Are Subsidized Student Loans Worth the Price?

By James Kwak

Previous guest blogger Anastasia Wilson has written a post on her own blog comparing the student loan racket (for-profit colleges help people take out lots of federally guaranteed student loans to pay for their tuition, then do a lousy job educating them, walking away with the money and leaving students to default) to the subprime loan racket. The flagbearer for this parallel is Steve Eisman, who has gone from shorting subprime mortgages to now shorting for-profit colleges.

In theory, for-profit colleges should not be able to do this. If too many of their former students go into default, the Department of Education is supposed to prevent their new students from taking out federally subsidized loans. (Since the government is ultimately underwriting these loans, it should have the power to make sure that the loans are being used to buy an education that will help borrowers pay back those loans.) But colleges have so far been able to get around the rules by pushing defaults outside the time period that matters for regulatory purposes, as described by the Chronicle of Higher Education.

Now, the traditional progressive solutions are (a) better regulation to crack down on colleges that don’t provide a worthwhile education and (b) relief for borrowers, such as allowing them to write off their loans in bankruptcy. But I think it’s worth asking: will that work? The latter won’t change the behavior of the for-profit college industry any. The former sounds good, but it assumes a competent and well-intentioned regulator that cannot be pushed around by congressional committees (bought and paid for by industry).

In the abstract, I believe that society should be subsidizing higher education, both because it’s an investment in human capital and because it helps equalize opportunity. But how do you weigh the people who benefit from subsidized loans against the people whose lives are being ruined by them?* Maybe we need another approach, like restricting subsidized loans to public institutions,** or restricting the amount so that it only covers public-school tuition, or switching from a lot of subsidized loans to a smaller volume of cash grants. It’s possible that a few tweaks to the current system could be enough, but I wouldn’t assume that at the beginning.

* “No one forced them to take out loans,” I’m sure some of you are muttering to yourselves. Well, most cocaine addicts were never forced to use cocaine in the first place — but we still consider cocaine worth banning.

** We already subsidize public education, so I don’t think we’re crossing any line here.

24 responses to “Are Subsidized Student Loans Worth the Price?

  1. I would ask how can everyone obtain the education they want – that they and their parents feel is best for them – that let’s them pursue their happiness (as expressed in the Declaration of Independence) – that gives them the freedom to participate in our society.

  2. What about some sort of national database which details the dropout rates, student loan default rates and employment success (this might be tough to do) of schools’ graduates. The problem with both public and private higher education is that there is little transparency or information available for applicants. This way the schools’ successes (and failures) can speak for themselves and the borrower can make their decisions independently, while maintaining fair and balanced access to the subsidized loans, because nobody’s going into school to fail or default on their loans.

  3. Too Easy. The schools, private or public, for-profit or non-profit, should act as guarantor for the loans. That aligns incentives adequately, does it not? Schools will be more cautious and selective about who they admit, more careful that they actually learn something, more circumscript with the curriculum, more focused on career counseling and services, and more careful to ensure that their graduates are marketable. That is – they would take the attitude of the banks in a market of private educational loans – except with the direct authority to modify their institutions accordingly.

  4. The current system also appears to generate perverse incentives to drive up prices in than the higher the tuition, the higher the required loans, the greater the profit from this game. It seems to me that some alternative system is required, one that actually creates incentives for schools to provide direct financial aid to needy students. Perhaps changing the tax status of schools and then rewarding them with substantial tax breaks based on the percentage of low-income students that are educated (using some combination of percentages of graduation rates and employment rates shortly after graduation, say 1-2 years). I’m sure there are many other options, this was just off the top of my head.

    What you want is for the schools to have some skin in the game. In order to get incentive money, they need to provide assistance to students who need it and effectively educate them (as measured, for example, by the percentage that graduate on time and are able to find a job in their field within a reasonably time frame). The key is to determine an incentive level (perhaps some combination of tax breaks/penalties, grants, low-interest loans or loan guarantees) that is sufficient to provide incentive to spend their money on educating as many people as well as possible, rather than on education only those that can afford it or that can quality for a government loan. With such a system, you would probably want to create slightly different incentives, etc. for public vs. private institutions, given their different financing models. Still, it seems like it should be possible to do this without forcing students into practically insurmountable debt.

