The Banality of Student Loans

The mythology of “college for all” has produced a perverse financing system for higher education. Because policymakers regarded a college education as necessary to opportunity, they made it a public obligation to facilitate any student attending any school, regardless of cost. Because they regarded a degree as sufficient for success, they presumed that the return on investment would always be high. And having granted “education” a sacred status unlike other goods and services, they gave the associated debt a sacred status as well: not to be discharged in bankruptcy.

The results have been disastrous. College costs skyrocketed, fueled by government subsidies designed to grow right along with tuition. Young Americans and their families were encouraged to assume whatever debt necessary—by not only policymakers promoting their loan programs, but also a culture that equated the practice with “investing in your future” and institutions that cashed the checks upfront and were never held accountable. In how many movies does the teenager, discovering his family’s financial troubles, concede gloomily that he can abandon his first-choice school and attend the state university nearby, only for a determined parent to insist, no, we will find a way?

In reality, meanwhile, students are more likely to drop out of college or else land in a job that does not require their degree than they are to graduate into a career. Research suggests that, for men, the selectivity of their school has no effect on future earnings; for women, more selective schools lead to more hours worked and lower marriage rates. The United States spends more than $25K per student—second only to Luxembourg among developed economies and more than twice the $10K–$11K spent in countries like Denmark, France, and Germany. And student loan debt has become the nation’s largest form of non-mortgage debt, sextupling from $260 billion in 2004 to $1.53 trillion at the start of 2020, by which point the U.S. Department of Education reported that about 20% of borrowers were in default.

Progressive politicians have responded with proposals to “forgive” existing student debt, at the extreme equating its very existence with “violence.” But such proposals badly miss the mark in several respects. First, while a subset of borrowers are in crisis, the majority of debt is held in the upper quintiles of the income distribution and by people with at least a master’s degree. The two degrees accounting for the highest share of outstanding debt are graduate degrees in law (JD) and business (MBA). Put another way, high levels of student loan forgiveness would go disproportionately to the Americans least in need of government assistance.

Second, while student loan debt has grown rapidly, it remains less than half of non-mortgage debt and just over 10% of all household debt. The same sacred status that drove the rise in this one form of debt now drives the call for its forgiveness, with no clear justification. Why is a household with relatively high student loan debt more deserving of government beneficence than a household with relatively high credit card debt, or with an auto loan it is struggling to pay off?

Third, forgiving student loan debt without fixing the financing system that created the problem is not only an embarrassing dereliction of duty by policymakers, but also an invitation to even more students to take on even more reckless debts on the assumption that they too will someday be forgiven. In many respects the problem is similar to that of illegal immigration: Millions of people now find themselves in challenging circumstances, due to their own irresponsible behavior as well as a policy regime that actively encouraged it. Progressives clamor for amnesty, by executive fiat if not legislative action, while refusing to countenance the tough reforms necessary to prevent the problem from replicating itself thereafter.

Conservatives should propose an alternative that treats indebted students fairly and provides relief at a cost for those who truly need it, while eliminating the rotten system that gave rise to the problem and replacing it with one in which the institutions collecting the tuition bear the risk of failing to deliver the results they promise.

Step 1: Discharging Student Loans in Bankruptcy 

America’s bankruptcy system is uniquely lenient. Unlike in most other countries, the typical American can walk into court, declare himself insolvent, hand over some remaining assets, default on his remaining debts, and return home to a house exempted from the proceedings. This choice is by no means an easy one—his credit score plummets and borrowing becomes more difficult and costly; friends and neighbors are likely to notice, along with anyone who runs a background check in the future; feelings of failure and accompanying shame are common. Thus, while Americans file for bankruptcy far more frequently than Europeans, the occurrence is sufficiently rare that consumer credit remains widely available and affordable. The cost of bankruptcy is low enough to encourage risk-taking and ensure that someone who truly needs a fresh start can get one, but high enough that most will do what they can to avoid it.

Student loans are the exception to this process. In 1976, Congress amended the U.S. bankruptcy code to prohibit discharge of student loan debt during the first five years of repayment unless the filer could show “undue hardship,” which requires additional proceedings and is a difficult standard to meet—a debtor must show at a minimum that he cannot maintain a “minimal standard of living,” he has made “good faith efforts” to repay the loans, and his “inability to pay is likely to persist.” In 1990, Congress extended the no-discharge period to seven years. In 1998, it made all discharges of student debt subject to the “undue hardship” standard.

The stated rationale for this exception is that, because the loans are offered without collateral, and because the valuable education that a student acquires cannot be repossessed by a lender, borrowers would face a strong temptation to default on debts that they could afford to pay. But there’s little evidence to support the concern about excessive—or fraudulent—bankruptcy. In 1975–76, prior to congressional action, less than 1% of federally guaranteed educational loans were discharged in bankruptcy. The U.S. Government Accountability Office found fewer than 5,000 annual bankruptcies discharging a total of less than $6 million in student debt, as compared to more than 1.7 million graduating students and $8 billion in outstanding loans. The better explanation for the special treatment of student loans is the sacred status accorded to the spending they enable, in pursuit of presumably precious degrees that consistently produce a high return on investment. You can run up tens of thousands of dollars of credit card debt taking vacations and walk out of bankruptcy court owing nothing. But the debt you incurred for the life-changing wonders of time on a college campus, that must stay with you indefinitely.

Allowing the discharge of student loans in bankruptcy would eliminate the sui generis student debt “crisis,” repositioning the loans as one of the many forms of debt held by large numbers of American households, sustainably serviced by most, and discharged for the small number who find the costs of bearing the debt higher than the cost of proceeding with bankruptcy. The reform would “take” no property and abrogate no rights of creditors, whose claims are inherently subject to the always-changing bankruptcy code. With virtually all student debt already held by the federal government, even an unexpectedly high bankruptcy rate would pose no risk of contagion for financial institutions. And the federal government would forego far less repayment than under any forgiveness scheme, and probably only from those borrowers who will never repay regardless.

