Is a Federal Student Loan Bailout on the Horizon?
That the cost of higher education is escalating is hardly news, least of all to families who borrow to pay for it. Less understood is that the relative ease of availability of college loans is a major reason for those rising costs - and resulting defaults. Late in January, FICO Labs, a San Jose, Calif.-based credit research company, released a report detailing a number of disturbing trends in the student lending industry. During 2005-12, the average outstanding loan balance rose by nearly 60 percent to over $27,000. And default rates were highest for recent originations. "This situation is simply unsustainable and we're already suffering the consequences," said FICO Labs analytics chief Andrew Jennings. Yet the Obama administration, in seeking to make college universal, may be fueling the problem to the point of inviting a bailout potentially rivaling that of home mortgages.
The present situation has been decades, not just years, in the making. For if there is a crisis in higher education affordability, that crisis has been brought about by rising expectations. Put simply, more people attend college - and expect to attend - than at any previous time in our nation's history. Given that a four-year degree has become the coin of the realm for most high-level employment, tuition and related educational costs have become the price one pays to enter the gates of a rewarding career. During the fall of 2010, slightly more than 18 million undergraduate students attended a degree-granting U.S. college (including two-year community colleges) or university on a full- or part-time basis. That was up from around 6 million in 1967 and 12 million in 1990. Even allowing for increases in the overall U.S. population, this is an extraordinary development. While it's hard to imagine, back in 1947 only 5 percent of all U.S. adults aged 25 and over held at least a four-year undergraduate degree. This figure has risen continuously over time, a fact to which the U.S. Census Bureau's annual "Educational Attainment" data series attests. In 1998 the share of adults 25 and over with at least a four-year degree had risen to just shy of 25 percent. The figure reached 30 percent in 2011 and 31 percent in 2012.
While most adults in this country are not graduates of a four-year college or university, that fact in itself is misleading, for they include a lot of elderly and near-elderly. Focusing solely on the young tells a different story. The U.S. Bureau of Labor Statistics recently estimated that college was the chosen path for 68.1 percent of recent high school graduates. Much of this tendency is the product of strong parental encouragement. It used to be fairly common for parents to beam with pride over a son or daughter who was the first on either side of the family to attend college. We have evolved to the point where a son or daughter who doesn't attend college often is perceived as letting his family down. And not just any undergraduate institution will do, for high social status and the best job prospects are accorded to those who graduate from a private institution or at the least a top-tier public one. For people who expect the best, Georgia Tech, Rutgers or North Carolina sort of suffice, but pale before Emory, Princeton or Duke. As the demand for admissions slots at the best schools far outstrips the supply, anxious high school students try to gain every possible advantage, at whatever cost in time and money, to get in. Unless they are affirmative action beneficiaries, they often frantically attempt to produce evidence of an ostensibly noble, life-changing experience on top of a perfect grade point average and a high SAT or ACT score.
Whatever one's chosen institution, higher education costs money. And its cost is increasing at a rate faster than that of the rest of the economy. During 1978-2011 college tuition and fees grew annually on average by 7.45 percent, compared to medical care and new homes, which grew by a respective 5.8 percent and 4.3 percent. The Consumer Price Index as a whole grew by 3.8 percent a year during this period. For higher education, unlike the other indicators, the fastest increases have occurred in the years after 2000. Price sticker shock is thus a common reaction. For the current 2012-13 academic year, the average in-state full-time student's tuition and fees at a public four-year college or university is $8,655, notes the College Board's annual report, "Trends in College Pricing." For an equivalent private nonprofit institution, the figure is $29,056. When one includes all charges (e.g., room and board) the average for the latter rises to $39,518.
In response to such costs, institutional lenders have made higher education lending into a niche industry. And federal and state governments have devised a wide array of institutional and student aid programs. According to preliminary College Board estimates, federal grants, loans, tax breaks and work-study aid to individual students during the 2011-12 academic year totaled about $174 billion. That's up about 150 percent from around $70 billion during the 1999-2000 year. For those unable to receive a partial or full scholarship, borrowing is the only practical way of paying for college. There are two main ways of doing this. The first is to take out a loan from a bank or other commercial lender. The second is to take out a loan from the federal government itself. Congress in March 2010, as a supplement to President Obama's health care overhaul, abolished the longstanding system of federal guarantees for private loans in favor of expanding the federal direct lending program, which has been around for some 20 years.
