ABC News is reporting that Congress is set to take up a student loan fix, but it’s difficult to fix a problem you have yet to define–much less understand. But when has that ever stopped Congress before?
What is the “student loan problem” to be fixed? The immediate issue is that the interest rate for new federally subsidized loans is set to double on July 1, from 3.4% to 6.8%. Republicans are offering a plan that would keep rates from going up as much in the short-term, but could potentially increase several years down the road (assuming Congress wouldn’t step in to stop it then…as they’re trying to now). Democrats, on the other hand, simply want to extend the current 3.4% rate…ostensibly for just two years, while working on a long-term fix (a familiar tune). Democrats believe that, by keeping the price of student loans artificially low, they are helping the average person or family better afford college.
And this is the point where economic reality (and the real student loan problem) is promptly ignored.When the price of borrowing money is artificially suppressed, it is true that more people will borrow more money. This is exactly why there are so many college graduates finding themselves burdened with record-high levels of student loan debt. But it doesn’t stop there. When students are able to borrow cheap money, it makes it easier for colleges and universities to increase tuition and fees because their consumers are less price-sensitive when they have access to more money. So the easy money for student borrowers becomes easy money for university treasurers…and students end up needing to borrow even more money than they would have to begin with.
The truth of this simple application of incentives was revealed in this year’s college financial aid offerings and acceptance rates. A May 6, 2013, Wall Street Journal article tells of how colleges–especially private colleges and universities–are offering more tuition discounts and financial aid than ever to cut their net cost down in response to lower student demand. Part of that reduced demand is demographic (and smart universities planned ahead for it), but part is due to the sluggish economy…and due to the fact that financial award letters for 2013-14 indicate the interest rates on federally subsidized loans will be at the higher (6.8%) interest rate (I know…we received one).
When the cost of borrowing increases, yes, fewer people may choose college–but the cost of college also goes down (or goes up less) for the much larger number of people who do go to college. And that reduces the total amount of money needed to be borrowed in the first place. And those who don’t choose college? There’s a good chance most of them will pursue post-secondary education in other venues (e.g., starting in community colleges) or will just earn their degrees more slowly, working to save up enough to pay for college themselves. And that, too, will reduce the amount of student loan debt.
So you want to fix the student loan problem? Stop artificially deflating the cost of borrowing for students. As Anthony Carnevale, director of Georgetown University’s Center on Education and the Workforce, was quoted in a Nov 2012 WSJ article, “The way the system works now…put money on the stump, people come and get it. … Can’t blame them. It’s sitting out there in plain view. It’s easy to get.”