Five Reasons Why Student Loans Are a Looming Disaster

Student loan debt

Federal efforts to alleviate the high and rising cost of attending college through student loans have morphed from a policy challenge to a fiscal time bomb threatening to blow up the financial future of tens of millions of Americans and the government’s own solvency. Dressed up as a progressive achievement, it is actually a failure – or more accurately, at least five intersecting failures. And the worst part is this: they would all be hard to fix — even in a “normal” political era.

The scope of these programs is enormous. More than 44 million Americans (about one in four adults) have student-loan debt totaling $1.5 trillion and rising. This debt is incurred (and encouraged) through a handful of U.S. Department of Education (DOE) programs for which public and private institutions constitute a powerful lobbying force.  Here, I can discuss only five of the programs’ failures:

1) their unsustainable cost trajectory;

2) the immense debt burdens they impose;

3) high college dropout rates;

4) DOE’s relative neglect of career and technical education (CTE) which would better serve many of the neediest;

5) programs’ perverse targeting and incentive patterns, which magnify all of these problems.

Related: The $1.5 Trillion Student Loan Debacle Has a Tipping Point

DOE’s Unsustainable Cost Trajectory.

The loan programs charge borrowers interest and fees, so they should be budget-neutral or even profitable. This feature made them politically popular for many years, but a major Obama-era policy change – the income-based repayment plan (IBRP) – has sharply reversed the budgetary trajectory. The IBRP became available to new borrowers starting in 2014-15. It allows qualified students to cap their monthly loan repayments at an amount geared to their income and family size; Obama further lowered that cap to 10%. A 2017 DOE financial report, analyzed by the Wall Street Journal, projected a $36 billion shortfall, up from an $8 billion shortfall just a year earlier. (IBRP’s fiscal effect will inevitably grow as more post-2014 borrowers take advantage of it).

Here’s the Journal’s bad news: “Federal data never before released shows that the default rate [for borrowers who started repaying in 2012] continued climbing to 16 percent over the next two years, after official tracking ended, meaning more than 841,000 borrowers were in default. Nearly as many were severely delinquent or not repaying their loans (for reasons besides going back to school or being in the military). The share of students facing serious struggles rose to 30 percent overall.” This, in a period of (slowly) rising incomes and job growth.

By law, DOE must track default rates for only the first three years, yet this is only the tip of the iceberg: delinquencies increase sharply starting in year 4, and DOE’s reports do not include borrowers who are “severely delinquent” or “not repaying the loans.” The number of schools experiencing high default rates by that post-2012 group has also increased dramatically, fueled vastly and disproportionately by for-profits. Even these default rates will presumably rise; more schools now urge students to use options that temporarily suspend repayments, accumulating more interest and simply postponing the day of reckoning. Student loans have the highest delinquency rates of any federal credit program, and higher than for private auto, home equity, and mortgage loans. The New York Fed emphasizes that this actually understates the delinquency problem because of students’ deferred payment obligations.

Borrowers’ Debt Burdens

The statistics are scary. Students owe about $1.5 trillion – about $620 billion more than the total U.S. credit-card debt. The debt of the average Class of 2017 graduate was almost $40,000, up 6% from the previous year’s cohort.  And this burden is greatest for lowest-income students eligible for Pell Grants; their loan debt is higher on average than for higher-income, non-Pell students. As college tuition inexorably rises – for public four-year institutions, more than doubling in constant dollars in the last 30 years, and roughly 5% a year in the last decade – debt burdens will increase accordingly, particularly for lower-income students who attend for-profit colleges such as the immense University of Phoenix (over 160,000 students on 38 campuses). According to the Hechinger Report, almost 80% of these students who had dropped out three years earlier had not yet repaid a cent of principal on their federal loans.