Whatever financial intermediary underwrites a loan, the beneficiary must pay the money back starting six months following departure, regardless of whether he or she has graduated. But more students are going into debt than ever before, and they are going deeper into debt as well. Not unrelated to this, defaults are rising. According to Ohio University economist and American Enterprise Institute adjunct scholar Richard Vedder, the number of student loan debtors in this country is now equal to that of people of all ages holding at least a four-year degree. He gives a few reasons in the new (April) issue of Reason magazine: "First, huge numbers of those borrowing money never graduate from college. Second, many who borrow are not in baccalaureate degree programs. Third, people take forever to pay their loans back." Size of debt and likelihood of default go together. Vedder writes: "When I started at Northwestern University in 1958, the tuition was $795 a year. Now it is $43,380." Even adjusting for inflation, that amounts to a quadrupling.
The result is a pileup of debt. According to the Federal Reserve Bank of New York, outstanding student loan debt at the end of Third Quarter 2012 had risen to $956 billion, up 4.6 percent from Second Quarter 2012. By contrast, auto loan and credit card debt stood at $768 billion and $674 billion, respectively, representing rises of 2.4 percent and 0.3 percent during this period. And debt for the categories "home equity lines of credit" and "other" were $573 billion and $311 billion, which represented declines, respectively, of 2.7 percent and 0.3 percent. That figure, noted the New York Fed in a new report issued yesterday, had risen to $966 billion by the close of the Fourth Quarter of last year. To put it in perspective, that's nearly triple the total of eight years earlier. Among students carrying debt, the average load in 2011 reached $23,300, according to the Pew Research Center. And should they default, they can't escape. U.S. bankruptcy law bars debtors from writing off student loans, regardless of situation. For the record, Federal Reserve researchers found that 11 percent of loans were at least 90 days delinquent.
That brings us to the new FICO Labs study. The report, based on a review in 2012 of 10 million consumer credit files, revealed several disturbing trends. In 2005, average per-student debt in the U.S. was $17,233, yet by 2012 had grown to $27,253, a rise of 58 percent. Perhaps even more telling was the increase in late payments. The delinquency rate (i.e., at least 90 days late) on student loan originations during the first three months of the October 2005-October 2007 period was 12.4 percent. Yet the delinquency rate for originations during the first three months of the October 2010-October 2012 period was 15.1 percent. For "account management" student loans (loans opened prior to these observation time frames), the rate increased from 17.0 percent to 25.1 percent. The situation may get worse before it gets better. A FICO Labs survey of bank risk managers in December 2012, which was cited in the report, revealed that nearly 60 percent of respondents expected the incidence of delinquency to rise over the next six months. This was the fifth consecutive quarter that a majority of respondents predicted this trend. By contrast, most respondents expected delinquencies for every other type of consumer loan to hold steady or decrease.
Andrew Jennings, who heads FICO labs, believes the ratcheting up of student debt has set in motion a process that may jeopardize the entire economy. "As more people default on their student loans," he remarked, "their credit ratings will drop, making it harder for them to access new credit and help grow the economy. Even people who stay current on their student loans are dealing with very large debts, which reduces the money they have available to spend elsewhere."
The prospect of a taxpayer bailout isn't causing any lack of sleep among leading campus administrators. Indeed, many welcome this prospect. In December 2008, prior to Barack Obama taking office as president, fully 31 presidents and chancellors of state university systems, along with several higher education public officials, took out a two-page ad in each of the New York Times and Washington Post to publish an "open letter" to Congress and the incoming administration. The ad, paid for by the Carnegie Corp. of New York, called for 5 percent of any future authorization of federal "stimulus" funds to be reserved for public colleges and universities. They didn't get their wish, but they do have a staunch ally in the current administration. When it comes to championing higher education as a social necessity, President Obama has few rivals. In his initial address to Congress in 2009, Obama stated: "Every American will need to get more than a high school diploma." He reiterated his position in his State of the Union Address of 2012, declaring: "Higher education can't be a luxury. It is an economic imperative that every family in America should be able to afford."
