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December 3, 2013

The Student Loan Debacle:
a Clear Moral Hazard

california-student-protests.gi.top.jpg

By Gary Jason

Here, in a nutshell, is the human toll of the student-loan mess: it is forcing many recent grads to defer marriage and having children; it is hobbling many prospective entrepreneurs that our economy badly needs and may well delay the retirement of new grads by 11 or 12 years.

The total student-loan debt hit $1 trillion dollars two years ago, eclipsing total durable goods debt, and credit card debt. It is now one-fifth higher, at about $1.2 trillion. Student loan debt tripled between 2004 and 2012, with more than 40% of 25-year-olds now carrying student loan debt, averaging $24,000 per debtor. And remember, it is nearly impossible to discharge student-loan debt in bankruptcy.

By "debacle," I mean this sad process: the ramping up of federal government guarantees for banks lending money to more and more students over the last 15 years (culminating in the complete nationalization of Sallie Mae in 2008), which led to an explosion in college tuition and consequently an explosion in total loan debt.

Other Debt Is Down

This debacle seems to be entering a crisis mode. A recent Atlantic piece indicates that while the first half of this year saw a modest decline in the delinquency rate on student loans, by September, nearly 12% of student loan balances were delinquent 90 days or more. In this period, please note, 3-month delinquency rates for credit card debt, mortgage debt, home equity revolving loan debt, and auto loan debt all declined.

Of course, it is manifestly clear that easy student loans are a classic case of moral hazard. They seduce students into taking on excessive debt, often to pursue college degrees that may simply be unmarketable. Worse, they seduce incompetent students to pursue degrees they never earn, leaving them worse off than if they had never gone to college.

However, it is important to note that the costs of the student-loan program are not just the explicit costs--the accumulated debt of the students--but the implicit opportunity costs as well. By "opportunity cost" we mean the value of the next best opportunity that they passed up in financing their college educations with debt. And a number of reports are beginning to explore these opportunity costs.

Retirement at Age 73

Start with delayed retirement. A piece by Joseph Egoian shows that students burdened with student-loan debt can look forward to a much later retirement age than the average person.

And the difference is staggering. Egoian calculates that a college grad with the current average level of student-loan debt will typically only be able to retire at age 73, which is 12 years later than the current average age.

He arrives at this by using the median starting salary for recent grads of roughly $45,000, and figuring that the grad will pay the average yearly payment of about $2,800 for the decade it takes to retire that debt. Paying off the student-loan debt winds up costing the grad $115,000 in lost savings by age 73, assuming a 6% rate of return (about what stock funds yield over long periods of time). That is the age at which that grad will be able to retire with 80% of peak earnings (including the Social Security benefits which start at age 67). This means the grad will enjoy only 11 years of retirement, at the current longevity average of 84.

Egoian notes that the news is even worse for students who graduate with heavier debt. A grad with $40,000 in student-loan debt is on average going to have to hold off retiring until he or she is 75.

As for those who go into debt but fail to complete college, retirement before death may be a complete chimera.

Parents on the Hook

Moreover, as a piece from the WSJ last year noted, the people who pay the cast of a delayed retirement may not be the recent college grads, but their parents, if those parents co-signed and the grad can't pay. Someone in their 60s who has to start paying off his children's loans may not just see his retirement delayed, he may see them forfeited.

Another opportunity cost is in reduced mobility.  A WSJ article by Ben Casselman and Marcus Walker argues that the steep student-loan debt that many recent grads have, together with the slow job market, are causing many recent grads to move back in with their parents after graduation. The authors note that 56% of young people aged 18 to 24 live now with their parents. This has a cost in their character development, with the dependence upon their parents retarding the growth of their self-reliance, resilience, and self-esteem.

Moreover, the student-loan debt makes it difficult for grads to seize opportunities that may involve a trade-off between lower-income short-term and higher-income long-term. For example, the high-debt grads can't avail themselves of unpaid or low-wage internships that can lead to careers in high-flying companies, nor take jobs in new companies with wonderful potential across the country because they cannot afford the short-term costs of relocation.