  5. Only 22 percent of first-time, full-time candidates at for profit-colleges get bachelors’ degrees, compared with 55 percent at public institutions and 65 percent at nonprofit schools, according to the National Center for Education Statistics.

    http://www.vawatchdog.org/10/nf10/nfsep10/nf092710-1.htm

  6. Moses Herzog

    Dedon’s idea (although certainly not original in premise) for a database is outstanding. I had often thought in the past that Vo-techs (back when they called them that), community colleges, and “institutes of losers with tattoos” should be required to keep a database just as Dedon says of “dropout rates, student loan default rates and employment success”. This might even be a great idea for major 4 year Universities as a matter of fact. I think this would help to clean up the for-profit education industry.

    In fact ,a lot of military veterans (men and women who risked their lives for this country, and people we might want to remember this July 4th) have been excessively abused by these for-profit “colleges” ( the word college has apparently lost a lot of its true meaning over the decades in America, as this word is posted on campuses which wouldn’t qualify as a good fart from a certified teacher’s butt). It is costing the military veterans a huge part of their future earnings, in high usury interest payments on loans, and wasted years of their lives. The military veterans end up with nothing (not even the questionable diploma) after using up all their GI Bill dollars, and interests payments that surpass the GI Bill funds. It was the focus of a recent PBS Frontline report.

    http://www.pbs.org/wgbh/pages/frontline/educating-sergeant-pantzke/

    Since people like Michele Bachmann and other Republicans are supposedly against government waste it is “shocking” (insert hilarious, borderline insanity filled laughter here) that Republicans choose to do nothing about it. I guess if the federal government has money to subsidize Bachmann’s “family farm” and federal money to subsidize Bachmann’s husband’s health clinic, what’s a few more federal dollars to ream the rear cavity of America’s military veterans???
    http://www.latimes.com/news/nationworld/nation/sc-dc-0627-michele-bachmann-20110626,0,7255963.story

    http://www.latimes.com/news/nationworld/nation/la-na-bachmann-20110626,0,1896024.story

  7. The internet and related tools (such as search engines, and websites) have made [most] human knowledge a commodity. (Which is fantastic.) Anyone with the desire and interest can learn just about anything they want inexpensively. For many undergraduate programs self study is 85% of the curriculum.

    Most people are woefully ignorant of the most powerful force in this universe (or greatest invention of mankind): Compound Interest!

    Educating people to be financially literate is critical to reducing a boatload of human misery. This activity is seldom discussed at any level of education (from JK to grade 12); and I believe it is by design.

  8. Society certainly should be subsidizing higher education. But to do so, we needn’t subsidize indebtedness, and we needn’t let inelastic supply convert subsidy into rents for providers. We don’t need to trade off the catastrophe of overindebtedness with the virtue of supporting education.

    Suppose we had a system where all qualified students had their tuitions funded up front, but the burden of repayment was a function of financial success. Very successful students would end up covering some of the tuition of their less successful colleagues. To the degree financial success can be predicted ex ante, the scale of funding would reflect that. We’d offer less money to people interested in nonremunerative disciplines or who fail to demonstrate an encouraging degree of aptitude in their subject of choice. People could still choose whatever course of study they wish, but they’d have to pay for any gap between the public’s willingness to invest and the tuition at their institution of choice, and no subsidized loans would be available to cover these gaps. But funding would be set at levels so that most students would not require supplementary cash, if they choose programs for which there is some evidence they can succeed and which the public is willing to support, either because graduates are likely to succeed financially or because the discipline generates public-good spillovers that justify an unrecovered subsidy. To ensure that moderate levels of funding can indeed cover students’ costs without supplement, the public sector would insist on elastic supply, by organizing programs in direct competition with high-price-growth providers.

    This sounds exotic and technocratic, but its easy. We already have a means of success-based burden sharing. It is called the progressive income tax. Students’ tuitions should be funded via grants, and the size of those grants should be based on ex ante estimates of the financial and/or social value of students’ participation in the programs. No loans would ever be repaid. People would simply pay their taxes. Since education would be publicly funded, cost control would be a matter of public concern. The best way to control costs is via a public option that provides adequate quality for a moderate price and forces private providers to put up or shut up in terms of adding value for money. Since we already have public universities, grants would generally be set at the full cost of provision at state schools, and private universities would woo students either by offering better education for the same money or by persuading students or philanthropists to pay more from their own pockets, without any subsidized loans on offer.

