"Whenever I go into a restaurant, I order both a chicken and an egg to see which comes first"

Monday, April 30, 2012

Don’t Lower Interest Rates on Student Loans–Raise Them


There has been a lot of press recently about interest rates on federal student loans, currently pegged at 3.4 percent and proposed to be doubled to 6.8 percent.  While many lobby groups and individuals are calling for keeping the rates where they are or even lowering them, the best path forward is increasing them to market rates.  The reason is clear.  Right now the low interest rates encourage both poor choices on the part of students and increased costs on the part of school administrators.

Right now with interest rates so low, students who should focus more on a lower-cost technical education, attend four-year colleges which leave them with a mountain of debt and little to show for it.  Few states have yet addressed the issue of structural reform within higher learning – that is, refocusing the curriculum of state universities to economically and civically productive concentrations (see my various blog posts on this subject), leaving the more esoteric courses to the private system.  This realignment would improve the cost-benefit ratio of educational investment.  Students graduate with a useful degree and practical experience.  University costs are kept down because of a more realistic limitation of courses; and not only are taxes less, but they result in higher value. 

As a result of the status quo, students, enticed by universities who see profit in their matriculation attend low-value institutions.  These public universities can anticipate more students with more money via easy loans which translates into more sports facilities, new auditoriums, and an expanded physical plant.  They are under no obligation to reform the educational curriculum and program.

If students had to pay market rates for their loans – i.e. eliminating the federal loan program altogether – more judicious choices would be made by students, and universities and colleges would be forced to realign their curricula to student demand.  If students agree to pay market prices, then they will choose the school which offers the best value for them, whether a technical school, pre-med, engineering, or pre-law; and these institutions would necessarily reform.

Although I have argued that state-initiated educational reform of higher education is necessary (and still do), a simpler and more realistic way of achieving the same end is to raise interest rates on loans and let the market determine school availability and curricula.  Rather than rely on a state to determine what are productive and non-productive courses, let the market decide; that is, let students decide based on economic choice.

This is not a revolutionary concept.  We, as a country, have consistently rejected central planning, dirigisme, or any other form of state decision-making in the economy.  While we have not been consistent in this (tax ‘reform’ is still and always will be a manipulation of the market), in most cases direct federal investment in a particular segment of the economy has been off-limits.  Why not in education as well?

Today’s (4.30.12) Washington Post http://www.washingtonpost.com/opinions/whats-better-for-college-students/2012/04/29/gIQA8kqKqT_story.html gets at the problem, but does not address all the issues:

It’s no surprise that extending the lower rate now comes at a high price: $6 billion for a year, according to the Congressional Budget Office, and much more if the rate is extended year after year. That spending would be more defensible if the rate cut reflected something other than a number picked in a years-ago campaign pledge. It would make more sense if the alternative were truly bleak, instead of a return to what was still a good deal compared with the rates and terms of loans in the private market. Keeping the federal rate extra-low would be less a concern if it didn’t risk encouraging runaway higher-education costs.

While it is true that the debate over interest rates is largely politically-driven in an election year, it is a debate which must happen; and the Post editorial does not consider the obvious possibility of raising interest rates even further or eliminating the federal subsidy program.  Nor does it raise the most compelling issue of a market-based alternative to state-sponsored educational reform.

The amount of outstanding debt is significant.  As another article in the Washington Post indicates http://www.washingtonpost.com/blogs/campus-overload/post/colleges-visited-by-obama-have-varying-records-on-student-loan-debt/2012/04/25/gIQAEP8BhT_blog.html :

The average University of Iowa senior in 2010 had loans totaling $27,391, higher than the national average of $25,250. The state of Iowa has one of the highest rates of student loan debt in the country ($29,598), just behind Maine ($29,983) and New Hampshire ($31,048).

Student loan debt is an issue that affects millions of people, even more so than credit card debt. For the Class of 2010, at least two-thirds of seniors took on some form of student loan debt. This debt is generally higher at private institutions than at public ones. Last year, the amount of outstanding student loans hit more than $1 trillion [Italics mine].

The biggest question, again not addressed in this or other articles is “What are students getting for their money”?  As importantly, “What are the states getting?”.  The argument for state, taxpayer-supported funds for education is that there should be maximum benefit to the state.  While there can be different opinions on what that benefit might be, few would argue that producing economically and civically viable students is of the highest priority.  While other arguments are posited – a college education, beyond the reach of most people in the earlier days of the nation, should be considered a right; college continues the process of institutionalized diversity, etc. – they should be far down the list.

A companion piece to the Post article entitled Differential Tuition addresses the cost issue in a different way, suggesting that higher tuitions should be charged for programs in high demand, such as nursing, business, and engineering.  This makes sense, for these courses will always be in higher demand than Comparative Literature for which there is no job market.  However if tuition rates and interest rates go up, most prospective students would be priced out of the market.  If interest rates alone were allowed to float into commercial territory, students would automatically choose the most promising and productive courses, forcing the universities to cut unproductive courses and maintaining reasonable tuition costs.

In short, raising interest rates to market values – that is, eliminating all federal subsidy programs – would force a quick and efficient reconfiguring of higher education to the benefit of both state and student.

The Post raises the issue of Pell Grants, suggesting that these should not come under any scrutiny and in fact be increased; and the argument in principle is sound.  There are many talented young people who cannot afford higher education.  Yet, if recipients of Pell Grants are allowed to use the money indiscriminately (as above selecting institutions and courses irrelevant to their own and the national interest), the money will be wasted.  If there are to be federal full-subsidy grant programs, then there must be certain conditions for their use.

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