Macro and Student Loans

I think the last several posts made a reasonable case that current interest rates on federal student loans are on the high side both in terms of net revenue for the government and relative to previous historical episodes with a similar interest rate climate. This post is intended to make the case that there are other macroeconomic benefits to lowering the interest rates on federal student loans that have to do with the current macroeconomic state.

I’ll take it as a given that our current economy is operating under potential due to a lack of demand, and that in the absence of government stimulus (which is not forthcoming), we need to look at alternative methods for generating private consumption again.

Indirect measures that ease private sector deleveraging are important tools to counteract the lack of fiscal stimulus over the past 4 years—the Federal Reserve has been important here, engaging in all sorts of unconventional maneuvers to bring down long-term interest rates. (Correspondingly, we are finally seeing the housing market begin to pick up after its 6 year slump). Unfortunately, even as housing debt falls, non-housing debt has been ticking up and the main factor in that has been an expansion of student loan debt (now ~ $1 Trillion in outstanding student loans across the US).

There are multiple factors driving the expansion of student debt–broadly speaking, they can be separated into structural factors and cyclical factors. Structural factors include the fact that, in general, education spending over time has increased because education is a labor-intensive industry and the cost of (highly educated) labor like professors and administrators has risen over the past decade. Additionally, colleges continue to spend more and more money on non-educational pursuits as the importance of adding amenities (quality housing, gyms, sports teams, etc) to the college experience has grown. These factors would be driving up tuition regardless of the state of the economy. However, cyclical factors resulting from the financial crisis have also contributed to an increase in student debt: stagnating (and falling) incomes during the financial crisis diminished the average family’s ability to afford college; and state cutbacks to education spending contributed to tuition increases without corresponding increases in grant aid from states or the federal government. Taken together, the amount of outstanding student loan debt has roughly doubled since 2005.

In and of itself, elevated student debt isn’t necessarily the worst thing in the world—obviously a world in which all students could receive grant funding to attend college would be better, but I would rather see more people get degrees with student debt than more people simply enter the workforce straight out of high school. The key caveats, here, are that

1) students need to earn a degree, and

2) students need to be able to find employment commensurate with their degree level after leaving college.

The absolute worst case scenario would be a student running up a significant amount of debt at a low-quality school, failing to get a degree, and then failing to find employment in the labor force (or working at the equivalent of a high-school degree job).

Unfortunately, a significant number  [page 12]  of students fail to meet the above criteria. 30% of borrowers that drop out of for-profit, less than 4-year institutions default on their loans; this is compared to the ~3.5% default rate average of all borrowers that graduate from a post secondary institution.

Furthermore, 12% of outstanding student loans are now more than 90 days delinquent, and though students that attend private, for-profit institutions make up only 10% of all post-secondary students, they account for half of all student loan defaults. There is now significant evidence that outstanding student debt is displacing other spending by young adults, primarily in the auto and housing markets. Seeing as how the housing market is one of the primary drivers of US economic growth, it seems obvious that putting measures in place to reduce the burden of student debt moving forward will allow the US economy to recover more quickly (by increasing the private-sector purchasing power of young adult consumers).

Furthermore, it seems that the federal government should use its federal financial aid bargaining power to force private, for-profit colleges to improve student performance. There are lots of options here–most for-profit, less than 4-year institutions are vocational schools focused on employing students in a specific career field. In theory, it would be relatively simple to make the schools liable for a percentage of their graduates’ loan debt based on the success rate at which graduates find work in their field of study (or implement some other similar risk-sharing arrangement between the institution and the student).

Of course, in practice, the Dept. of Education doesn’t even have the ability to track graduate outcomes at that level of detail right now. On top of that, any change to institutional eligibility for Dept. of Education loans would have to be worked out through Congress, so I think we can assume that this isn’t going to happen anytime soon…

PS: shout out to Lil Laurie for the topic suggestion.

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