The Clock Is Ticking... An Insight to the Student Debt Crisis

This is yet another crisis that is taking its toll on the American economy and according to the Federal Reserve Bank of New York, Americans now owe more on student loans than on credit cards.

The issue at hand is one of the many things that the Occupy Wall Street protesters seem to be upset about; with many pledging against the repayment of student loans. Petitions have been set up with demands that the federal government take action and forgive student debt as a means to stimulate the economy. As a response to the public outcry, President Obama recently presented a new student loan program in order to ease the burden on college students.

Colleges have been the recipient of recent criticism due to substantial increases in tuition over the years, creating a greater financial burden on today’s young scholars; but are the colleges at fault for this?

According to American Economist Peter Schiff, one major factor affecting the inflation of tuition could be the financial aid provided at the federal level. Since the government’s Higher Education Act of 1965 was put in place to provide financial aid for students, rises in tuition have outpaced inflation by four times^[1]. This could have been caused by the fact that government subsidies and guaranteed loans for students are also guaranteed sources of income for colleges.

With these loans, colleges have less incentive to maintain efficient tuition levels as students are able to pay the high costs anyway. Knowing this, it is only rational for colleges to charge the price that students are willing to pay. If students are not provided with guaranteed loans from the government, and as a result could not afford the high prices of tuition, would colleges cease to exist? No. Colleges would be forced to increase efficiency and lower prices as a result of competitive market dynamics.

Millions of Americans have had enough of the rising costs of education, and have formed online petitions asking for the forgiveness of loans. A petition on signon.org  (containing over 650,000 signatures) states, “Forgiving the student loan debt…. will have an immediate stimulative effect on our economy… millions of Americans would suddenly have hundreds, or in some cases, thousands of extra dollars in their pockets every month….to spend on ailing sectors of the economy.”

However, if economic stimulus was the reason for such a bailout then an equivalent hand out of money to those in financial strain – according to Freakonomics.com – would potentially yield a larger stimulus to the economy, as lower income households would be less likely than college graduates to put the money in banks.

In reality, forgiving student loans may not be the optimal solution to the problem of excessive student debt. Despite this, there has been a vicious spread of online petitions that have caught the attention of the Obama Administration as they have decided to unveil a new plan. As reported by the Wall Street Journal, major changes include: to shrink interest payments from 15 percent of income to 10 percent of income; and, to shorten debt forgiveness from 25 years to 20 years.

While this seems like an appropriate solution, long-term problems may be immanent. Obama’s plan will now allow students to borrow more money and end up paying less, due to decreases in interest rates and forgiveness period. Given the aforementioned changes, students are then more likely to take on larger loans that will come at the expense of American taxpayers.

According to Peter Schiff, if students know they can take bigger loans while having to pay less, they are given incentive to finance their personal lifestyles. This is actually something I have witnessed across the border, here in Canada – on one occasion I heard students discuss using their OSAP loan money to buy clothes or to purchase a car, since the amount of money they need to pay back is less than the loan itself. This is certainly unfair to the taxpayers who are the ultimate financiers of these loans. Furthermore, if it is true that guaranteed loans raise tuition prices, then college tuition will continue to soar to unprecedented levels with the influx of student debt.

Government loans account for 80 percent of the student loan debt, and there is already plenty of speculation of a higher education bubble. Tuition payments are rising, and the degrees are providing less marginal returns. Students who are failing to find employment at the level needed to pay back their loans are facing the same situation as debtors whose homes became worth less than what they owed to the bank. These loans often do not require credit checks or collateral, and just as how easy access to loans contributed to the housing crisis, student loans could result in a similar scenario.

With all that said, the government is not solely responsible at blame. Times have changed, and earning a degree does not guarantee the type of security that it did 30 years ago. At the age of 18, many Americans do not know what they want from their future, and to take on thousands of dollars’ worth of debt at an expensive university can result in serious consequences.

An undergraduate degree is a four year process and by second year many students are already locked into their major with little room to change. Therefore, making a mistake during these four crucial years can be very costly after taking on large amounts of debt.

The labor market has also changed, and students need to recognize this before taking on large amounts of debt. As reported by CBS News, certain college majors are in much higher demand in the labor market, and provide more job opportunities and higher salaries than other fields of study. This is not an advocacy for choosing a salary over something one is interested in studying, but rather for future planning: students who are taking on large amounts of debt should think about career prospects and how they will be able to pay back their loans.

While equal access to education is the goal, we have to remember that not all students are equal. Besides the fact that federal loan issuers usually do not ask for things like collateral or down payments, they also do not ask for previous performances in high school, what major a student is pursuing, how a student plans on paying back the loan, or interviews to gauge a student’s academic ambition. Would a private bank issue out a large loan to someone without a business plan? Of course not, and this is what is dangerous about student loans at this point in time: almost anyone can get one.

If government loans are contributing to rising tuition prices, then it is finally time to step out of the lending industry and let the free market lower tuition prices, or cap the loan limits– at least start behaving like a lender who cares about their money.