Loan programs

Obama said to propose market-based interest rate for student loans

When President Obama's budget proposal emerges today, it is expected to include a proposal for a market-based student loan interest rate, putting him at odds with student advocates who were former allies.

House holds hearing on student loan interest rates

With the interest rate for subsidized loans set to double July 1, House hearing focuses on the broader future of the federal loan program.

Federal agency requests comment on private loan modifications

Consumer Financial Protection Bureau asks for suggestions on how borrowers might refinance private student loans.

CGS forum focuses on minimizing graduate student debt

With student debt surpassing $1 trillion, graduate school deans discuss the implications for graduate school admissions and retention and the importance of financial literacy.

Encourage bankruptcy, not forgiveness, for student loans (essay)

Student loan debt is soaring. Since 1999, average student loan debt has increased by more than 500 percent, and in 2010, it exceeded outstanding credit card debt for the first time in history. Total outstanding student loan debt, by some counts, exceeded $1 trillion this year.

While many approaches have been taken to the problem (trying to cut university costs, for example), there seem to be just two proposals for lessening the burden on the students themselves. These are to allow the loans to be discharged in bankruptcy or to forgive the loans altogether. Both have been the subject of Congressional bills.

Only one of these has the proper long-term incentive effects, and even it should be hedged with some restrictions: restoring limited bankruptcy protection. That is, students should be allowed to get out of their student loan burden as part of bankruptcy proceedings, just as they are able to get out of car loans now. However, this option should be restricted to private loans and should be allowed only after a set amount of time, such as 5 or 7 years, as it was prior to 2005.

While Senator Dick Durbin (D-Ill.) has proposed the idea of restoring bankruptcy protection for borrowers of private student loans several times, it has gone nowhere. Instead, there’s a growing chorus in favor of loan forgiveness. U.S. Representative Hansen Clarke (D-Mich.) introduced H.R. 4170, the Student Loan Forgiveness Act of 2012, earlier this year.

The law would allow students to pay just 10 percent of their discretionary income for 10 years, whatever their total loan amount; then, the remaining debt would be canceled. This is the “10-10 standard.”

In addition, under this bill, the current 3.4 percent cap on undergraduate student loan interest rates (enacted by Congress as a temporary measure) would be made permanent. Private borrowers whose educational loan debt exceeded their income would be allowed to convert their private loan debt into federal Direct Loans, and then enroll in the “10-10” program.

A critical part of the bill is to reward graduates for entering public service professions -- like teaching and firefighting -- with even greater forgiveness. Already, under the Public Service Loan Forgiveness, some graduates can have their loans forgiven if they work in public service for ten years. Few students use the current programs, however, because the rules dictating structure of repayment are relatively restrictive, as Inside Higher Ed recently reported.

The Clarke bill would lower the public service requirement to five years. Similarly, medical graduates would be rewarded for working in underserved communities by reducing the service requirement to 5 years from its current 10 years.

While this bill would benefit the small proportion of students who have extremely high debt levels, it would enormously distort incentives for students and universities -- causing larger problems in the long run.

The problem is that loan repayments will be the same whether students borrow cautiously to attend a state school or borrow extravagantly to attend an exclusive private university. Their payments will be capped at 10 percent of discretionary income for ten years. Because future students will know about the option of loan forgiveness, it will destroy any incentive for them to borrow prudently. They will have no reason to consider the varying costs of higher education.

Their unfettered willingness to borrow will have a ripple effect. Because the federal government will ante up (until it runs out of money), more and more money will flow to the schools through these loans, spurring them to continue to raise tuition and minimizing pressure on cutting costs. (Greater demand typically leads to higher prices.) Students would be simply middlemen -- passing government largesse on to colleges and universities that can’t stop their habit of seeking revenue wherever possible.

Limited bankruptcy protections would send a better message to both graduates and lenders. In 2005, Congress prohibited private student debt from being discharged through bankruptcy, except in rare cases. Government student loans have not been subject to bankruptcy protection since 1976, when Congress exempted them following reports that new doctors and lawyers were filing for bankruptcy to avoid paying student loans.

Indeed, if bankruptcy were available, many young graduates -- who often have no major assets such as a house or a car -- would be tempted to walk away from loan obligations. The federal government lends money to any student who meets minimum standards; it does not evaluate whether the student is likely to pay the money back.

Thus, restrictions are needed to make bankruptcy “work.” First, there should be a waiting period before students become eligible for bankruptcy protection -- perhaps five years after beginning to make payments on student loans.

Second, only loans from private lenders would be dischargeable through bankruptcy. The famous cases of student debt in the $100,000-plus realm tend to include large amounts of private loans. Lenders were able to rely on federal laws preventing bankruptcy -- so the sky was the limit. Federal loans, on the other hand, are capped at $31,000 for dependent undergraduates and $57,500 for independent undergraduates.

By making private loans dischargeable in bankruptcy, there would also be a ripple effect -- a good one. Lenders would become much more cautious. They would actually consider the likelihood that the student would be able to pay back the loan. Instead of relying on government policy to guarantee their profits, banks would have to return to time-tested, responsible banking practices. In the end, fewer students would take private loans and total debt would decrease.

Current student loan policy has led young people down the wrong path -- away from frugality and prudence to profligacy. It’s time to start sending better signals.

