Opinion

James Saft

The perversity of student debt: James Saft

December 11, 2012

Dec 11 (Reuters) – U.S. student debt levels are surging but
along with degrees and skills the loans are producing perverse
incentives and unforeseen economic consequences.

Consumers upped their debt by a seasonally adjusted $14.2
billion in October, driven in substantial part by strong growth
in student loans, a market dominated by the government.

U.S. student debt has grown at a nearly 14 percent clip
annually since 2005, hitting $904 billion in the first quarter
of 2012, partly cushioning the impact on the economy of an
overall fall in outstanding debt as people sought to use a
period of slack growth to retool.

A tough job market, however, has led to growing rates of
delinquency and default, with 10.6 percent of loans more than 30
days past due, a figure that masks the difficulty students are
having because it does not include the many which are in
deferment or forbearance.

To be sure, student loans are a form of economic stimulus,
driving jobs and consumption, but there are real questions over
how effectively the money is being used and how the accumulation
of debt will affect borrowers in the future.

For one thing, the average borrower is getting older and
older. Loans to people 50 and over now account for about 16
percent of all student loans outstanding, in part because of
older workers trying to reinvent themselves during a bruising
recession, but also because many parents act as co-signers. Both
groups are arguably questionable risks, with fewer working years
left in which to generate income and repayment.

But even a poor job market doesn’t entirely explain the poor
performance of student loans. In a market dominated by the
federal government, which accounts for more than 90 percent of
all such loans, it is remarkable that lending criteria take
absolutely no account of current or future repayment capacity.

That leaves the loan market driven by two groups, students
and schools, with potentially opposing incentives, both to one
another and to the common good. Colleges and universities, which
have an incentive to expand, don’t have to convince the lender
the loan is a good risk, only the borrower, who most likely has
only the vaguest and sometimes most optimistic conceptions of
the future demand for dental assistants or lawyers.

This is eerily similar to the sub-prime loan market in 2005,
where loan originators with no skin in the game were pushing
loans to borrowers who figured that prices could only go up.

One potential medium-term impact of this is that a large
cohort of borrowers will find themselves shut out of other
credit markets because of all the student loans they are
carrying. That could drive a large group of captive renters,
unable even in mid-adulthood to qualify for a mortgage, a
phenomenon many investors in rental housing are banking upon.

LOAN FORGIVENESS

Partly in response to the heavy burden of debt, the U.S. is
instituting income-based repayment (IBR), a series of programs
that allows borrowers to cap monthly repayments at 15 percent of
income with forgiveness of any debt remaining after 25 years.

While it is extremely hard to have student debt included in
bankruptcy, IBR means that many, up to 50 percent according to a
study by the Kansas City Federal Reserve, may limit repayment
and have some debt ultimately forgiven.

Cooper Howes, an economist at Barclays Research, estimates
that this could ultimately cost the Department of Education an
additional $300 billion between now and 2020.

Besides being a cost to the taxpayer, IBR sets up perverse
incentives in education, or rather exacerbates existing ones.

Students and schools will only become less price sensitive
the more they are insulated economically from the value of the
education they are providing and obtaining, fueling the
above-inflation-rate growth in tuition costs.

As well, IBR disproportionately benefits better-off
borrowers, according to an October study by the New America
Foundation.

Under pending IBR changes higher-income borrowers will incur
no incremental cost for each dollar they borrow over $60,000,
even in some circumstances if they earn well over $100,000.

“If left unchanged, the program is set to provide huge
financial windfalls to people who, far from being needy, are
among the most financially well-off graduates in today’s job
market,” according to the study authored by Jason Delisle and
Alex Holt.

That’s the dichotomy of the student loan system – well-off
borrowers skating away from loans and poor ones, who were
perhaps sold a program they were not suited to and did not
finish, left financially crippled for much of their working
lives.

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