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Feds Should Take a Big Step Back on Student Loans


April 3, 2024

The federal student loan program has gone off the rails. What was first designed as a program to alleviate the liquidity problem students face when paying for college is now an out-of-control entitlement program that rewards students for spending as much as possible on higher education, causing tuition costs to skyrocket in turn. Biden’s reforms to the student loan repayment program (absent an intervention from the Supreme Court) will make it such that borrowers seldom pay back all of what they borrow.

Some on the right would say that I’m late to the game in reaching this conclusion. After all, the economic integrity of the student loan program has been under attack for over a decade, especially as lawmakers used income driven repayment (IDR) as a vehicle for delivering under-the-radar subsidies to key voting blocks. And even the original design lacked some of the features that would be part of an effective and efficient intervention.

But I’ve long held onto the notion that federal intervention in student lending was appropriate. Even Milton Friedman, Nobel Prize winning economist and extoller of the virtues of free markets, described a role for the government in solving the failure of the market to adequately fund efficient investments in education. But our persistent mismanagement of this essential program has taken away its functional integrity and undermined the intention of its creators. I have to imagine that the lawmakers who crafted the Higher Education Act back in 1965 would be appalled at what their well-intended program, designed on economically sound principles, has become.

This, as they say, is why we can’t have nice things. In theory, federal intervention in student lending make sense. It could ensure that inefficiencies in private financial markets wouldn’t lock students out of economically worthwhile investments in higher education. But it seems that the temptation to use student lending as a political mechanism for handing out ill-conceived subsidies is too great.

According to research from Adam Looney, Professor of Economics at the University of Utah and Senior Fellow at the Brookings Institutions, under Biden’s new plan undergraduate borrowers can expect to only have to repay $0.50 of every dollar they borrow and some students can reliably expect to pay back nothing at all. This is no longer a loan program, but a poorly targeted hand-out program that creates incentive for students to overpay for college and for colleges to precipitously raise costs. 

These are just some of the reasons why I argue, in a new paper out this week with Preston Cooper and Joe Pitts that we need to make room for the private marketplace to replace at least parts of the role of the federal government as student lender. The characteristic feature of the private marketplace is discipline, which is precisely what the realization of federal student lending has lacked.

I won’t go as far as to argue that we should shut down federal lending altogether and allow the private market for student loans to reign. But we do argue in the report that constraining federal lending to make room for private lenders to operate could have immediate benefits. The conversation about how to accomplish this is nuanced, but much of the benefit comes from the fact that the economic incentives between student borrowers and private lenders are aligned. Borrowers don’t want to take out loans they can’t afford to repay and lenders don’t want to give out money they don’t expect to be paid back.

Of course, this would mean that many of the loans made today under federal student lending wouldn’t be made. And many students who currently use federal debt to afford their enrollment might not be able to afford to go to college. We’re conditioned to think that this is necessarily a bad thing. College is the golden ticket to the American Dream, after all. Or so we are told. But I’d argue that giving a student a predictably unaffordable loan to attend a program of study that likely won’t pay off isn’t doing anyone any favors.

The mismanagement of the federal student loan program has been an utter disappointment. I, for one, am disheartened to see that we could not seem to maintain an economically principled intervention without corrupting it for political gain. It’s precisely these sorts of things that turn small government conservatives, like myself, into even smaller government conservatives. While contraction of the lending program isn’t possible in the current political environment, it’s what I hope Republican lawmakers will be considering the next time a political opportunity arises. And the silver lining in this fiasco is that as student lending gets more and more expensive, it will also become more and more appealing for lawmakers to cut, as they are always looking for ways to pay for the next shiny policy idea.