Deflate the Bubble: Fixing Our Student Loan System

Imagine you’ve received acceptance letters from two universities you’ve always dreamed of attending. You applied to a prestigious, private university as well as a public school with a distinguished reputation of its own.

As you flip through the packet of forms and information they’ve attached along with your acceptance letters, you come across a document that stops you in your tracks: a financial disclosure form. The document says that if you plan to take out federal student loans to help pay for school, which about 70% of college students do, there are certain factors you will need to consider:

1. For every $10,000 you receive in federal loans, you will be required to pay 1% of your income for 25 years or until the loan is repaid. For instance, attending that prestigious, private university would cost $65,000 or 6.5% of your income until the loan is repaid. Alternatively, the public university would cost $40,000 or 4% of your income.
2. Not only does this document project the percentage of income you will owe after attending, it also predicts how much money you’ll likely make. Based on a survey of graduates from the last 20 years, the form clearly projects your expected income across every major. With this information, you come to learn that if you pursue that liberal arts major of your dreams at the private university, you’re unlikely to make a lot of money within the first 10 years of your career.

Unfortunately, this scenario does not take into account the reality of our current higher education system. In reality, aspiring college students are not armed with this level of information. The federal student loan program is not as straight-forward and logical. Colleges and universities are not required to divulge important figures around expected cost of attending and projected income post-graduation. Instead, students today find themselves navigating an overly complex, upside-down system where college tuition rates are increasing while the perceived value of a bachelor’s degree is dwindling. 

Here are some eye-popping facts about our current system:

• Total student loan debt in the U.S. currently stands at more than $1.3 trillion and growing by $2,700/second.
• Student loan debt is the second largest consumer debt behind only home mortgages.

The student loan crisis is becoming a damper on the American Dream. Entrepreneurship among young people is down significantly - people under age 30 who own private businesses has reached a 24-year-low. Additionally, the share of 18-to-34-year-olds who own a home has fallen to a 30-year low. While there is a multitude of factors that have contributed to both problems, it’s not hard to imagine how excessive student loan debt might prevent a young person from investing in a home or starting a business.

As the problem grows worse, politicians on both sides of the aisle have offered up solutions that don’t take into account the dynamic nature of the student loan crisis. The Left’s proposal to make college free does nothing to require institutions to control costs - colleges would be able to essentially charge whatever they want - the federal government would pay the bill. Free college would also create a supply and demand issue - more prospective students will opt to attend the free, public institutions rather than private. Alternatively, The Right’s solution of privatizing the whole system does nothing to offer low-income students the protections and support they need to afford college.

Improving our higher education system requires a multifaceted approach where both the federal government and the institutions themselves, buy in. If colleges and universities don’t have skin in the game, any government reform will likely be an unsustainable band-aid. Likewise, if the government isn’t willing to entirely remodel the current system, graduates will continue to find themselves drowning in student loan debt.

The Government’s role in the problem

On November 8th, 1965, President Lyndon Johnson signed the Higher Education Act in the gymnasium of his alma mater, Texas State University-San Marcos.

The HEA aimed to expand financing options for low and middle-income students who traditionally struggled to get access to student loans. The law required the Treasury to back all student loans from private banks, even upon default. In essence, banks need not worry about issuing student loans to risky, young borrowers because the government will fit the bill no matter what.

With new access to lending, students began enrolling at colleges and universities in record numbers. Just ten years after the Higher Education Act was signed into law, college enrollment doubled from six to eleven million students.

It’s important to note that the signing of the Higher Education Act coincided with an economic revolution in the United States as we began to shift away from a predominantly industrial manufacturing economy to one that was more services-driven. The spike in admissions pressured institutions to expand facilities, build larger dormitories and hire more faculty and staff. As costs went up, so did tuition. At the time the law was signed in 1965, total tuition, fees, room, and board at public four-year universities averaged $950 and $1907 at private.  

As President Johnson intended, the HEA successfully expanded access to higher education. Although, the law also created a system of easy money where anyone can get a loan to attend any institution, at any price.

Since HEA was enacted decades ago, student loan borrowers have taken on over a trillion dollars in debt. The current per-student debt figure in the U.S. sits at $30,000. While students continue to take on unsustainable amounts of debt, the federal government is making a killing. In 2013, the federal government made $41 billion in profits from student loans, putting it right behind only Exxon and Apple as the Nation’s third most profitable enterprise.

Colleges and Universities role in the problem

Since the mid-20th century, colleges and universities have been run like corporations - on a trajectory of continuous growth, accepting more and more students every year, constantly building new facilities and dormitories. To fund their ambition growth goals, institutions have raised tuition substantially over the last few decades knowing that the federal government would help students fit the bill no matter what they charged. 

