President Obama's executive order easing repayment requirements on federal student loans would enable students to manage their growing debt burdens more easily. But even the best of intentions cannot repeal the law of moral hazard. Making it easier to borrow -- and often default -- could push an already deeply troubled program over the brink by magnifying taxpayer losses due to even higher default rates, encouraging even more tuition increases, and increasing drop-outs, perverse incentives, and fraud.
No crystal ball is needed to predict this. Because the Department of Education (DOE) has been slow to conduct effectiveness analyses of the program, outside watchdog agencies like the Government Accountability Office (GAO) and the Congressional Budget Office (CBO) have had to do so. Their consistent findings are alarming, and the President's new dispensation promises to make matters worse.
Growing student debt and default rates. Student debt rose by over 56 percent in real terms between 2007 and 2012 -- a much faster growth than credit card debt even as private household debt fell by 18 percent due to the mortgage crisis. This growth is not surprising. First, the program has ballooned to immense proportions. Last July, the Consumer Financial Protection Bureau (CFPB) estimated that outstanding student loans, almost all federally guaranteed, reached $1.2 trillion, almost doubling since the end of 2008 and growing 20 percent just since late 2011.
In just the last four years, the proportion of college students receiving federal aid jumped from 47 to 57 percent. Second, Washington demands no collateral, has no underwriting requirements, and cares little about students' assets, ability to repay, or career plans. Its collection efforts are so sketchy that Sallie Mae, the agency that finances student loans, recently withdrew its bond offering because investors lacked confidence that DOE would collect from delinquent borrowers.
No wonder, then, that student loans have the highest delinquency rates of any federal credit program -- even higher than for private auto, home equity, and mortgage loans. Indeed, they approximate the credit card delinquency rate. And this delinquency data actually understates the problem, for several reasons. Many students had not yet reached their first payment date. And Congress mandates a misleading accounting method that seriously underestimates default risks and thus the ultimate cost to taxpayers -- a deception that enables some members to claim falsely, but with straight faces, that these programs actually run a profit rather than incurring huge default losses. The CFPB's director, a staunch consumer advocate, likens the situation to the subprime mortgage disaster.
Effects on tuition, financial aid, and college completion. While seeking to increase student access, the programs have likely reduced it by encouraging colleges to raise their tuition and fees, which have nearly tripled over the last twenty years. Colleges have incentives to use the federal aid as a limit their own financial aid, reducing the program's overall effect. Federal loans likely encourage many marginal students to over-invest in higher education by foregoing options like cheaper-on-the- job training and earlier entry into the work force, options that might spare them loss of time, money, and self-confidence. Student borrowers may also underestimate the large risk - 47 percent, if community colleges are included, and much higher for disadvantaged students - that they will drop out before graduation.
Skewed benefits, incentives, and fraud. Relatively little of these huge federal subsidies go to students from low-income families. Nor do the loans even alter students' educational attainment, according to the CBO and GAO. Indeed, some of the subsidies had no effect on college attendance because most recipients would have attended even without them. The President's new plan for income-based repayment will surely help some low earners. But like his loan forgiveness plan, it will encourage students to borrow as much as they can, getting them hooked on loans they won't be able to fully repay and leaving taxpayers holding the bag. It will also magnify a serious and growing problem, documented by the DOE's own inspector general, of fraud by both student borrowers and Pell grantees, much of it facilitated by community colleges and by over 34,000 participants in crime rings.
Expanding educational opportunities for low-income youngsters is one of our most urgent goals. But we can almost surely get more bang for the anti-poverty buck by investing it in other ways. Research by Nobel laureate James Heckman, for example, confirms what common sense suggests -- that early childhood interventions can help these kids develop mobility-enhancing attitudes and skills long before the disadvantages of deprivation are too deeply implanted. Even short of such a fundamental shift in federal priorities, student loan programs can be reformed, as Australia and some other countries have done, to lower default rates, reduce collection costs, and improve the incentives of lenders, borrowers, and colleges.
Peter H. Schuck is a professor at Yale Law School. His new book is Why Government Fails So Often, and How It Can Do Better (Princeton University Press).