The president hasn't been hesitant about putting such words into action. On the most important issue - Stafford loans - he's prevailed. In March 2010, the White House persuaded Congress to scrap the prevailing method of financing higher education. Prior to the 2010-11 academic year, most loans involved the federal government guaranteeing bank loans against the risk of default. The new system, in the name of eliminating costly middlemen, puts the U.S. Department of Education squarely in the role of banker of the first resort. The role of commercial lenders as a participant in federal programs is now limited to loan servicing. In its Obama-era incarnation, the federal direct loan program, initially authorized by Congress in 1992 and signed into law by President George H.W. Bush, doesn't prevent banks from underwriting college loans. But by supplanting federally-insured Stafford loans, it creates a disincentive for banks to make them. Advocates of 100 percent direct lending appear to be thinking less about efficiency than about crowding out the competition so as to achieve national educational goals. The result speaks for itself: For the 2011-12 academic year, the U.S. Department of Education issued 93 percent of all student loans. In a real sense, a federal bailout has begun.
But even if unintended, wouldn't a switch to direct lending make the system more efficient? After all, federal direct lending cuts out middlemen and passes on the cost savings to consumers. That's the official line anyway. The problem is that federal lending doesn't deal with moral hazard in ways the private sector must. "Other people's money," in this context, refers to taxpayers' money; i.e., funds raised through coercion. This is the main reason why direct lending standards are more lax. And even with monitoring, they don't necessarily reduce the risk of default. College students, at least those who enter straight out of high school, rarely have any credit record. Moreover, William Bennett, Education Secretary during the second Reagan administration, notes that direct loans don't take future employability into account. Students pursuing fields with a low employer demand are as likely to receive loans as those pursuing fields with a high employer demand, such as health care, hotel management and engineering.
Supporters of universal college education argue that without it, young adults face severely restricted career choices. Census Bureau data reveal that for the year 2009, average monthly earnings for an adult with a professional degree were $11,927. This contrasts with only $5,445 with a bachelor's degree. But even the latter is a royal sum compared to $3,179 for those with only a high school diploma and $2,136 for those completing no more than elementary school. It's a similar story with lifetime earnings. Slightly over a decade ago, the Census Bureau came out with a widely-cited study, "The Big Payoff," comparing "synthetic" estimates of work-life earnings over a hypothetical 40-year career (ages 25-64). Researchers calculated that full-time, year-round workers with a professional or doctorate degree averaged, respectively, $4.0 million and $3.1 million over their lifetimes. Workers whose highest level of educational attainment was a master's or bachelor's degree made $2.1 million and $1.8 million - impressive, but not nearly as high. But workers whose highest level of attainment was "associate's degree," "some college" (i.e., no degree), "high school" or "not a high school graduate" averaged a respective $1.3 million, $1.3 million, $1.0 million and $800,000.
On the surface, such statistics indicate that in order to remain an economically competitive nation, we need to encourage as many young people as possible to attend college. Colleges and universities are incubators of human capital. Thus, those without at least a bachelor's degree suffer from a severe skills deficit. Not just President Obama, but also a host of business leaders, legislators, teachers, guidance counselors and parents, hammer home this view. There are, however, a number of problems with this policy of "no college applicant left behind."
First, it fails to take into account that the value of anything, higher education included, lies in its scarcity. By making a bachelor's degree the minimum par for the course, we effectively would be raising the ante as to what makes someone hirable. That's another way of saying that young adults, in order to realize an edge over peers in job searches, would have to add years to their higher education experience. And that means more people seeking a master's, doctorate or professional degree. University administrators everywhere have an interest in promoting this, yet the dubiousness of such an enterprise eventually would become apparent. About a dozen years ago economist and historian Thomas Sowell noted that everyone at some point "drops out" of formal schooling; it's just a question of when. By universalizing the higher education experience, we extend its length with diminishing returns.
Second, when it comes to earnings, field of study matters. Indeed, it matters at least as much as the fact of college attendance itself. According to a report presented to a meeting of the Florida State Board of Education in December 2010, persons who received associate's degrees in science from the state's two-year community colleges earned an average annual salary of $47,708 right out of school. By contrast, students who graduated from one of Florida's 11 public universities earned just $36,552. Equally telling, students who graduate from vocational programs offered through community colleges also do well after graduation, and with less time and money invested up front. A nationwide survey published in Community College Spotlight indicated that students who graduated from vocational programs that took six months or less to complete earned an average annual salary of $37,356. For those completing certificate training in a specific industry, the figure was $39,108.