  9. I doubt that many cocaine addicts are lured into initial use by a well-founded belief that it is their only hope of achieving a living wage.

  10. What this piece (and what all pieces on this topic) fail to understand is that this is an inherently, structurally predatory lending system, where not only do the large lenders (who also own collection companies), and the guarantors stand to make far more money from defaulted loans…even the Department of Education gets back $1.22 for every dollar it pays out in FFELP default claims (and no, collection costs and the Department’s “cost of money” do not come close to taking this surplus away).

    So the Department of Education is also making, not losing money on defaulted loans. This is the problem. This is a defect. This is a defining feature of a predatory lending system that explains the anti-student, pro-bank culture that seems to be so deeply ingrained there. As long as this is the case, the Department won’t take any strong actions to compel the schools to improve quality, and reduce cost (and this applies broadly to all schools, not just the for-profits).

    So It is helpful that the author asks whether returning bankruptcy protections to federal student loans will help. It will. When the Department of Education’s “skin in the game” is betting with the borrowers, instead of against them, we will see them crack the whip on the bad schools, and mean it. Until then, no remedies for this or other problems will be meaningful.

    This predatory dynamic is extremely important to understanding the problem.

  11. Mr Kwak, your piece seems to suggest a dilemma analogus to the one being played out in our political system -i.e. supply-side vs demand-side economic policy. Of course here, it is with respect to education.

    (Small beside: Actually, I would argue that its not education that being addressed, but education-certification. Which is quite different from mere education. Education, or self-education is achievable by all though any number of routes, most of which at relatively little cost. So, perhaps the policy argument is more appropriately stated as – demand-side education-certification vs supply-side education-certification.)

    A supply-side education-certification policy advocate might suggest that a better education-certified society leads(?) to greater productivity, (hence?) a stronger economy, and (hence?) ultimately a greater demand for education-certification itself.

    Whereas, a demand-side education-certification policy advocate would tend to let market forces drive the general need and level of education-certification of society.

    The analogy gets even more interesting (and fun) when you start to apply ‘bubble’-metrics. That it is now possible to find substantial numbers of people, both young and old, whom are education-certified but are either out of work or working at or around minimum wage, tends to suggest that an education-certification bubble may already be leaking some gas. Gee… perhaps we should encourage the education-certified to ‘walk-away’ from there loans, in the same manner that people are now ‘walking-away’ from there mortgages? Of course, people do ‘walk-away’ from their student loans but stigma and general consequences of doing so are somewhat different, and no one, at the moment seems to be encouraging the practice. (I’ll stop there,… the puns are endless.)

  12. Bruce E. Woych

    http://search.aol.com/aol/search?s_it=webmail-hawaii1-standardaol&q=goldman%20sachs%20and%20student%20loans

    just a primer on who is targeting student loans. The Universities are indirectly complicit in these exploitations, since they only concern themselves with expanding revenue in the name of quality service.
    Perhaps the next sub-prime (subsidized) bubble base?
    But many “scholarships” are actually “unsubsidized” direct loans that entrap unsuspecting students and parents alike with trappings of a merit based “award” system they dare to deceptively call “scholarships”

    But overall the system is parallel to
    MUCH LIKE THE MEDICAL / INSURANCE SERVICE INDUSTRY COMPLEX.

    But instead of brokering access to health, they broker access to careers and wealth. The University admission system has become a recruitment agent for debt accumulation for our future generations in return for quick and easy “wealth” accumulation in the short term that only serves to amplify the current process of economic cancer on the systemic “cash-exia” we promote as economic prosperity.

    see:
    http://www.dailykos.com/story/2010/11/29/923780/-The-Warburg-Economy-and-Cash-exia
    The Warburg Economy and Cash-exia
    by arendt

  13. Jim Coffman

    For-profit higher education is a very profitable business. Why should taxpayers be subsidizing it or the lenders who prey on those who are recruited by for-profits schools? Obviously, many areas do not provide enough public higher education to meet community needs. Where public options are lacking or unsatisfactory, the public’s money should be spent on strengthening and expanding public options. Community college programs, specializing in business and trade courses (the most popular at for-profit schools), taught by part time instructors/full time practitioners in the subject matter (the for-profit model) can be offered at relatively low cost. They can be tailored to appeal to adults and returning veterans that might otherwise be put off by programs filled with teens. Let’s subsidize education, not lenders and providers of sub-par programs that, by design, cause more harm than good.