Jenna Ashley Robinson is director of outreach for the John W. Pope Center for Higher Education Policy in Raleigh, N.C.

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New report on debt and class of 2011

Annual report from the Institute for College Access and Success finds students borrow an average of $26,600.

Standards tightening for federal PLUS loans

Over the past year, the Education Department has made it harder for parents to borrow on behalf of their children in college. Historically black colleges say they are disproportionately affected.

Report finds uneven implementation of net price calculators

Review of net price calculators finds that many are hard to find, confusing to use or inconsistent.

Two-year default rates for student loans increase again

The two-year default rate for federal student loans increased again this year, but defaults at for-profit colleges fell. 

Milton Friedman was actually a financial aid progressive (essay)

July 31 marked the 100th anniversary of the birth of the late economist Milton Friedman. As a champion of school vouchers and other well-known conservative ideas, Friedman is far more heralded on the right than the left. But Friedman is also widely cited as the father of one idea that many progressives love: income-contingent student loans, in which borrowers pay a certain percentage of their income and loans are often forgiven after a certain time.

There’s just one problem: Friedman didn’t propose income-contingent loans. In fact, his student financial aid ideas were more radical and progressive than the loan policies supported by Democrats today, and he probably wouldn't have liked how his ideas have been put into practice so far.

Supporters of income-contingent loans have long cited Friedman as their intellectual patriarch. A 1988 New York Times article claims that the key concept of Michael Dukakis’s student loan reform proposal was the income-contingent loan, “first proposed by Milton Friedman, guru to a generation of conservative economists.” That claim has been popping up ever since.

Friedman’s actual proposal was something closer to an equity investment: think stocks, not loans. Under his plan, the government would provide students with financial assistance to pay for college and, in return, the students would pay a percentage of their income back to the government each year regardless of the amount of money initially provided to them. In other words, income-contingent loans socialize losses and privatize gains. Friedman’s plan socializes losses and gains. Let’s walk through what that means:

When the government issues a loan, it is agreeing with the borrower that it will get back the principal plus interest, no more, no less. Once the borrower repays what the government initially lent her, plus interest, she’s free of the debt.

However, under our current income-contingent loan system borrowers who are consistently low-income will not pay back the full amount of their loan, meaning that taxpayers will bear the cost of that loan (socialized loss), whereas high-income borrowers will pay back the loan and then continue to personally reap the dividends of the initial loan (privatized gain).

Friedman’s plan isn’t a loan at all. It’s an investment, in the true sense of the word. Under an equity investment arrangement, a student who realizes a big return on her education investment shares it with taxpayers by repaying more than was originally invested in her (socialized gain), but if she never earns much, she won’t even pay a fraction of what taxpayers originally invested in her (socialized loss).

Yet despite the seeming fairness of the equity investment approach to funding higher education, it turns out that individuals hate paying more when their lives turn out well, especially when they feel like they are subsidizing the perceived failure of others. When Yale University tried something similar to Friedman’s proposal in the 1970s, the most prosperous students complained that they paid a lot more than others.

“The only significant way the program seems really to have gone awry is in misjudging the gratitude of those who would benefit from it,” wrote Timothy Noah in response to a Wall Street Journal piece about the program ending.

“Twenty to 30 years on, the richer ones are bitching about how much they've had to pay. ‘[E]asily the worst financial decision I ever made,’ gripes David Bettis, a physician in Boise.… An e-mail support group for self-made Yalie plutocrats who now regret opting into the repayment scheme was started by Juan Leon, ‘who now sells Gulfstream jets in Latin America.’ "

In the end, the program ended prematurely, and Yale ate the outstanding costs. It’s worth noting that the program varied from Friedman’s plan in a significant way. An entire cohort of a class was invested in, and the cohort would pay a percentage each year until that cohorts’ loan was paid off. Those Yale students were complaining because 30 years on, they were still subsidizing the perceived deadbeats of their class, and that wasn’t fair. By tying investment to a group of borrowers, the Yale program was seen as a socialist dream gone awry, instead of a return on investment per individual.

The Yale program demonstrates that people do not like it when they feel they are subsidizing others for their success. So it is essential, if Friedman’s plan were to ever be implemented, that the investment in an individual was not tied to any other, and the terms of the investment were fixed. For example, no matter how much you earn, you will pay a certain percent of your income for twenty years, no more, no less. The percentage would, ideally, be calculated so that the program paid for itself, but it’s important that the terms of the investment don’t change. 

The equity investment proposal may have inspired liberals and progressives to create income-contingent loans, but the original idea proposed by Friedman, that prophet of conservative economic thought, is more progressive. The reason it has fallen flat thus far is not just that recipients hate paying their fair share, but also that it is such a departure from the status quo.

It is “the novelty of the idea,” wrote Friedman, “the reluctance to think of investment in human beings as strictly comparable to investment in physical assets” that prevents us from implementing this idea more than it is rich Yale graduates whining about a contract they themselves entered into and reaped the benefits from.

If the government were to ever attempt the equity investment program, we as a society would have to overcome that novelty. Both Republicans and Democrats speak of higher education as an investment in our nation’s future. Perhaps it’s time to socialize the gains and not just the losses and to truly “invest” in higher education.

Alex Holt is a research associate with the Education Policy Program at New America Foundation.

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