Republicans have their best opportunity in decades to significantly reform or even eliminate government involvement in student loans. As I explain in a new Cato Institute paper, doing so could generate up to $212 billion in savings over the next ten years. But Congress needs to act quickly as the window of opportunity will close soon. This opportunity rests on a series of relatively simple points, which nevertheless add up to a very exciting possibility.
Student Loans Should Exist
Borrowing to finance profitable investments is usually a good idea; some college education fits into this category. For about two-thirds of students, the benefits of attending college outweigh the costs. But some of these students may not be able to pay for college out of savings or current income. For these students, borrowing student loans to enable a college education that leads to a higher-paying job is a good investment.
Our Current System Depends on the Government as the Lender
But our current system entails borrowing directly from the federal government. This government-as-lender system emerged because the Federal Credit Reform Act of 1990 made it look like the government could make a profit from being the lender, in part by using the wrong discount rate. Politicians in DC wanted to spend those profits, so the government took over the student loan business.
[RELATED: Student Loans Are the “Fudge Factor” That Allows Institutional Profiteering]
A System Using Private Lenders Would Be Better
A system that utilized private lenders would be better for five main reasons.
First, private lenders would finance less malinvestment. While private lenders would only make loans that are expected to be repaid, the government routinely makes loans that are unlikely to be repaid. For example, about one-third of students graduate from a program with a negative average return on investment, meaning the costs of attending outweigh the benefits. It would be trivial for the government to analyze past loans and identify college programs where students fail to repay their loans and then curtail future lending for those programs, yet it has never bothered to do so.
Second, private lending would ensure greater accountability for colleges. Colleges that offer substandard quality education or profit from oversupplying degrees in certain fields face virtually no accountability. But private lenders would quickly weed them out because those students would have lower loan repayment rates, so failing to do so would lead to losses on their loans.
Third, since private lenders would adjust interest rates on loans based on their riskiness, students would have better incentives to study hard.
Fourth, colleges would also have better incentives since they would be rewarded for improvement with better loan terms for their students.
Fifth, private lenders would vary interest rates based on the quality of the college and the major chosen, which would provide students with valuable information about the riskiness of various educational options. In contrast, the government-as-lender system offers the same loan regardless of which college a student chooses or whether their academic field is in high demand or oversupplied.
But Transitioning from the Government-as-Lender System to One Using Private Lenders Has Not Been Politically Feasible
While switching to private lending would be beneficial, historically, it has not been politically feasible. Since government lending was profitable, switching would have required painful sacrifices like cutting other spending, raising taxes, or increasing the national debt.
[RELATED: Don’t Let Colleges Keep Ducking Accountability on Student Loans]
But the Biden Administration’s Overreach on Student Loans Has Created an Opportunity to Make the Transition
But the Biden administration has reversed that. By forgiving massive amounts of student loans and creating the SAVE repayment plan—largely a backdoor loan forgiveness initiative—the Biden administration transformed the historical profits into massive losses. The latest estimates indicate that government lending went from making a profit of around five cents for every dollar lent prior to Biden’s term, to losing around nineteen cents today. These losses mean that switching from the government-as-lender system to private lending would save taxpayers $212 billion over the next ten years. These savings, in turn, mean that the transition from government lending to private lending no longer requires painful sacrifice for politicians in DC but rather provides an enticing free lunch–where else can you improve the student loan system while simultaneously generating massive funds that could be used for tax cuts or other spending?
But the Window of Opportunity Will Close Soon
But the window of opportunity to act will close soon. The SAVE plan is currently paused by the courts, and if the courts throw it out or if the Trump administration rescinds it, then much of the savings will disappear.
In sum, the Biden administration’s overreach on student loan forgiveness has laid the perfect groundwork to get the government out of the student lending business. But Congress needs to act quickly to lock in the $212 billion in savings from switching from government lending to private lending.
Image by ozerkina — Adobe Stock — Asset ID#: 404167062
This article was originally published at www.mindingthecampus.org
