Another Good Reason for No Student Loan Bailout

Mish

The subject of student loan debt cancellation keeps resurfacing. Let's recap why it's a bad idea starting with a new study by Wharton.

How Student Loan Forgiveness Could Increase Inequality

Wharton’s Sylvain Catherine and University of Chicago’s Constantine Yannelis explain How Student Loan Forgiveness Could Increase Inequality

Forgiveness of outstanding student loans has been a recurring theme in policy debates on the roughly $1.6 trillion in such debt that the U.S. government and private lenders hold. Calls for such forgiveness have increased now as the Joe Biden administration prepares to assume office.

However, partial or full student loan forgiveness is “regressive,” according to a recent working paper, titled “The Distributional Effects of Student Loan Forgiveness,” by Wharton finance professor Sylvain Catherine and Constantine Yannelis, professor of finance at the University of Chicago’s Booth School of Business. The paper’s findings are being actively discussed on Twitter.

“Any policy that is a universal loan forgiveness policy or a capped forgiveness policy — say forgiving debt up to $50,000 — is going to give most of the dollars in forgiveness to upper-income individuals,” said Yannelis, who was interviewed along with Catherine on the Wharton Business Daily radio show on SiriusXM. 

Moral Hazard

Wharton presents a very good reason but the mortal hazard aspect is an even better one. 

I discussed the moral hazard aspect  in Biden Is Off to a Bad Start Under Progressive Pressure

Here's a recap.

Rogue Executive Actions

Biden is already bending to the wishes of Elizabeth Warren and Bernie Sanders to want to forgive student loans. 

Schumer held a press conference alongside Democratic Congressmen-elect Ritchie Torres, Mondaire Jones and Jamaal Bowman of New York, during which the group announced they have “come to the conclusion” that Biden can “forgive $50,000 of debt the first day he becomes president.”

Even if legal, this is a terrible idea. It mainly benefits middle-class whites and unfairly so.

Less Education for Your Buck

Less Education for your buck

The above chart is from US College Tuition & Fees vs. Overall Inflation.

Costs accelerated when Congress passed the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005”.

That act, which Republicans wanted and Bush signed made student debt non-dischargeable in bankruptcies. 

Disease vs Symptoms

I graduated from the University of Illinois in 1976 with a degree in Civil Engineering. The cost of tuition was $250 a semester when I entered college in 1971.

Some blame states for not contributing to education. Indeed, states would would not raise taxes to cover escalating costs because of voter backlash.

But that is blaming the disease on the symptom. The disease was then and still is high administration costs, public unions, outrageous coaching contracts, unbelievable pensions, and serious lack of competition. 

The “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” made matters much worse.

For discussion, please see The Debt Deflation Guarantee Act of 2005.

Huge Moral Hazard

Debt discharge is a huge moral hazard that encourages more overpaying for useless degrees. 

It will do nothing to address the cost of higher education.

We need more competition, more accredited schools, more alternatives, and less public union graft.

Forgiving debt fosters less competition and more graft and does nothing to fix any fundamental issues.

Mish

Comments (69)
No. 1-21
BobHertz
BobHertz

Thanks for an excellent article. What we could do is to allow bankruptcy for any student debtor who cannot get income-based repayment and is drowning in payments. That is a relatively small number who are really suffering.

For most student debtors, the monthly payments are about what they would incur for a modest new car, $300 to $400 a month. If they have a good job, they can handle this. If they cannot find a good job, they can get income-based repayment in most cases. (although the process of doing so can be needlessly complicated.) If they cannot get income based repayment, let them declare bankruptcy.

If Biden really could forgive the first $50,000 in debts, that would cut government revenues from loan repayments by at least $50 billion a year, and for many years. That would argue that Congress must be involved.

shamrock
shamrock

Wont new student debt start accumulating on day 2 of the biden administration?

Webej
Webej

Discharging debts by the AOC's of this world by making plumbers and hair-dressers pay taxes ... shameful.

