Submitted by Alex Holt on August 17, 2012 - 3:00am
July 31 marked the 100th anniversary of the birth of the late economist Milton Friedman. As a champion of school vouchers and other well-known conservative ideas, Friedman is far more heralded on the right than the left. But Friedman is also widely cited as the father of one idea that many progressives love: income-contingent student loans, in which borrowers pay a certain percentage of their income and loans are often forgiven after a certain time.
There’s just one problem: Friedman didn’t propose income-contingent loans. In fact, his student financial aid ideas were more radical and progressive than the loan policies supported by Democrats today, and he probably wouldn't have liked how his ideas have been put into practice so far.
Supporters of income-contingent loans have long cited Friedman as their intellectual patriarch. A 1988 New York Times article claims that the key concept of Michael Dukakis’s student loan reform proposal was the income-contingent loan, “first proposed by Milton Friedman, guru to a generation of conservative economists.” That claim has been popping up ever since.
Friedman’s actual proposal was something closer to an equity investment: think stocks, not loans. Under his plan, the government would provide students with financial assistance to pay for college and, in return, the students would pay a percentage of their income back to the government each year regardless of the amount of money initially provided to them. In other words, income-contingent loans socialize losses and privatize gains. Friedman’s plan socializes losses and gains. Let’s walk through what that means:
When the government issues a loan, it is agreeing with the borrower that it will get back the principal plus interest, no more, no less. Once the borrower repays what the government initially lent her, plus interest, she’s free of the debt.
However, under our current income-contingent loan system borrowers who are consistently low-income will not pay back the full amount of their loan, meaning that taxpayers will bear the cost of that loan (socialized loss), whereas high-income borrowers will pay back the loan and then continue to personally reap the dividends of the initial loan (privatized gain).
Friedman’s plan isn’t a loan at all. It’s an investment, in the true sense of the word. Under an equity investment arrangement, a student who realizes a big return on her education investment shares it with taxpayers by repaying more than was originally invested in her (socialized gain), but if she never earns much, she won’t even pay a fraction of what taxpayers originally invested in her (socialized loss).
Yet despite the seeming fairness of the equity investment approach to funding higher education, it turns out that individuals hate paying more when their lives turn out well, especially when they feel like they are subsidizing the perceived failure of others. When Yale University tried something similar to Friedman’s proposal in the 1970s, the most prosperous students complained that they paid a lot more than others.
“The only significant way the program seems really to have gone awry is in misjudging the gratitude of those who would benefit from it,” wrote Timothy Noah in response to a Wall Street Journal piece about the program ending.
“Twenty to 30 years on, the richer ones are bitching about how much they've had to pay. ‘[E]asily the worst financial decision I ever made,’ gripes David Bettis, a physician in Boise.… An e-mail support group for self-made Yalie plutocrats who now regret opting into the repayment scheme was started by Juan Leon, ‘who now sells Gulfstream jets in Latin America.’ "
In the end, the program ended prematurely, and Yale ate the outstanding costs. It’s worth noting that the program varied from Friedman’s plan in a significant way. An entire cohort of a class was invested in, and the cohort would pay a percentage each year until that cohorts’ loan was paid off. Those Yale students were complaining because 30 years on, they were still subsidizing the perceived deadbeats of their class, and that wasn’t fair. By tying investment to a group of borrowers, the Yale program was seen as a socialist dream gone awry, instead of a return on investment per individual.
The Yale program demonstrates that people do not like it when they feel they are subsidizing others for their success. So it is essential, if Friedman’s plan were to ever be implemented, that the investment in an individual was not tied to any other, and the terms of the investment were fixed. For example, no matter how much you earn, you will pay a certain percent of your income for twenty years, no more, no less. The percentage would, ideally, be calculated so that the program paid for itself, but it’s important that the terms of the investment don’t change.
The equity investment proposal may have inspired liberals and progressives to create income-contingent loans, but the original idea proposed by Friedman, that prophet of conservative economic thought, is more progressive. The reason it has fallen flat thus far is not just that recipients hate paying their fair share, but also that it is such a departure from the status quo.
It is “the novelty of the idea,” wrote Friedman, “the reluctance to think of investment in human beings as strictly comparable to investment in physical assets” that prevents us from implementing this idea more than it is rich Yale graduates whining about a contract they themselves entered into and reaped the benefits from.
