The Student Debt Problem Is Bigger Than Interest Rates

May 31, 2013
Diana G. Carew

If you believe the recent blitz of student debt coverage, greedy private lenders and high interest rates are to blame for the economic woes of recent college graduates. Lending at what is seen to be excessively high interest rates, the pressure on private lenders to restructure student loans, even at the expense of public funds, is rising. At the same time, the government is taking concrete actions to squeeze private lenders out of the student loan market. Now Sen. Elizabeth Warren (D-Mass.) has followed in President Obama’s footsteps by proposing to peg student loan interest rates to the government’s historically low borrowing costs.

Tempting as it may be, attacking private lenders alone will not solve the student debt problem. For one, private student loans are an increasingly small fraction of total outstanding student debt. And while overall student loan defaults have been rising, private student loan defaults have been falling. Second, although not innocent, villainizing private lenders misses the point: outstanding student debt is rising too much too fast. A government-controlled student loan market will not solve the underlying problem that recent college graduates are struggling in today’s slow-growth economy.

Since the 2008 financial crisis, the Department of Education has essentially taken over the entire student loan market. The federal guarantee program was scrapped, and interest rates on subsidized Stafford loans were “temporarily” cut in half with another extension debate underway. New government student loans increased 40 percent over 2008-2012 while new private loans fell 75 percent, to just $6 billion last year. The government now holds more than 85 percent of the $1 trillion in outstanding student debt. Meanwhile, just three major private lenders remain active in the market.

There’s no doubt that subsidized government student loans must be an essential part of higher education funding. College remains the best way to raise incomes, and the government plays an essential role in providing access to higher education for those who are otherwise unable to afford it.

But making the government the only higher education lender, at subsidized rates, risks turning student lending into a faucet that can’t be turned off. A government that controls all student lending could eventually be forced to get into the business of controlling today’s excessively rising tuitions. That could be a slippery slope the government may not want to slide into.Instead of attacking the bearer of bad news, we should use private market insights to help guide future education policy. Right now the private market is questioning the financial viability of student debt. The student loan asset-backed securities (SLABS) market remains well below pre-crisis levels. The latest bond offering from Sallie Mae, which tied performance to older student debt obligations, was canceled after two weeks. Clearly the market has doubts about the underlying quality of certain classes of student debt. We would be wise to take these doubts seriously.Part of this private market uncertainty is due to the rising chorus of student debt legislation – nobody wants to invest in an asset that may not make it to maturity.But that’s exactly the point – investors realize young college graduates are struggling to pay off their debt for reasons other than interest rates. Progressive Policy Institute research shows earnings for recent college graduates fell 15 percent – or by $10,000 in annual terms – since 2000. The slow-growth economy of the last decade hit young people harder than other age groups, with many college graduates taking lower-skill jobs for less pay. The private market is signaling that recent college graduates are financially over-extended.

It’s easy to attack private lenders for unfairly charging high interest rates at a time when borrowing costs are historically low. But the fact is students are charged higher interest rates because they are not AA+ rated governments. They are borrowers with little to no credit whose repayment is dependent on future earnings, taking out a loan with no collateral. It’s not so simple to refinance this debt, public or private, especially if expected future earnings are falling.

Eventually the Obama administration will have to decide if subsidizing the entire student loan market is desirable or sustainable. Until then, it should work with private lenders instead of working to squeeze them out. That includes requiring better communication with borrowers and encouraging more repayment alternatives for private loans. It also includes borrower protections in the form of responsible oversight from the Consumer Financial Protection Bureau. But it should not include showing private lenders the exit.

This article appeared in The Hill.