They should make it possible to discharge the debt in bankruptcy, but the universities and colleges should absorb the fall instead of the tax-payer.

Eddie_T
Eddie_T

The whole narrative is a lie.

Although the media (I heard the typical pitch yesterday on public radio) tells a story about “unmanageable student loans that are crushing young people with debt” the actual numbers don’t reflect that.

The typical defaulter is not a college grad at all, but rather someone who borrowed around $10K to attend a trade school of some kind. It doesn’t matter much whether he/she graduated or not. They just can’t get work that pays enough to let then service a modest amount of debt.

The defaulter is also much more likely to be closer to middle age, and a person of color, too, for what it’s worth. Look it up. Many of these for-profit trade schools and “colleges"are also minority owned businesses that make a ton of money for somebody. The student loan mill is a scam, at that level. It’s not that different than the mortgage scams that were perpetuated in the early 2000’s subprime mortgage scandal.

Let me quote from the 2015 Brookings Institution paper:

"These data show that to the extent that there is a crisis, it is concentrated among borrowers who attended for-profit schools and, to a lesser extent, 2-year institutions and certain other nonselective institutions. We refer to these borrowers as “nontraditional” because, as students, they tend to be older, often enroll less than full time, and are living independently of their parents, and also because historically there were relatively few for-profit students and because 2-year students rarely borrowed. "

"As a result, in 2000 these borrowers represented a small share of all federal student loan bor- rowers and an even smaller share of loan balances."

"However, during and soon after the recession, the number of nontraditional borrowers grew to represent almost half of all new borrowers. They experienced poor labor market outcomes, had few family resources, and owed high debt burdens relative to their earnings. Their default rates sky- rocketed."

"Of all the students who left school, started to repay federal loans in 2011, and had fallen into default by 2013, about 70 percent were non- traditional borrowers."

"In contrast, the majority of undergraduate and graduate borrowers from 4-year public and private (nonprofit) institutions, or “traditional borrowers,” have experienced strong labor market outcomes and low rates of default, despite having the largest loan balances and facing the severe headwinds of the recent recession. While the number of traditional borrow- ers also increased rapidly over time, recent borrowers’ family backgrounds and labor market outcomes are not much different from their peers’ in ear- lier years, especially for graduate students and undergraduates at relatively selective institutions."

"In fact, traditional borrowers earned more, on average, in 2013 than their peers had in 2002. recent borrowers in 2002.”

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I predict that there will be forgiveness, but it will only be at that $10K level that’s been kicked around....just enough to wash away most of the the defaults. They will do it for all the loans, so the people who are paying their loans back will get a break.....but I’m fine with that....because the interest rates should have never been so high in the first place.

In my view the the rates are part of the problem. They should be much lower. Why does the government need to charge a high rate of interest?

Fwiw, tuition is still way too high in states (like mine) with no public unions. At real colleges I mean.

I think the management layer is a big part of the problem....and that management layer is problematic in many ways, because they have way too much say in how universities are run these days. Bu that’s another story.

FromBrussels
FromBrussels

What a crazy nation the US of A is ....Students in most european countries don' t have debt, worst case they owe some money to friends or relatives, that's all! I don t think your students are smarter than ours are they, despite all that debt ?

Sechel
Sechel

My big problem with your post Mish is you don't really have a prescription on how to fix the problme from what I can see. The system is unversally believe to be broken? Are we in ageement on that point? If we are how would you fix it?

Me personally I'd get rid of the law that prevents bankruptcy judges from doing what they do and stop the non-sense of making student loans somehow unqiue from every other debt which is subject to our bankruptcy laws.

What we hae now is not workable

Rocky Raccoon
Rocky Raccoon

The student loan industry doesn't encourage competition as it is now, so there is already a lack of competition before you even forgive a dime. Tuition doesn't go down because of competition. It increases as the government raises annual allowances for student loan amounts.