Third, reaching progressively lower layers of income and wealth among families of applicants would require an aggressive increase in lending. And that would raise the risk of defaults, possibly with consequences rivaling those of the mortgage meltdown. Fears especially would be justified for loans enabling students to attend for-profit colleges and universities, which heavily market their sales pitches to blacks and Hispanics and which have chronically high default rates. Citigroup recently estimated that paying off all current defaults would cost taxpayers $74 billion. That represents a lot of middle- as well as lower-income students - and with it, widespread discontent. At least some members of Congress want to rectify the situation with what amounts to a demand-side bailout. Last spring, then-Rep. Hansen Clarke, D-Mich., sponsored legislation, the Student Loan Forgiveness Act of 2012 (H.R. 4170), to wipe away student debt for any person devoting 10 percent or more of his or her discretionary income toward loan repayment for at least 10 years. The measure, which attracted several co-sponsors, also would cap interest on federal student loans at the current reduced rate of 3.4 percent (President Obama partially obliged him last July by signing a one-year extension of the 3.4 percent cap, as it applied to subsidized Stafford loans for undergraduates - graduate students and unsubsidized undergraduates would pay the standard 6.8 percent). Under the Clarke plan, individuals who go into teaching, public service or who practice medicine in underserved areas - presumably more idealistic pursuits than others - would have their debt forgiven after only five years. Loans up to $45,520 could be forgiven. The bill didn't get to a subcommittee vote. But the latent support is there. An online petition in support of the bill generated more than one million signatures.
Fourth, by devoting increasing sums of public money to subsidize higher education costs, we inadvertantly drive up the costs. This is an example of an unwritten economic law: Subsidizing something produces more of that something. This rule especially applies to higher education, where cost increases have outstripped those for other goods and services. And a major reason is that institutions, not students, receive student loans. It is hardly surprising that colleges and universities have "captured" much of the funds, applying them to non-teaching staff, campus facility construction, athletic departments and other areas of perceived need. A lot of campuses, especially due to pressures to comply with racial and ethnic "diversity" mandates, have boosted their non-teaching administrative hiring to unprecedented heights. University of Arkansas professor of education Jay Greene has calculated that during 1993-2007, student enrollment at the nation's leading research universities increased by 15 percent yet the number of administrators per 100 students rose by 39 percent; by contrast, the number of professors and researchers rose by only 18 percent. President Obama would do the nation a great service if he asked: Do our institutions of higher learning need to hire so many bureaucrats?
Finally, and perhaps most importantly, college is not for everyone. Such a statement might seem subversive in this day and age, but the reality is that many young adults would be better off, financially and socially, developing career skills in a vocational, military or other nonacademic setting. A good many careers simply don't require a college degree - at least by the Bureau of Labor Statistics definition of "required." Data from Professor Vedder's Center for College Affordability and Productivity at Ohio University estimates this figure at 48 percent. Moreover, a great many young adults coming out of high school (assuming they even have graduated) lack the intellect and self-discipline to handle the demands of a full college course load. The fact that colleges and universities now spend $3 billion a year on remedial education - that is to say, on education that elementary and secondary schools should have provided - alone attests to the fact that we are admitting many people to college who have no business being there. This isn't to denigrate importance of a college education. But by trying to make it universally accessible, we raise the likelihood of enrolling students who are unprepared to handle the rigors of a four-year undergraduate degree program. The term "higher education," after all, implies establishing and meeting standards far exceeding those of high school.
There are ways to finance a college education without having to borrow from the government, such as state-sponsored "529" plans whose earnings are tax-deferred and whose account holders maintain full control over assets. There also are cheaper, non-institutional alternatives for career-building; in recent years there has been a worldwide proliferation of online universities and individual online courses at regular institutions. Whether sees a federal bailout as a process either already in progress or somewhere on the horizon, it would be hard to dispute that student loan debt will climb a lot higher unless education consumers don't consider as many financing options as possible. With a college education, like with anything else, the bills eventually come due.