Facing Up to Debt

Last fall, my wife and I drove to Philadelphia for a long weekend. We spent Sunday afternoon wandering along famous Benjamin Franklin Parkway, the street that Rocky ran down before sprinting up the steps of the Philadelphia Museum of Art and raising his arms to the sky. There was some kind of fair going on that day, and the parkway was lined with food vendors, jugglers, and booths where various companies hawked their wares. Many of the companies seemed to be selling something involved with education, but it wasn't clear what. So I walked up to the booths, which were all staffed by friendly, attractive 20-somethings handing out free T-shirts, Frisbees and pens that light up if you twist them the right way. They turned out to be for-profit student loan companies. They were selling debt.

Debt, we are told, is a good thing. Cultural prohibitions against borrowing have caused whole civilizations to falter in the modern world. Our current maybe-recession has been pinned on the "credit crisis" – i.e., not enough available debt. Borrowing has become an ordinary, acceptable feature of American lives. We've come a long way since Franklin warned against becoming "a slave to the lender."

And few sectors have embraced debt with more enthusiasm than higher education. As the price of college has increased sharply in recent years, debt has followed. According to the College Board, total federal student loans increased by 61 percent in inflation-adjusted terms from 1997 to 2007, to nearly $60 billion per year. But that still wasn't enough to match rising costs -- the percent of borrowers maxing out on federal loans increased from 57 percent to 73 percent during roughly the same time. The private loan market (the nice people with the Frisbees) stepped in to fill the void, exploding from $2 billion in loans 10 years ago to over $17 billion today. More students are borrowing more money for college than ever before.

The logic is compelling: Given the huge earnings differential between college degree haves and have-nots, it seems like there's no amount of money one could borrow for higher education that wouldn't be worth it in the long run. Debt opens the doors to opportunity for people with no collateral other than the promise of their older, better-educated selves. College debt is an investment in their future, and it’s a chance that everyone feels good about taking.

But somewhere along the line our unreserved enthusiasm for college debt has gotten out of hand. It has masked tough choices and allowed pressing problems to remain unsolved, in a way that harms the most vulnerable students. This is partly because we tend to talk about debt in ways that obscure its meaning. We've allowed the lofty promise of higher education and the cold-blooded realities of borrowing to become confused. Sometimes we speak as if debt isn't debt at all.

Grants and loans, for example, are routinely bunched together under the common label of "financial aid," as when the College Board noted that "more than $130 billion in financial aid" was distributed last year. This isn't unusual -- everyone in higher education talks this way. And when federal loan programs were first established in 1965, it made some sense. Credit standards were far tighter then, and students had no recourse in the private market.

But the world has changed, dramatically so -- the debt vendors on the parkway are evidence of that. While federal loan programs undoubtedly give some students access to loans they couldn't get elsewhere, for many students the only real "aid" is the subsidy, the amount they save in terms of deferred or reduced interest compared to what they could have gotten in the private market. In an era of single-digit interest rates, the subsidy often amounts to only pennies on the dollar. Now that federal loans have a 6.8 percent fixed interest rate and PLUS loans stand at 8.5 percent, for some students there may be no subsidy at all.

It's true that the credit crisis has tightened the student loan market temporarily, but that's what crises are—temporary. As of this writing, the private lender Think Student Loans (they gave me a pen) is offering to lend students up to $250,000, with funds disbursed within 48 hours and online applications approved "in as fast as one minute." That's with no government subsidy – we're not going back to 1965. Characterizing student aid as the amount of the loan instead of the amount of the subsidy dramatically overstates the real assistance students receive.

The conflation of debt with real financial aid is abetted by individual colleges and universities, which present aid "packages" to incoming students that allegedly make up the difference between the ever-rising price of admission and the family's "expected contribution." For many students the "aid" consists mostly of lightly-subsidized debt -- as if paying money back, with interest, doesn't qualify as a "contribution." The easy conflation of real aid and debt also taints federal policy -- as with the recently-enacted "TEACH Grant" program, which purports to give grants (thus the name) to students who agree to teach in high-poverty schools. Yet due to eligibility restrictions, the U.S. Department of Education estimates, 80 percent of the "grants" will actually turn into unsubsidized loans.

Lenders, meanwhile, are eager to rhetorically bind their product with the greater good of higher education. Sallie Mae isn't so much lending money as "helping millions of Americans achieve their dream" while Nelnet "makes educational dreams possible" and Brazos promises to "help you finance your dreams." I don't fault the dream-weavers in the student loan industry for marketing their services, but seriously: when Capitol One tries to sell me a credit card or a car loan, it doesn't pretend to serve some ethereal higher purpose. It's hard not to see parallels in the sub-prime lending crisis, where unaffordable and sometimes predatory loans were dressed up in the rhetoric of homeownership.

Why does all of this matter? Because the rapid expansion of student debt, combined with the soft-pedaling of debt's true meaning, has served to forestall higher education's inevitable day of reckoning when it comes to price. While a few massively wealthy institutions have recently taken steps to reduce borrowing at the margins for the middle- and upper-middle class, constantly rising prices and debt to match remain the norm elsewhere

There are two main culprits here. Traditional colleges and universities, protected from competition by regulatory barriers and buoyed by public subsidies and rising demand, have managed to avoid most of the difficult choices inherent to becoming more efficient and restraining price. There are exceptions -- University of Maryland Chancellor Brit Kirwan has held down tuition in recent years by cutting operating costs, centralizing purchasing, and increasing faculty productivity (with the support of the faculty). At the same time, the Maryland system re-focused student aid dollars on lower-income students, reducing their need to borrow. Unfortunately, few other higher education leaders can make similar claims.

Governors and state legislatures, meanwhile, often treat universities and students as revenue source during economic downturns, shifting the funding burden to tuition as a means of softening the impact of fiscal crises brought about by their incompetent stewardship of the public treasury.

Debt has been an enabler for both groups. By grabbing money from the future income streams of students and parents, colleges and policymakers have managed to put off hard choices today.

The consequences of these bad actions have largely been hidden from public view. Student loan default rates have been a non-issue since the early 1990s, when federal policymakers cracked down on unscrupulous fly-by-night colleges that were abusing the system. But the most commonly-used measures -- the institutional two-year default rates that were established after the scandals -- are seriously flawed. As my colleague Erin Dillon recently noted, the average time to default is four years. While widely-reported 2-year default rates hover below 5 percent, the 10-year default rate for low-income students is more than 15 percent. For students who borrow more than $15,000, it's more than 20 percent. For black students, it's nearly 40 percent. These numbers, moreover, are for students who graduated from a four-year college. Default rates for drop-outs, of which there are many in higher education, are substantially worse. But since colleges get paid up front, and the federal government guarantees most lenders' loans, there are few incentives for those institutions to care.

The tectonic shift toward debt-financed higher education reinforces the notion that college is a fundamentally private good -- exactly the wrong message in a time when the nation's collective prosperity is increasingly tied to competition for information-age jobs that can cross national borders with ease. It has embroiled college financial aid offices in embarrassing scandals. It limits the life choices of debt-burdened graduates, and can devastate the financial futures of those who default. It fuels inefficiency, price escalation and public disinvestment in higher education while transferring scarce resources from families and students to financial giants' bottom line. Debt in moderation is the right choice for some students, some of the time. But it's no substitute for efficiently-run universities supported by real aid policies for students in need. Higher education debt has grown into far too much of a good thing.