Student Loans: College Responsibility Will Lead to Greater Care

It’s time to end the student-loan bubble by demanding measurable results.

Just as government-subsidized easy money fueled a real-estate bubble in the 1990s and 2000s, boosting house prices while promoting unwise borrowing and lending, today government-subsidized easy money is fueling an education bubble — boosting tuition rates and reducing students’ incentives to choose education options smartly.

The progressive approach for addressing the student-loan problem envisions the government subsidizing student-loan interest rates and refinancing all outstanding loans. But this “solution” will only encourage more student-loan debt. A true fix must recognize the glaring similarities between the subprime-mortgage crisis and the student-loan crisis. Like the brokers who caused the subprime-mortgage crisis, colleges push naïve students to take on debt regardless of their ability to repay, because colleges bear no cost when graduates default. A true solution requires a new financing system where colleges retain “skin in the game.”

College Board data suggests that between 1975 and 2015, the real value of outstanding student-loan debt grew at an annual compound rate of nearly 20 percent. At year-end 2015, according to the Federal Reserve, student-loan debt exceeded $1.3 trillion. The average 2015 graduate has borrowed $35,000 in student loans, not including educational loans taken out by his parents.

In 2015, the student-loan default rate was 11.8 percent even though 45 percent of borrowers were not yet required to make any payments. Moreover, after correcting for payment deferrals, nearly one-third of borrowers were delinquent. Even among borrowers who took advantage of government income-based loan repayment programs, roughly 20 percent were in in default.

The high delinquency rate is a symptom of a wider problem — a broken higher-education system. Colleges are paid tuition regardless of whether their alumni succeed. They face little incentive to control costs when those costs can be passed on to students who fund them with government-guaranteed loans that are available regardless of the students’ ability to repay.

Between 1975 and 2015, the real cost of attending a private college increased by 171 percent while the real cost of public universities rose by 150 percent. If the tuition, room and board, and other fees at a four-year private college in 1975 were projected forward to 2015, adjusting for the average inflation rate, the cost of college in 2015 would have been $16,213. Instead, the actual cost in 2015 was $43,921.

A large share of rising college costs can be attributed to expanded administration, new non-educational services, athletic programs, and government regulation. Colleges have economized by switching to part-time adjunct faculty. The American Association of University Professors estimates that roughly 3 out of 4 college courses are taught by adjuncts. In 2012–13, the average adjunct was paid just $2,700 to teach a semester class.

The continuing escalation of costs unrelated to educational instruction fuels tuition increases for all students, not just those who take advantage of expanded services and non-academic activities. Many have no choice but to fund them with student debt.

#share#Colleges typically do not lend to students directly. Consequently, they have little incentive to ensure that the debts incurred by their students are repaid. So, like brokers in a predatory lending process, colleges and universities push their students to take on debt, regardless of their future ability to repay.

Americans continue to accept unreasonable student-debt burdens because of a pervasive belief that a college education is essential for the American dream. While many careers do require college, too few students recognize that the bottom 25th percentile of college graduates earn only about as much as the average high-school graduate. These graduates would have been better off financially if they had avoided the expense of a college degree.

The bottom 25th percentile of college graduates earn only about as much as the average high-school graduate.

In an effort to control student debt, Purdue University recently began offering income-sharing agreements (ISAs). ISAs provide student funding but do not charge a fixed interest rate or require the student to repay a specified amount. Instead, students give the college a fixed percentage of their future earnings, subject to some protections. For example, the Purdue ISA requires students to share a fixed percentage of income for up to nine years or until 2.5 times the total amount of money they received under the ISA has been paid off.

But ISAs alone will not get college costs under control. The key to controlling costs and student-debt burdens is to require colleges themselves to have “skin in the game” so they have strong incentives not only to provide a good education, but also to safeguard the financial solvency of their graduates.

Colleges should be required to offer all students the first tranche of their funding. The funding could be an ISA or a student loan, but in either case, the student’s future payments on these obligations must be subordinate to all outside student-loan obligations. In other words, federal student loans must be paid before loans or ISA reimbursements are paid back to colleges. Students need not accept the college’s funding offer, but those who do would be limited by the college as to the amount of outside student loans they can borrow. As lenders, colleges would be required to abide by all appropriate consumer financial-protection regulations.

With “skin in the game,” colleges will face pressure to control unnecessary costs and limit student indebtedness. Colleges will redouble their efforts to ensure that students graduate with the skills necessary to succeed in the job market. Resources will no longer be freely available for unnecessary non-educational university spending.

To achieve these goals, the share of university-provided student funding must be large enough to give colleges the requisite incentives. The optimal college financing share is open to debate, but once the program is fully phased in, we recommend that every student be offered at least 20 percent of his funding from the institution he attends.

#related#Institutions can pay for this new requirement in a combination of ways. Many institutions could tap their endowments to provide the funding — literally investing in their students’ future. Alternatively, colleges can phase in a system where tuition increases are collected on a deferred basis in the form of repayments on student ISAs or loan contracts issued by the college. Finally, colleges could restructure the contracts of highly paid university administrators so that a significant share of their compensation is deferred and linked to the future performance of current students’ ISAs and loans.

The key to controlling student debt and college costs is to fundamentally change the current financing system so that colleges have a long-term interest in their graduates’ solvency and success.

— Paul H. Kupiec, a resident scholar at the American Enterprise Institute, has served as director of the Center for Financial Research at the Federal Deposit Insurance Corporation and chairman of the Research Task Force of the Basel Committee on Banking Supervision. Ryan Nabil is a research associate at the American Enterprise Institute.