The piece also touches on an issue of even more profound concern. Workers with student-loan debt are deferring marriage and especially having children.

This was the subject of an extensive earlier article in the WSJ, which told the story of an engaged couple, both of whom were graduates of a good school (Kent State) with marketable degrees, one of whom spends 60% of her take-home pay on student-loan payments, while her partner spends 40% of his on the same. They are deferring marriage, buying a home, and having kids--all of which they desperately want to do.

The article notes that a survey conducted by the National Association of consumer Bankruptcy Attorneys reports a large uptick in grads with student-loan debt delaying forming families.

This cost is as tragic as it is costly. To the people involved, it delays or even deprives them of the most meaningful experiences of human life, the wellsprings of the most reliable happiness. For society, it means a slower real-estate market and fewer workers, with all the future disruption that will bring.

What Would Schumpeter Say?

One last major opportunity cost of the student loan debacle should be mentioned, one that economist Joseph Schumpeter would appreciate.

Schumpeter compellingly argued that economic progress is driven by innovation and that innovation is the province of the entrepreneur--the risk-taker willing to try something novel, and back it with his human and financial capital.

But as a recent piece by Ruth Simon reports, the tsunami of student-loan debt drowning recent graduates is stopping many of the best and brightest among them from starting new companies.

Simon tells the stories of several entrepreneurs whose ambitions were blocked by student-loan debt. For example, there is the couple who have a designer toothpick company--an interesting niche market, to be sure--who cannot afford the equipment that would allow them to expand their profitable business.

The social cost here is literally incalculable. Every Apple, Microsoft and Facebook that never gets to exist because the men and women capable of starting them get derailed by student-loan debt is an opportunity of national riches foregone.

The burgeoning costs--especially no understood as opportunity costs--are beginning to concentrate minds wonderfully.

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Gary Jason is a lecturer in philosophy and a senior editor of Liberty. His book, Philosophic Thoughts: Essays in Logic and Philosophy, is forthcoming through Peter Lang Publishers.

(Photo Credit: CNN.)



Comments (4)

Expecting the government to bail you out of your irresponsible behavior is probably the major problem with the country today. Let's not teach it in college.

Anony:

This article is just the tip of the iceberg.

I'm still waiting for the general public to grasp the magnitude of the corruption and ineptness of the companies the government has contracted to service these loans.

A lot of students went out of their way to find good lenders, only to have the government seize most of these loans in 2009 and farm them out to various cronies. The failure of the ACA site is no surprise to anyone who has been dealing with these companies for years. Broken websites, lost records, loans ping-ponged back and forth between servicers every year or so. These people were paid hundreds of millions of dollars, and in many cases took *months* to just to get a phone number and a broken web page up.

Loans double counted, loans lost entirely, payments lost in the void as you're informed (weeks late) that they're switching your servicer again. Throw in the IBR/ICR carrot and the "force you off of your repayment plan with paperwork errors so you have to start over again" stick, and this is a trillion dollars of loans that will never get paid off, but will be a millstone around the necks of a generation.

Try Googling up some horror stories about ACS to start with....

f_explorer:

"(culminating in the complete nationalization of Sallie Mae in 2008)"

I believe that's incorrect... SLM hasn't been a GSE since 2004, per their website:
https://www.salliemae.com/about/investors/stockholderinfo/

In any case, this was interesting - I think discussing the opportunity costs of massive student loan debt with high school students more frequently may help dissuade them from borrowing so much (more than a sober analysis of monthly payment figures and average salaries would).

cas127:

"Expecting the government to bail you out of your irresponsible behavior is probably the major problem with the country today."

Right up there with the unquestioning, unabating, dead-at-the-switch funding of utterly corrupt institutions of higher education that have been pumping out false graduation placement/salary statistics for *decades*.

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