What Elizabeth Warren Got Right About Student Loans

Sep 21, 2014 by

Serial class warrior and anger merchant Senator Elizabeth Warren recently proposed that colleges with high student loan default rates be required to repay part of those loans. Warren is actually on to something. It’s certainly better than the Trojan horse she tried to sneak into law in June.

The current student loan system is a mess. The risk is assigned to immature young adults and unsophisticated borrowers. It gives a green light to colleges to cash in and to lenders to indiscriminately loan out money. Possibly Warren is more thoughtful than she has led us to believe. Then again, even a stopped clock is right twice a day.

A properly functioning finance system apportions responsibility to both lender and borrower. The student loan system fails to do that, which is at the heart of the problem. A system where borrowers can walk away from their debts with impunity would quickly collapse. Alternately, a system where borrowers can never discharge their debts would be highly damaging to the economy, leaving people mired in penury.

Not only that, an unbalanced system incentivizes fraud. Where borrowers can easily escape, they have every incentive to lie about their income and forge documentation. Where lenders can always get paid, they have every incentive to lend to anyone and everyone, regardless of ability to pay as well as lure people into loans which feature hidden fees, escalating interest rates and other shady practices.

A financial system that imposes risk on everyone is not only fair and productive for the economy, but is the best way to control fraud.

Granted, the student loan system is a strange animal. By and large, student borrowers would never qualify for the substantial loans they need. Would you lend $100,000 to an 18-year-old? With no collateral, the lender is betting on the future career of the borrower. Any conditions for debt relief would have to be much more stringent than for other forms of finance.

The current problem is that all the risk is borne by the borrowers and that never works. There is not only every incentive to lend to anyone and everyone, but there is every incentive for the colleges to admit anyone and everyone and charge a king’s ransom. What does the higher education industry care? They cash in, graduate the students and move on.

The second twist is the nature of the purchase. The value of education does not manifest itself for many years. And there is no guarantee the education will be valuable. Good luck paying back a $100,000 loan with an ethnic studies degree. And universities don’t offer refunds.

But, worst of all, colleges have become customer-focused in a very bad way, catering to the demands of immature teenagers. They lure prospective students with dorm rooms that are more like condos, extensive recreational facilities, grade inflation and easy majors. After all, the best way to attract and retain students is to respond to their immediate demands. Unfortunately, those immediate demands lead to enormous debt and useless degrees, but plenty of money for higher education.

It’s easy to adopt a “tough luck” attitude toward young people who make these foolish decisions. But the costs to society are significant. Student loans totaling over $1 trillion are depressing consumption and hampering the ability of millions to establish their independence, buy homes, save and invest. The result is the economy suffers and we all pay.

Shared risk would incentivize colleges and lenders to more closely track students’ progress. If colleges and lenders were on the hook for a percentage of a student’s loan, you better believe the free ride would be over. Facing the prospect of future losses, what would schools and lenders do? For one thing, they would withhold loans from underperforming students. They would demand better, non-inflated grades, worthwhile majors and career plans. Students drifting along with a 2.0 in art history would soon be history themselves.

via What Elizabeth Warren Got Right About Student Loans | The Daily Caller.

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