If the government were to ever attempt the equity investment program, we as a society would have to overcome that novelty. Both Republicans and Democrats speak of higher education as an investment in our nation’s future. Perhaps it’s time to socialize the gains and not just the losses and to truly “invest” in higher education.
Alex Holt is a research associate with the Education Policy Program at New America Foundation.
Every article I’ve read on the student loan debate seems to be missing one very crucial, simple way to completely eliminate student loan debt. It’s so painfully obvious that it flabbergasts me that no one, I mean no one, has pointed this out.
Many ideas are put forward. Lower tuition. Let students discharge their student loans in bankruptcy. Offer more Pell Grants, don't cut them. Limit the amount of aid that goes to for-profit colleges. Push for more disclosure of student loans and the cost of college.
None of those are the best solution to this problem. The real answer is simple and unpopular. It lies not with Congress, or the president, or the colleges and universities, but with the students. Students have to stop borrowing money to pay for college.
I know what you are thinking: “What, they can’t do that!” “How do you expect them to pay for school!” “That’s impossible!” “Colleges are too expensive!” I know there is a lot of emotional reaction to this statement, mainly because it flies in the face of popular wisdom, which is, “Borrow money now, focus on school, pay the money back after you finish school, when you may, or may not, be earning a higher salary.” We are borrowing on anticipated future earnings, or “leveraging,” as it might be called.
But I think we’ve forgotten a basic rule of economics: If you can’t pay for it, don’t buy it. Go to a school that you can afford.
Students have options. They can go to community college at a relatively low cost for two years, then go to a four-year school after that. They can work full-time and take online courses at cheap universities that are making education affordable and that will not accept federal financial aid, not because they are not accredited, but because they want you to graduate debt-free, at schools like New Charter University, or even tuition-free universities like University of the People. It’s not Plan A, per se, but it is doable. It’s not the freshman college experience, but it is a path to graduating debt-free.
Isn’t this how education is supposed to be? Work gives you the practical, real-world experience, and adding the educational understanding helps create a holistic learning approach. Three-quarters of college students juggle families, jobs and school.
The debate is not, should lower or increase interest rates? The “debate” should be about students taking a tough stand, for themselves, for their future, for the next generation’s future -- saying no to student loan debt.
Don’t get me wrong. Colleges and universities across America need to do everything possible to lower the cost of tuition. Absolutely. But do college students need to choose schools that are more affordable for them? Absolutely.
I know this is unpopular, but so have been many things in history that go against the grain. Thomas Paine, one of our nation’s founding fathers, stated, “Perhaps the sentiments contained … are not yet sufficiently fashionable to procure them general favor; a long habit of not thinking a thing wrong, gives it a superficial appearance of being right, and raises at first, a formidable outcry in defense of custom. But the tumult soon subsides. Time makes more converts than reason.”
Aaron Broadus is a financial literacy counselor at the University of Missouri-Kansas City School of Medicine.
A no-cost solution to the impasse on extending the 3.4 percent interest rate on some federal student loans is hiding in plain sight.
Lawmakers can cut interest rates and lower student debt burdens at no taxpayer cost starting with the upcoming school year by pegging interest rates to those on 10-year Treasury bonds, plus 3.0 percentage points. This policy is better for all students, even those who would qualify for the 3.4 percent interest rate. Yet, in a show of election-year theatrics, lawmakers are deadlocked over how to offset the $6 billion cost of extending the 3.4 percent rate -- raise taxes or repeal part of the 2010 health care law -- and aren’t looking for what helps students most.
Why is Congress debating interest rates on student loans in the first place?
Since 2006, the Department of Education has issued most federal student loans (Unsubsidized Stafford loans) with a fixed 6.8 percent interest rate. In recent years, however, Congress has allowed undergraduates with greater financial need to get lower rates on Subsidized Stafford loans. Funding has now dried up for those lower rates -- which hit 3.4 percent last school year -- so all newly issued loans starting this school year will carry the 6.8 percent rate. That is, unless Congress comes up with more funding. So it is now a “how do you pay for it?” debate that is going nowhere.
Congress and the president should just call a truce and agree instead to peg the rate on all newly-issued loans (for graduate and undergraduates) to 10-year Treasury bonds, plus 3.0 percentage points. The Congressional Budget Office says this plan (which was introduced as a Senate bill on Wednesday) reduces the cost of the loan program by $52 billion over 10 years because the agency estimates that rates on 10-year Treasury notes will eventually rise and newly issued loans will carry rates higher than 6.8 percent.
