Today, I’m writing about our student debt problem.

Before diving in, a little context is needed.

• I am a student of business at Columbia University and have student loans.
• My classmates are all student loan borrowers.
• Many of my former classmates at Mercer University are in debt.

Since many of my friends and I have student loan debt, I think I am qualified to write on student loans.

Cool. Let’s go!

A ticking time bomb

Since a long time, I’ve thought that student loans would be the most likely asset class (or liability?) I have thought for a while that student loans are the most likely asset (liability?) Look at this chart.

As of August 2022, we will have outstanding student loans worth more than $1.675T . In March 2007, the total value of US subprime Mortgages was only $1.3T. The subprime collapse nearly broke our entire financial systems.

Instead of greedy banks bundling bad mortgages as securities, and strippers aged 22 buying 10 houses in 2007 (that was wild), we decided to allow millions of 18-year old kids to take on nearly $2T of debt to pay for their schooling.

It certainly looks sustainable, doesn’t it?

lol. lmao.

How did we arrive here?

Perverse Incentives

All decisions are driven by incentives

What happens if you receive free money and suffer no consequences if you never pay it back? You misuse that money and want more.

You probably think that I am talking about those “entitled” students that had their $10,000 loans forgiven.

You’re wrong! You’re wrong!

When I say colleges and universities in the United States, I mean the entire country. Nassim taleb tweeted yesterday about my point.

 

Student loans: The costs of the debt-jubilee are to be paid by the universities and not the taxpayers.

— Nassim Nicholas Taleb (@nntaleb)
Aug 29, 2022

Let me show you what Taleb means:

Jimmy, a student in college, receives a loan from Uncle Sam. Jimmy uses the loan to pay for his tuition at Ball-So-Hard University. Jimmy enjoys his time at Ball-So-Hard U and graduates with a GPA of 3.4 in finance. Jimmy gets a job and spends the following years repaying Uncle Sam’s loans. Who is not involved in the payback cycle?

Ball-So-Hard University.

Student loans are provided by the government. Students use loans to pay school. The school is paid in advance. After graduation, student owes government money. School is chillin.

Your potential revenue has just grown exponentially without costing you anything if you’re a university and you offer student loans. The student pays you the loan money up front, but it is the government that collects the debts.

It’s nice to charge $10,000 for tuition. What if you charged $20? What if you charged $20,000? Or $60? The kids could take out larger loans and pay you up front, but then they would owe money to the government for the rest their lives.

From an economic standpoint, it’s inhumane for universities not to charge the maximum amount possible. After all, the government is giving the money away. Who cares how much Uncle Sam will owe the students after graduation? You got paid, fam.

As you might have guessed, the universities and colleges are taking full advantage of government’s lax policy on student loans.

Sallie Mae was founded in 1973 as the first major US government loan program.

Since 1977, the first graduating class that would be eligible for Sallie-Mae, tuition at colleges has been on average inflation 6.28% annually. What was the average US inflation rate at that time? 3.54%.

Source: In2013Dollars

In 1977, the average tuition was $2275. After 45 years of increasing by 6.28% annually, the average tuition has risen to more than $35,000 If tuition rates had followed the general US inflation trend, they would have been closer to $10,000 a year.

Is it possible that schools have artificially increased their costs to respond to the extra money they receive from student loans?

Crazy I know

Don’t worry. I’m certainly not the only one thinking about this. The Federal Reserve Bank of New York, which has many people smarter than I am, published a report in 2015. In 2015, the Federal Reserve Bank of New York (which has a lot more smart people than me!) published a study that showed that institutions that were exposed to maximum student loan programs tended to respond by increasing tuition.

What if schools are not held accountable if students struggle to repay their student loans, and the government writes a blank cheque to them (via tuition)?

Consider me shocked that the schools have increased their tuition so much.

What is this Loan Forgiveness?

We have ctrl+alt+delete millions of student loans between $10k to $20k, resulting in a massive $330B loss to the federal budget (or $2,000 for each taxpayer).

Is it fair? I don’t really know. Who am I? Sure, I’d be annoyed if I hadn’t paid off my student loan. If I had never gone to college and my tax dollars were (in theory), going to pay someone else’s student loans, I might be annoyed.

Even with student loans, most college graduates will still be better off in the long run. It’s simple: College graduates make more money.

A quote that is widely misattributed to Joseph Stalin says “One death is tragedy.” One million deaths are a statistic.

A student who is struggling to pay back their debts is tragic, but a million students with net positive outcomes are just a statistic. This relief is aimed at a group of people (college and grad school graduates), who as a collective, are the ones most in need.

This student loan forgiveness program is not bad because of either one of these examples. Even though I have some reservations, I support reducing the student loan burden. Student debt is a predatory business that chains too many students each year.

This “solution” is bad, because it exacerbates the problem. We tried to cure the cancer with a simple bandaid.

The debt forgiveness program will have two side effects that are significant:

• In response to the “loan forgiven”, universities will increase their prices once again to pass on some additional costs.
• Students who feel that future loan forgiveness will be high , may take out additional loans in response to higher tuition fees or because they believe the likelihood of future repayment is high .

The short-term effect of the loan forgiveness is that it helps those who are currently in debt. They now owe $10,000.

What about the long-term effect? It is likely that colleges will increase tuition prices more . It’s been done for 40 years, and students will continue to take on more student debt in order to attend even more expensive colleges. This time, students and universities alike will assume that, at the very least, if things get bad enough, the government may forgive more student loans.

One-time student loan forgiveness can result in more debt for future students and higher tuition fees.

We applied a bandaid to a tumour and pretended that we had cured it.

What’s the solution to HTML0?

I don’t really know. This is why I am not President, not in Congress and do not plan to run for Secretary Education.

I think that we need to align incentives in order to reduce costs. The schools should be responsible for the debts that their graduates have not paid. If Harvard faced the possibility of owing billions in debt if graduates did not repay their loans, tuition would drop very quickly.

If the government didn’t guarantee such high amounts of money to children, tuition rates would fall. This would make school more affordable. If universities were partly responsible for student loan defaults, the tuition would decrease to reduce the risk. If the government continues to write blank checks for schools in the form student loans, these checks will only grow.