Not Just About Healthcare Reform

Tacked onto the reconciliation bill that the House passed Sunday was legislation overhauling the student loan industry. The sector, once subsidized by the “Federal Family Loan Program” under which the government subsidized loans made by private lenders to students, has now been nationalized, eliminating private lenders from the equation. While institutions such as Sallie Mae will still assist in servicing the loans, the federal government will now be contracting loans directly to students. This change should result in lower interest rates for student loans, reducing the total cost to the borrowers and perhaps helping them pay off their loans earlier. The legislation also expands the Pell Grant program for low-income students, making more aid available to them which doesn’t have to be repaid.

Will nationalizing the loan program be a good thing in the long run? The Congressional Budget Office calculates that the legislation will “save” $80 million or so in taxpayer dollars. However, CBO Director Douglas W. Elmendorf acknowledged that this projection did not adjust for the cost of market risk of increasing defaults that the federal government will assume with the shift to direct lending. The CBO estimated losses incurred from loan defaults to be about $40 billion. Also, the costs to taxpayers could potentially balloon if the federal government proves less efficient in administering and collecting loans than private sector lenders who have the incentive to collect loans efficiently in order to sustain profit levels. Historically, “efficiency” hasn’t been at the top of the government’s list of strengths.

So what happens when students fail to repay their federal loans and default? The American taxpayers pick up the tab. The new legislation has taxpayers on the hook for 100% of student loan defaults, placing even more demands on the already-burdened American taxpayer. Many argue that subsidizing higher education at all is unjust. Princeton economics professor Uwe Reinhardt has asked, “Where is the justice in taxing a young auto mechanic to provide a heavily-subsidized education for a friend who will earn three times as much money when he gets out?” But others contend that higher-education subsidies which make it easier for student from low-income families to get an education have a positive impact on economic growth. Reinhardt’s mechanic may actually be helping a talented student from a low-income family prepare to become someone whose impact will benefit many more.

In addition, studies suggest that families will soon be burdened by increased tuition as well. A 2005 analysis written by Hillsdale College Professor Gary Wolfram examined numerous studies spanning decades and found a definitive correlation between tuition increases and boosts in federal financial aid. His data shows that increases in federal aid increase the demand for higher education, and, as introductory economics tells us, an increase in demand means an increase in price. Just before the turn of the century, a committee at the University of Pennsylvania noted that “financial aid is directly tied to tuition; if not for the higher level of financial aid expenditures, we would not have been able to increase tuition rates over the past ten years at the levels we did.”

So, as students, we will probably have to borrow even more in the future to complete our education. As taxpayers, we will directly bear any losses from the loan programs in years to come.

Photo courtesy of Flickr.