Students would be better off under this plan than what Congress is currently debating. That is true even though the formula doesn’t get the rate on Subsidized Stafford loans down to 3.4 percent (at today’s 10-year Treasury rate it would be 4.5 percent). While Congress and the president have been focused on the seemingly magical number of 3.4 percent for Subsidized Stafford loans, they’ve overlooked the fact that a smaller rate cut applied to both Subsidized and Unsubsidized Stafford loans adds up to a better deal for borrowers. Here’s why.
Undergraduate students (who are still dependents) can borrow up to $5,500 in Unsubsidized Stafford loans their first year in school, $6,500 in the second, and up to $7,500 each year thereafter. However, Subsidized Stafford loans, those that qualify for the 3.4 percent interest rate, max out $2,000 below those annual limits. So undergraduates who qualify for the lower rate, but borrow the maximum in total federal loans, actually have both types of loans.
Under the proposed extension of the 3.4 percent rate, one loan would charge 3.4 percent interest and the other 6.8 percent. Under the 10-year Treasury note proposal, rates on both loans would be the same, at 4.5 percent based on today’s rates.
While the weighted average interest rates a student will pay under either plan are very close, the 10-year Treasury plan is more favorable because Unsubsidized Stafford loans accrue interest annually while a borrower is in school. (No interest accrues on Subsidized Stafford loans during that time.) As a result, lowering that rate on both loan types to 4.5 percent, as the 10-year Treasury note plan would do, means borrowers would leave school with lower overall loan balances than they would under current law or the pending proposals to extend the 3.4 percent interest rate on some loans.
For example, a first year student’s loan balance upon graduating four years later would be $6,044 under the proposed extension of the 3.4 percent rate. But under the 10-year Treasury note plan, it would drop to $5,860 because the Unsubsidized Stafford portion of the loan balance accrues interest at the lower rate of 4.5 percent while the student is in school. Therefore, the student’s monthly payment would be $3 lower under the 10-year note plan than if he were to take out a Subsidized Stafford loan at 3.4 percent.
Graduate students and undergraduate borrowers who don’t qualify for any of the loans at 3.4 percent also would realize savings under the 10-year Treasury note plan because they would pay lower rates, too. Parent and Graduate PLUS loans rates would be lower as well.
So far Congress and student advocates haven’t warmed to this alternative, despite its clear benefits. Some would-be supporters are concerned that pegging fixed rates to the 10-year Treasury note would mean that rates on new loans could eventually be higher than 4.5 percent or even 6.8 percent. There is certainly a risk of that happening, but that’s the only way to reduce the cost of the loan program in the long run while lowering interest rates in the short run.
Besides, there is merit to pegging rates to a market index. Students will get lower rates when the economy is weak and will pay higher rates only if the economy improves. That’s a fair approach, for both taxpayers and students.
If only Congress would look past the politically charged 3.4 percent interest rate, they would see that a better plan for reducing student debt is right in front of them.
Jason Delisle is director of the Federal Education Budget Project at the New America Foundation.
Of late, American higher education has been suffering more than its share of the shocks that flesh is heir to. As a result, we will likely see soon a retrenchment in government-subsidized student loans.
First, the alarm has gone out following the Federal Reserve Bank of New York’s latest study of student-loan debt. In addition to finding that student debt now exceeds $1 trillion, exceeding credit-card debt, the study found that senior citizens are bearing an ever-greater burden of student loans.
Surprised to read “senior citizens” in the same sentence as “student loans”? The study found that fully 18 percent of delinquent student-loan debt now rests on the slumping shoulders of those 50 and older. Parents increasingly are taking out loans to help their children through college. These late-life excursions into debt threaten parents’ retirement prospects, producing the “possibility of another major threat on par with the devastating home mortgage crisis,” says a recent report by the National Association of Consumer Bankruptcy Attorneys.
With this gloomy prediction, Chase, America’s largest bank, appears to agree. Chase just announced that it will stop providing student loans to those who are not its customers. Bad student-loan debt at the bank has increased 72 percent since 2009. So in a move unnervingly reminiscent of the buildup to the housing-market meltdown, Chase Bank has opted to cuts its losses.
But will those ultimately on the hook for these unpaid, government-subsidized loans -- the American taxpayers -- likewise be able to cut their losses? Not according to Vice President Joe Biden.
