the minds of some students. Students don't need cheaper loans; they need better educations.
Living beyond one's means is a very old practice. That is why imprisonment for debt - and even enslavement for debt - occurred in Roman society as well as in other societies of the Ancient World. Indeed, As recently as the mid-nineteenth century, young British aristocrats, imprisoned in Fleet Debtors Prison for running up debts, waited for parents or friends to take pity on them and pay off their creditors. But imprisonment for debt is now rare, partly because debt has become ubiquitous. And today -- in modern societies - nearly everyone is in debt. The question in affluent societies is not whether to live beyond one's current means, only whether one's future means will make repayment possible.
Like adults, teenagers obtain credit cards, frequently several cards in order to maximize their ability to buy things they want that they cannot currently afford. They often fail to realize that, if the debts are to be repaid, high interest rates make credit card debt very expensive. So, if teenagers want to attend college, they already know intellectually that borrowing the money to pay tuition and living expenses is a possibility. Student loans extend practices that they and their parents have already been doing.
One difference, however, differentiates student loans for higher education from credit card debt. The federal government guarantees repayment of many student loans. Therefore, each loan default on federally guaranteed loans eventually adds to the national deficit. Initially, the cost of defaulted loans was negligible because the federal loan portfolio was small and the majority of graduates were paying their loans off. However, defaulted student loans have become more costly and are receiving more attention in the media. The Department of Education announced on September 13, 2011, that the overall default rate for federally guaranteed student loans had risen to 8.8 percent for the fiscal year ending on September 30, 2010, up from 7 percent the previous year. This was the highest default rate since 1997.
Tip of the Iceberg
The 8.8 percent rate of defaults is only the tip of the default iceberg because this number refers to the 320,000 graduates who defaulted within two years of their graduation, when their first payments became due. It did not anticipate how many of the 3.6 million graduates from that cohort of students who graduated two years earlier with outstanding student loans would default later. Experience suggests that many would - with this result: postponed marriages and moving back with parents. Longitudinal studies of student borrowers show that defaults peak in the fourth year after payments begin to be required and continue in subsequent years. Estimates are that about 40 percent of student borrowers will default before they pay off their loans or die. This will happen despite Department of Education efforts to prevent students from falling into the default category by postponing the repayment requirement through deferments or forbearance mechanisms. Students can also try to avoid defaults by enrolling in graduate or additional undergraduate programs because the repayment requirement begins only when students are out of school, but this merely postpones the repayment obligation - and increases the load of student debt. Students must eventually either get jobs to enable them to start repaying their student loans or default.
By 2012, students and former students had accumulated debts of more than $1 trillion on their student loans, more than the total of American credit card debt. Defaults increased in 2011 and 2012 as a higher proportion of college graduates failed to get jobs. Unfortunately, current college graduates are finding it more difficult to get jobs than college graduates were four or five years ago. One reason they can't find jobs is the weak economy, but it is also due to a fatal flaw in the student loan program that was present from its beginning in 1965. Instead of giving students loans to promote their educational commitment and effort, the federal student loan program has, from its beginning, given educationally promiscuous student loans.
As with sub-prime mortgages given by Fannie Mae, Freddy Mac, and banks, the Department of Education and Sallie Maes gave students loans without scrutinizing their ability to repay them. Congress hadn't asked them to. This design flaw will lead to larger contributions to the deficit from defaults in future years unless Congress requires credit worthiness for students receiving federally guaranteed student loans.
When Congress originally decided to help youngsters from low-income families go to college, it provided Pell grants. Loans were an afterthought. Pell grants were intended to give youngsters from such families the opportunity to prepare at college for well-paid, interesting careers. Congress did not anticipate how popular Pell grants would become and how much they would cost. In 2009-2010, 7.7 million students received $28.2 billion in Pell grants (plus the administrative cost of about $4 billion to administer this large program). Pell grants add to the deficit in the year they are given out but not to future deficits because they do not have to be repaid. Congress limited the maximum size of Pell grants to individual students, although it gradually increased that limit as college costs rose. It was $5,350 for the academic year 2009-2010, $5,550 for 2010-2011, and $5,710 for 2011-2012. Limiting the size of Pell grants was politically necessary because bigger grants would have been very expensive.
Pell grants did not cover rising college expenses, and Congress established various guaranteed loan programs (beginning with Title IV of the Higher Education Act of 1965) as supplementary student aid for college costs. Loans rather than grants now comprise three-quarters of federal student aid. Unlike grants, student loans must be repaid after graduation or after leaving school without graduating--along with accrued interest--regardless of whether their educations help former students get jobs. Guaranteed student loans have always required only an assessment of economic disadvantage, never the ability to repay student loans; graduates who major in having fun--as many college students may do, especially in "party schools"-- may fail to learn enough to get jobs afterwards, especially well-paying jobs.
Congress should require for federally guaranteed student loans evidence of ability to repay the loans by examining students' academic records, credit histories, and other criteria of credit-worthiness. This change would treat student loans as risky investments, which they are, and ensure that they are given only to student borrowers with a good chance of being able to repay them. Needy college students would still be eligible for Pell and other college grants. Like loans, grants have never imposed a requirement of credit worthiness.
The prospect of costlier loans sounds like a practical way for the United States to teach students to live within their means. Again, students need stronger educational preparation for the job market, not cheaper loans.
Jackson Toby is professor of sociology emeritus at Rutgers University where he was director of the Institute for Criminological Research. He is an Adjunct Scholar at the American Enterprise Institute. The paperback edition of his book, The Lowering of Higher Education in America, was published in March.