Leaving the debtor to make the difficult-by-design decision about bankruptcy is much preferable to political attempts at sorting borrowers into those deserving and undeserving of help. In a recent New York Times column, David Brooks illustrates the pitfalls of the latter approach with his proposal to distinguish “precarity grads” from “secure grads.” Forgive up to $20,000, says Brooks, but only for “precarity grads—perhaps to those from families making less than $75,000, perhaps to those who already received Pell grants.” But many, probably most, in this preferred group don’t need the help. Of those who do, many are in trouble only because they behaved irresponsibly. And a much larger population outside the chosen group never had the opportunity to attend college but borrowed for some other purpose—say, to buy a car to get to work—and could sure use $20,000 themselves (call them the “precarity dads”). Desacralize student loans, and then making this particular set of $20,000 gifts makes no sense. Offer bankruptcy as an option to anyone in sufficiently dire straits, and the right group will receive the relief they need, at the price we have always believed someone unable to keep their financial promises should pay.

Step 2: Shifting to Institution-Led Financing

The goal for policymakers should be not merely to provide a fresh start for the most heavily burdened borrowers, but rather to put an end to the vicious cycle created by a financing system that relies heavily on public funds, which allows tuition to increase, which creates greater need for public funds. Public subsidies for higher education increased by 50% from 1993 to 2018, after accounting for both inflation and enrollment increases. Yet as rising student loan balances suggest, this largesse didn’t relieve pressure on students; it fueled even faster increases in tuition. While the industry likes to attribute rising prices to the cost of providing education, instruction accounts for only 30–40% of expenditures; less than what is spent on “academic support, student services, and institutional support.” Over the past decade, at public institutions, non-instructional costs rose three times as fast as instructional ones in real terms.

To be sure, the public has a strong interest in helping young adults become productive citizens, and a college education will best accomplish that for some. But only half of young Americans attain even a community college degree, and among bachelor’s degree recipients 40% find jobs that do not require their degrees. For most people, the path on which they would benefit from support should not pass through a leafy quad. Higher education subsidies should make college relatively more attractive for those who are most likely to benefit from it without luring in large numbers who are unlikely to complete a degree. Meanwhile, whatever level of support is offered to college-goers should be matched with equivalent support on noncollege pathways (see, for example, The Workforce Training Grant).

Thus, rather than provide myriad tax credits and deductions that primarily benefit high-income households or loan subsidies that assert an open-ended public commitment to financing anything a university can think to charge for, public support should come at the state level through the funding of state university systems and at the federal level through a simple, means-tested grant. The federal Pell Grant is a good model, and its level should be calibrated to the cover 50% of the in-state tuition at the median state’s four-year public university. In 2019–20, the median state was Colorado and 50% of in-state tuition and fees totaled $4,172. Tying the grant value to the median state would prevent schools from attracting greater funding by raising tuition. Costs of room and board would be excluded. Young adults not enrolled in college do not expect the public to pay for their housing or food; neither should those enrolled.

Where would students find the remaining funding that they need? A private loan market would likely exist but, absent federal guarantees and subsidies, credit would be scarce and expensive. Borrowers would tend to have limited credit history and few assets. Lenders would be poorly positioned to evaluate the likelihood of successful repayment. The prospect of discharge in bankruptcy would add further risk. These obstacles are features, not bugs. Loaning large amounts of money to teenagers with uncertain prospects and no collateral is a bad idea for lenders because it is a bad idea, period. Finding ways to make it sufficiently attractive to saddle those teenagers with the loans does them no favors.

Fortunately, institutions exist with the capital to finance all the necessary borrowing, the information to assess the wisdom of borrowing to enroll, the resources to help ensure student success, and the incentives to make the system work. Those institutions, of course, are the colleges themselves. Just as sellers provide financing for cars, capital goods, and sometimes real estate, colleges should be expected to finance the education they provide. Instead of cashing tuition checks from day one and leaving the student to someday pay back some other lender, colleges should receive tuition from their students after the fact, when those students have been launched into careers that allow them to afford the payments.

This shift would initially require institutions without large endowments to borrow working capital with which to provide today an education that would be paid for tomorrow. But most institutions would have sufficient fixed assets to secure the needed loans, and the federal government could play a role in guaranteeing that financing—with the understanding that any institution defaulting on its loan would be liquidated. Much of the policy work here entails simply eliminating the various sources of public subsidy so that colleges would have no choice but to pursue this route. But policymakers could support the process by defining the parameters of various gold-standard contracts between students and colleges (e.g., income-share agreements, provisions for drop-out or transfer, claims on future assets, etc.) and, for instance, providing colleges access to earnings data through unemployment-insurance systems.

Colleges dependent on their own alumni’s future earnings to fund their operations would face a new set of incentives. They would have no choice but to structure their programs to be affordable, relative to the value they deliver. They would have no choice but to make admissions decisions on the basis of likely future success, rather than ability to pay up-front. And they would find it suddenly in their vital interest to ensure their students’ successful connection to the labor market and even to provide subsequent training opportunities. Colleges that failed to do these things would find themselves, not just their students, on the financial ropes.

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With loans dischargeable in bankruptcy, with subsidies limited to a straightforward grant, and with providers responsible for financing the investments they promise to facilitate, the white-washed “ivory towers” would lose much of their magical allure. The vital access to opportunity provided by a high-quality education would be available at an affordable cost to all who might choose to pursue it. Colleges could offer a much pricier experience, but in doing so would bear much of the risk themselves. And those who benefited the most from the system would fund it in the long run.