  14. CBS from the West

    Future generations will look back with horror on a society forces its children to go into debt in order to get a basic education. It is nothing but shameful that we have revised the institution of indentured servitude.

    To make matters worse, student loans are touted as giving access to higher education to those who otherwise can’t afford it. But how can injecting debt-money into the higher education sector do anything other than inflate the price and make it _less_ affordable? (That might not happen if the education sector were poised to greatly improve the value of its product with the new source of funds–but I think everyone agrees that the only thing that colleges now offer more of than they did in the past is frills. The basic education is, at best, unimproved, and possibly deteriorated.)

  15. Bruce E. Woych

    University and College or Vocational Training? A Government Voucher System with cost distribution founded upon a Banking Transaction tax along with a 1% National Sales Tax (permanently capped). Increases competition and provides a one time asset credit to every citizen to enter a career or market training area (coupon booked so it guarantees continuous attendance and service). If I can figure that out in one afternoon, what can the high and mighty geniuses come up with that do the “elegant” math of economics. Where there is a will, there is a way…where there is a way…, there is a con artist.
    Put vouchers in people’s hands and let them choose where they can get the best returns…if they can add to the vouchers…it is pure market incentive across the board!

    http://search.aol.com/aol/search?s_it=webmail-hawaii1-
    standardaol&q=College%20finance%20voucher%20system

    http://en.wikipedia.org/wiki/School_voucher

    http://search.aol.com/aol/search?s_it=webmail-hawaii1-standardaol&q=educational%20finance%20voucher%20system

  16. Bruce E. Woych

    http://search.aol.com/aol/search?s_it=webmail-hawaii1-standardaol&q=College%20finance%20voucher%20system

    should link to “College Finance Voucher System” (search phrase)
    if the above link fails

  17. Bruce E. Woych

    http://centerforcollegeaffordability.org/archives/1602 (Says it all! Book title referenced as well).

    RIGHT ON THE MONEY!
    http://centerforcollegeaffordability.org/archives/1602

    (ps…note that for some reason the 1st link …does not light up completely. Use the corrected one just above this one for that particular link.

  18. Bruce E. Woych

    But something is happening but you don’t know what it is…

    do you…

    Mr. James….

    http://centerforcollegeaffordability.org/

  19. Good stuff, but I’m not clear why we single out for-profit colleges.

    There are plenty of big name elite schools where students can run up six figure debts on degrees with little market value (one a saw in the NY Times featured a woman who was bemoaning her $100k+ loans used to obtain a degree in women’s studies from NYU just to use an example).

    Law schools are even worse.

    Doesn’t econ 101 just tell us if there’s a generic subsidy, the result will simply be for eligible institutions to raise their prices?

  20. dclawyer is absolutely correct. there is no reason to make this distinction…

  21. “In the abstract, I believe that society should be subsidizing higher education, both because it’s an investment in human capital and because it helps equalize opportunity.”

    While I somewhat agree with the former claim, I would argue with the latter claim. How exactly does it help equalize opportunity? If everyone had a college degree we’d all be in the same relative positions. I view college as more of a credential; if it’s about pure learning, you can learn online for free (as other commenters have alluded to).

    The world needs ditch diggers too and I think we will have metaphorical college-educated “ditch diggers” who will be bitter at the world if we keep encouraging more and more people to go to college. Oh wait, I think these types of people already exist.

    I recently wrote an essay about higher education titled “Is Higher Education Worth It”.

  22. “Too Easy. The schools, private or public, for-profit or non-profit, should act as guarantor for the loans. That aligns incentives adequately, does it not?”

    That sounds like the right tactic to me, but 100% exposure would be way too risky. Even 10% or 20% exposure ought to produce the right behavior- maybe 20%, cut to 10% if the student graduates.
    Alternatively, assess this via a tax/fee per loan, based on the historical graduation and default rates for that school/field/etc. Or do the same thing via private means by requiring ‘default insurance’, paid by the institution (allowing the market to determine risk factors and using price to encourage pro-student behavior).

    Besides which, if the institutions are behind the loans 100% when they default, then what exactly is the government’s role? Wouldn’t this leave us with the previous situation where higher education was problematic for individuals with great potential but lacking funds?