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Unintended Consequences of Obama’s Student Loan Policies

Personal_Finance / Student Finances Jun 13, 2014 - 10:26 PM GMT

By: F_F_Wiley

Personal_Finance

So this week, President Obama’s populist, class-warring, shut-out-the-legislature, ignore-the-long-term-consequences romp through every corner of life turned to the education sector.

His new policies on student loans include greater access to both payment reductions and loan forgiveness.


And, needless to say, his Rose Garden speech oozed election year politics.

As the Boston Herald put it: “This is nothing more than politics as official policy … the president’s shout-out to U.S. Rep. John Tierney, a vulnerable Democrat, at yesterday’s White House ceremony was just one of the clues.”

To be clear, student debt has become a huge problem that demands attention. Alongside other challenges, such as finding a decent job in a stagnant economy, student borrowers face daunting payment burdens that they’re failing to meet at record rates.

But the problem requires more than just a political instinct to bail out a wide swath of the voting public.

In a better world, policymakers would take a cold, hard look at the effects of federally-funded student loan programs, including the good and the bad. Here are a few such observations that you’re unlikely to hear from your president:

1)  Student loans are a fiscal time bomb, notwithstanding the government’s ridiculously flawed cost estimates, which Obama chose not to update despite this week’s policy changes. Official cost estimates ignore the near certainty of continued bailouts, while relying on shoddy accounting practices that you wouldn’t get away with in the private sector. In an editorial published after Obama’s latest announcements, the Wall Street Journal wrote:

Democrats claim to care about inequality, but kids who don’t go to college are in even worse economic shape than college kids, with even higher unemployment rates. Yet when the cost of defaults and debt forgiveness finally comes due, it will be paid by all taxpayers, including those who didn’t go to college. So the townies with jobs will end up paying more in taxes to give former college kids and grad students a break on their student debt.

2)  Skyrocketing college tuition costs are explained partly by extensive public subsidies to higher education, including past enhancements to federal student loan programs that all but eliminated private lenders. Ample government support allows universities the kind of pricing power that other industries only dream of. Obama characteristically framed his preferred policies as a choice between “lower tax bills for millionaires or lower student loan bills for the middle class.” To see the absurdity in this bit of rhetoric, you only need to look up the generous incomes and perks enjoyed by administrators and senior faculty at your local university. Arnold Kling put it this way:

The right way to think about student loans is that they are a gift from taxpayers to the higher education industry, both non-profit and for-profit. Most of the benefit goes to those who work in that industry, not to students. Most of the risk is borne by students and taxpayers, not by those who work in the industry.

3)  Public support for higher education helps to create unnecessary barriers in many fields where advanced degrees are now required credentials. Economics – a frequent topic for this blog – is just one example of a profession where “entry” requires indoctrination in methods that are useless if your goal is to actually understand your subject (rather than maximizing your publication count). Neal McCluskey argues that “cheap college has almost certainly fueled credential inflation, not major increases in knowledge or skills.”

4)  McCluskey’s position is supported by a recent study showing that borrowing for graduate school explains much of the increase in student loan issuance since 2004. The WSJ attributes the surge in graduate school loans partly to “an open spigot of government credit,” while quoting the study’s author, Jason Delisle:

Graduate schools have essentially found a way to capture more of someone’s future income and future spending than what would probably occur if we had some sort of underwriting standards and loan limits.

5)  Data shows that substantial portions of student loan proceeds are used for rent, bills and lifestyle expenses for borrowers with questionable ability to meet repayment obligations. Some of these “students” appear to have little intention of actually putting in the class and study time to obtain a degree. Again from the WSJ: “Even when schools suspect students are over-borrowing, they are restricted by federal law and Education Department policy from denying funds.”

6)  Moreover, reckless decisions about how much to borrow are not only enabled but encouraged by government policies. Back to McCluskey:

In the name of helping them, federal politicians, and many other people, massively oversell higher education to the detriment of students. Perhaps as much as half of people who enter college don’t finish; a third of people with a bachelor’s degree are in jobs not requiring the credential [and]; underemployment is even worse for graduate-degree holders…

7)  Special provisions for public sector employees, who can achieve loan forgiveness after only 10 repayment years compared to 20 for those in the private sector, are arguably the most heinous of all student loan policies. They are the political equivalent of a flagrant foul on the producing classes. Those who choose to put their efforts to the test of the market are penalized, to the benefit of public “servants” who live comfortably off the taxpayer without any accountability to the market. Such public sector perks can only be explained by the hubris, sense of entitlement and government-run-amok cronyism of the political class.

. . .

Now, none of our observations and editorial comments are meant to deny that there are many student loan success stories.

We’ve deliberately focused on the risks of federally-funded student loan programs, as these are too often swept under the carpet.

Problems with student loan programs are deep-rooted – thanks mostly to the government’s domination of the market – and were only worsened by Obama’s actions this week.

F.F. Wiley

http://www.cyniconomics.com

F.F. Wiley is a professional name for an experienced asset manager whose work has been included in the CFA program and featured in academic journals and other industry publications.  He has advised and managed money for large institutions, sovereigns, wealthy individuals and financial advisors.

© 2014 Copyright F.F. Wiley - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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