Tuesday, October 5, 2010

Subprime School Loans?

Although I am generally reserved about government subsidies, education is so vital for the economic and cultural health of a nation, that in principle I support subsidies towards higher education. Without a doubt, federal guarantees of student loans have provided countless opportunities for students of limited means to pursue a higher education, which in turn has helped facilitate greater social mobility. However, federal subsidies, in their present form have increasingly generated negative unintended consequences,the gravest being the interrelated phenomena of "sub-prime" school loans, an increase in debt and unsustainable price inflation.

In my line of work I have encountered countless students who have amassed considerable debt via their student loans. In many cases, this was an economically rational investment, because the degree that the student obtained dramatically increased their earning potential. For example,
one individual amassed $100,000 in student loans in the pursuit of his medical degree, however as a high paid surgeon he would be able to pay this off in a relatively short time. However, I also encountered individuals who amassed similar levels of debt in the pursuit of a fine arts or liberal arts degree. Unfortunately, far too many of these individuals were only able to low paying
service sector jobs. This means that the most probably outcomes that they faced were two decades of crushing debt or a default that would damage their credit and future opportunities such as a home or small business loan.

Having gone through the gruelling process of obtaining private sector loans, I am quite certain that had more students been forced to seek financing in the private sector, the number of disastrous school loans would have been significantly reduced. In contrast to the federal government, the vast majority of private banks would carefully assess the long term sustainability of a student loan. For example, a semi-competent loan officer would have analyzed the median earning opportunities for art of literature students and would have determined that a $100,000 loan would pose an undue risk to the bank, as well as the student. The bank would have factored in the credit of the student and / or their family to determine the risk of default. In contrast the federal government is generally careless with tax payer money.

Many progressives would respond "that may be true, but if the private bank denies the individual a student loan you cut them off from all opportunities for a higher education..." This is clearly a half truth, because the said student would still have other viable options. First, they could pursue an area of study that offers a higher return for their investment, which would greatly increase their chances of obtaining a loan. For example, they could pursue a practical major in architecture and a fulfilling minor in art or literature. The second option would be to pursue their education or at least their core requirements in a more affordable state or local school. The third would be to determine that their most probably option is a lower paying service sector job and forgo a formal higher education, instead treating art and literature as non-monetary cultural pursuits. Either way, the pursuit of financing through the private sector would encourage more students to pursue more economically sustainable paths.

Federal subsidies have indirectly allowed for unsustainable price inflation; in other words, student loans are a major factor in the rapid increase in the cost of tuition. Without widespread federal loans, a surge in costs would have quickly prompted a drop in demand. And when any private institution or industry faces declining demand their two options are two go out of business or restructure to drop costs. But, student loans have temporarily spared schools the
need to pursue painful but necessary cost cutting measures.

Especially with increasing needs for an educated workforce I cannot support the termination of all federal subsidies to higher education. However, we clearly the system of federal student loans needs to be reformed. But, unfortunately the Obama Administration's efforts to "cut out the middle man" and have the federal government directly issue student loans will not bring us closer to a more economically rational system. And like the federal government, students will continue to amass unsustainable levels of debt with no end in sight.

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