Eddie_T
Eddie_T

So....it would be nice to have a data driven discussion in the national media, but that isn’t happening.

The default rate for ALL public 4 year colleges is about 7%.

At the link above, you can see that Larry’s Barber College (in Chicago, natch) is above 50%...but Larry is famous in Chicago....as a successful black entrepreneur who gives a lot back to the black community. A philanthropist.

It’s shameful scam that nobody writes about. There are many for-profit schools like this one.

At flagship public state colleges (like U of Texas here for instance) defaults are mostly far less than even the four year average default rate.

UT is 2.6%

U of AZ is 4%

U of IL (Urbana) is 1.9%

U of AL is 5%

U of MN (Twin Cities) is 2.2%

MATHGAME
MATHGAME

It would be nice to know what percentage of bankruptcy filings are personal vs business both by count and dollar. I'm sure the business bankruptcies are a small percentage by count but perhaps the larger percentage by dollar.

And of the personal bankrupcies, the same questions for student (potential not actual) and non-student in terms of counts and dollars.

RunnrDan
RunnrDan

"Biden is already bending to the wishes of Elizabeth Warren and Bernie Sanders to want to forgive student loans."

Surprised? We're just getting started too...

Sechel
Sechel

its not about bending to the wishes of Warren or Sanders. People saddled with student debt do not purchase homes, start families or businesses .Student debt is a huge tax on our gdp. maybe bien is bending to common sense

Doug78
Doug78

OK we wipe out the debt today but what about next year? Do we do the same thing and every year after that? It's not even remotely a solution. It's just a payoff but it doesn't disadvantage one party-voter over another. However it will piss-off those who paid off theirs turning them into future responsible voters.

Louis Winthorpe III
Louis Winthorpe III

Do we only care about moral hazard now?

Did we care about moral hazard when banks were bailed out in 2008?

Did we care about moral hazard a few months ago when Boeing received billions in bailout dollars after spending their cash on stock buybacks?

Did we care when large corporations with cash reserves that didn't need more, applied and received PPP funds anyway?

I am very much in favor of people being held to account for the consequences of their actions, but we should at least apply it equally.

Corporate bailouts has turned the idea of moral hazard into a big joke.

Doug78
Doug78

All universities are feeling the shortfall and some are forced to react. The University of Vermont announced that they will emphasise STEM. They consequently cut programs in Liberal Arts notably in some languages and in Native American History.

RunnrDan
RunnrDan

"The disease was then and still is high administration costs, public unions, outrageous coaching contracts, unbelievable pensions, and serious lack of competition."

No, those are the symptoms. The disease is the money spigot which feeds the beast. The money spigot is primarily government, fortified with fiat currency.

Johnson1
Johnson1

Jackula
Jackula

Should be able to discharge in bankruptcy. No personal debts period should be non-dischargeable in bankrupcy. Students loans are foolish. Delay college for a few years trying a few jobs, travel for a year so income is low, after you are 22 yrs old fill out a FAFSA for grant that pays for tuition and living expenses not based on your parents income, and you can get a free ride to a 4 year high quality instution with no student debt.

KidHorn
KidHorn

I'm in favor of the gov't getting out of the loan business. The housing bubble was caused mostly by the GSEs buying garbage loans from banks. The education bubble would not have happened without Sallie Mae.

Why not have businesses do what the military does. Give education money in exchange for service. Basically indentured servitude.

randocalrissian
randocalrissian

The PSLF Public Service Loan Forgiveness Program exists to help people get rid of student debt. Make 120 consecutive qualifying payments while working for a qualifying employer and the balance can disappear after ten years. My wife could potentially vaporize $15,000 in loans via this program, could have been way more (1.5-2x) if she knew about it when she got current job. Small loan in the big scheme but a worthy illustration of how it can help.

killben
killben

"Debt discharge is a huge moral hazard"

Since 2009 moral hazard has been deleted from the English vocabulary.


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