Some institutions have taken advantage of the easy student lending system more than others. Despite the fact that only 11 percent of college students now attend for-profit colleges (i.e. Devry, University of Phoenix) they receive about a quarter of federal student loans and grants. Supporters of for-profits have argued that these institutions are reaching an underserved market of non-traditional students. Critics have accused for-profits of using predatory marketing tactics to recruit military veterans and low-income students knowing they’d easily qualify for the GI Bill and federal loans.

When you consider the fact that college graduates make on average $1 million more than high school graduates over the course of a career, it’s no surprise college enrollment has skyrocketed. Colleges and universities would argue that tuition hikes and increased administrative spending are simply a function of them trying to keep up with demand. In a time where high-skilled labor is scarce, even critics of overspending and tuition hikes struggle with the idea of capping the growth of colleges and universities.

While relaxed student lending practices arguably created the bubble we find ourselves in, it also expanded access to higher education for millions of students who traditionally could not afford college. Instead of the federal government pulling back on lending, we should reform the way borrowers repay their student loans and demand more transparency from colleges and universities.

Automate and Reform Income Based Repayment Programs

Throughout his presidency, Barack Obama took steps to expand and improve income-based repayment programs (IBR). Graduates enrolled in these programs have their student loan payments capped at 10% of their discretionary income for 25 years or until the loan is repaid. Any balance left over after 25 years is forgiven. While income based repayment plans offer students a more sustainable repayment structure, only 14% of eligible borrowers are enrolled.

The reason only a fraction of eligible borrowers are enrolled is because most students don’t know these programs even exist. To make matters worse, signing up for IBR is a tedious process and participants are required to report their income annually to the Department of Education. Instead, we should automatically enroll borrowers in IBR once they take out federal student loans. In addition to enrollment, the government should automate loan payments via income withholding. Similar to Social Security, payments would be automatically withheld from a borrower's paycheck. This approach would not only streamline the enrollment, repayment, and income reporting processes, it would also dramatically reduce defaults and administrative costs.

Politicians on both sides of the aisle seem to notice the potential of expanding and reforming IBR. During his 2016 Presidential campaign, Jeb Bush had his own take on income-based repayment programs. Instead of borrowers repaying 10% of their income across the board, Jeb proposed a plan that required borrowers to pay just 1% of their income for every $10,000 they receive in student loans. While income percentages and caps can be debated, tying the percentage of income owed to the amount borrowed naturally extends the repayment schedule which in turn prevents defaults. While borrowers are contributing a much smaller percentage of their income, payments are spread out across a much longer time horizon. As Susan Dynarski of the New York Times pointed out, this approach makes the most sense. A core principle of finance is that the length of debt payments should align with the life of the asset. We pay for cars over five years and homes over 30 years because homes last a lot longer than cars. An education pays off over a lifetime, so it makes sense that student loans should be paid off over a long term. 

Require Transparency from Colleges and Universities

As Penn State Business School Professor Sajay Samuel so articulately illustrated in his now famous Ted Talk, as long as colleges and universities continue to operate like corporations, students should begin to recognize higher education as a consumer good. As with most major transactions, consumers are entitled to a certain level of information before making a purchase. If car manufacturers have to disclose a vehicle’s expected miles per gallon, colleges and universities should have to divulge how much money their graduates make.

The government should require colleges and universities to continuously survey graduates to determine an average expected salary post-graduation. Additionally, institutions should also be required to disclose the average debt figure per student, post graduation. With this information, students can make more informed, financially sound choices.

Beyond reforming the loan repayment system and demanding more transparency, much more can be done to improve the debt crisis and college affordability. The federal government could issue more Pell Grants to low-income students as well as demand better outcomes and job placement numbers from for-profit institutions. States and local governments should continue to invest in public education and return funding levels to where there were before the recession. Colleges and universities could make an honest effort to reduce tuition rates and the federal government could set student loan interest rates at a break-even point rather than make a profit. While there is no shortage of actions that should be taken to improve higher education, expanding income-based repayment programs and demanding more transparency from institutions would be a significant step in the right direction.

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Many have equated the student loan crisis with the 2008 housing bubble. The similarities between the two crises are vividly apparent: unabated lending to subprime, risky borrowers and those easy lending practices leading to higher prices. Although, this bubble will never burst. As long as The Bankruptcy Reform Act of 1978 stands, which made student loans non-dischargeable in nearly all circumstances, lenders will always get paid back. If the same bankruptcy rules applied to home loans, the housing crisis would likely have never accord. As long as things stay as they are, student debt will only continue to grow, colleges will continue to raise tuition, and students will be left to bear the burden. The only way we can deflate this bubble is by radically reforming our student loan system and by requiring college and universities to prove their value as a worthy investment.