The vice president took part recently in a Twitter town hall, at which he was asked, "Have you ever thought about lowering education costs by decreasing the role of government intervention in the education business?" His Twittered response conceded that reducing government subsidies “could reduce [tuition] costs.”
Biden’s concession is noteworthy. Generally, defenders of these loans have been loath to admit that the resulting distortion of market forces escalates precipitously both prices and debt in the same manner and for the same reason as occurred in the home-mortgage industry.
But Biden’s extraordinary concession immediately gave way to an ordinary dodge. Even allowing that reducing government intervention could lower tuition costs, it would be “against [the] national interest to do so,” he tweeted, because fewer students would then be able to attend college, cheaper though it may become.
According to the vice president, then, the trillion dollars of loan debt, the rising defaults on these loans, and the skyrocketing tuition prices (average tuition has risen four times faster than inflation over the past quarter-century) are all worth it. They are the price for increased access to a college degree. Refusing to pay this higher price would be “against the national interest.”
Give the vice president credit for honesty. The question then becomes, “What exactly are we taxpayers getting for the increased price he wants us to continue to pay?”
According to Academically Adrift, last year’s landmark national study of collegiate learning, the answer is “not very much.” Of the national sample of students it surveyed, 45 percent failed to show “any significant improvement” in “critical thinking, complex reasoning, and writing skills (i.e., general collegiate skills)” after two years in college. Even after four years in college, 36 percent continued to show only insignificant improvement.
The disappointment produced by these results magnifies when we consider the cost of the drive for greater access. Today, about half of the students who enter college graduate. Of this half, Adrift tells us, only two out of three succeed at demonstrating some substantial learning. In all, then, only one in three college-headed students leaves with both a degree and the learning a degree is meant to certify.
For this sad outcome, Americans are footing an unsustainable debt burden. The vice president urges that we stay the course nonetheless. Will his countrymen follow him, or will they make like Chase Bank and exit before the bubble bursts? Would growing numbers begin to abandon the quest for a college degree?
This is hard to imagine when for decades we have been told, and with some truth, that a college education is the alpha and the omega. Consensus regarding the value of a degree has served to justify the upward spiral of government subsidies, tuition prices, and student-loan debt. But Chase Bank’s move is only the latest bit of evidence that, for some time now, the benefits of college are plummeting proportionately as tuition prices and loan-debt soar.
Nevertheless, Americans, at least for the short term, likely will continue to borrow for college as long as government-subsidized loans are available. But the short term may prove to be very short.
If we continue on the course urged by the vice president, loan defaults will continue to rise, which means that the bill to the federal government, which guarantees the loans, will continue to rise. The increased dollars required to foot this bill can come only through raising taxes, or cutting funding for other programs, or government borrowing. In a still-stagnant economy, raising taxes is knotty. Cutting other programs has rarely been an option for which our national leaders have shown much stomach, as it creates only a new class of aggrieved constituents. Equally problematic is increasing government borrowing when the deficit and national debt already stand at historic highs.
What seems likely, regardless of who wins the November elections, is a cutback in government-subsidized student loans. It seems that as Chase goes, so eventually must go the federal government. As the federal spigot closes, so will be the number of students able to attend college, at least initially. But the resulting downward pressure on demand will force universities to reduce prices, restoring market equilibrium in time.
How and when this will transpire is a matter for speculation, but may be explained reasonably, and not without humor, by what is known in investment circles as the “greater fool theory.” According to this theory, market bubbles are caused by overly cheery investors (“fools”) who buy overvalued products believing that they will be able to sell them at a profit to other (“greater”) fools. The bubble stays intact so long as greater fools are available to prop up the market. The bubble bursts when there are no greater fools left. At this point, the last greater fool finds that he is in fact the “greatest fool.”
Mr. Biden’s critics charge him with betting that there are still fools out there (students, parents, and taxpayers) who will continue to invest in the overvalued asset higher education has become. However, a bubble requires more than the credulousness of fools. It also requires that they be solvent. Collective foolishness has driven the country to brink of insolvency, leaving even the foolish among us with no option save self-restraint. As the maxim has it, “The wise man does at once what the fool does at last.” In higher education, the country may be poised finally to do the right thing, having exhausted all other alternatives.
Thomas K. Lindsay directs the Center for Higher Education at the Texas Public Policy Foundation. He served as deputy chairman and COO of the National Endowment for the Humanities during George Bush’s second term.