Related: How Federal Student Loans Increase Tuition and Decrease Aid

High College Dropout Rates

These burdens might be sustainable if borrowers were to graduate and then earn at levels reflecting their new credentials.  But the reality is altogether worse. Only 57% of college students graduate from any institution within six years of entering. (Another 12% of that cohort are still enrolled after six years). Nearly one-third – disproportionately low-income, first-generation, and minority students – drop out entirely, carrying their student loan debts with them. Importantly, those who later transfer to a 4-year institution are not counted as dropouts. Dropouts are stunningly high at public community colleges (62%) and at 4-year for-profit colleges (64%). Unsurprisingly, dropout rates of 4-year public and private nonprofit institutions are much lower, reflecting the institutions’ greater resources and their students’ more prosperous families and better prospects.

The much higher dropout rate at for-profit institutions has various causes, including poorly-prepared and lower-income students, many who must simultaneously hold down jobs, and fewer support services for at-risk students. But an important factor is the well-documented fraudulent practices at many of these schools, practices that the DOE recently proposed to protect by easing “gainful employment” disclosure rules.

Fraud by Educational Institutions and Borrowers

The student loan programs have long been rife with fraud, which seems only to have increased since the Obama administration took over the programs from the private sector (although private for-profit agencies still do much of the collection and other work).  Not all of the documented fraud is perpetrated by private for-profit institutions and collection agencies; some are by student borrowers and even Pell grantees. Indeed, in 2013 the DOE’s inspector general reported that this fraud included over 34,000 participants in crime rings. The Obama-spawned IBRPs, which include loan forgiveness options, have surely enabled more fraud. Just since 2015, the DOE has received more than 100,000 fraud complaints; according to a recent review cited by the New York Times, “almost 99% involved for-profit institutions.”  The Trump DOE, widely criticized for weak enforcement against these schools, which Secretary Betsy DeVos is keen to promote, recently proposed new “Institutional Responsibility” regulations purporting to curb some of this fraud but, according to critics, will actually make fraud harder to combat.

Neglect of CTE in Favor of Higher-Status Education

In our cosmopolitan world, one can easily forget that most Americans lack even a community-college diploma. Yet federal (and state and local) student loan programs largely neglect CTE and other intensive work-focused vocational programs, instead emphasizing higher-level, campus-based institutions. The economic returns of a college diploma are certainly large, and unemployment risks are lower: a 2015 Georgetown study found that workers with a bachelor’s degree earn $1 million more over their lifetimes than those with only a high-school diploma, even though the latter has a four-year head start. (This is on average; field of major matters a lot). But many of the student loans go to art, music, and design students who carry a disproportionate debt load while facing limited future income prospects.

College is not the best choice for everyone, especially when one considers its high cost (including the opportunity costs during those four years), the substantial probability of dropping out along the way, and the consequent waste of much of the money expended (depending on the value of the foreshortened college experience), the interest paid on the loans, and the debts’ limiting effect on their future ability to obtain loans and thus life choices. Importantly, Oren Cass points out, “A college degree is neither necessary nor sufficient for reaching the middle class. The wage and salary distributions for college graduates and high school graduates overlap significantly; high-earning high school graduates in a wide variety of fields that require no college degree earn substantially more than low-earning college graduates.”

Yet, despite the strong arguments to enlarge CTE opportunities for those who reject or drop out of college, all levels of government fail to support this alternative path significantly. Washington spent only $1 billion on CTE in 2016, compared with more than $70 billion subsidizing college attendance; much the same is true of state and local governments.  CTE programs vary in their effectiveness, of course, but we have seen that the same is true of higher education institutions and the loan programs that support, and in many cases, sustain them, including the worst ones.

Perverse targeting and Incentives

Federal student loan programs are a classic example of distributive politics: coalitions designed to concentrate benefits while widely dispersing costs. Typically, relatively few of the subsidies go to low-income families; instead, they tend to go to the better off. Nor is it clear that this taxpayer-provided subsidy actually affects educational attainments in general. Those who receive them would likely have attended college even without them; the IBRP tends to benefit high-earning people who can carry high debt, which is one reason that politicians across the political spectrum use the loan programs to appeal to middle- and upper-class voters. And as the Wall Street Journal editorialized in 2013, IBRPs increase moral hazard, incentivizing delinquency: “Take out a big loan, work 10 years for the government repaying as little as possible, and then have your debt entirely forgiven. . . .Borrowers who enroll in [such] plans owe on average three times more than those who opt for the standard 10-year amortization schedule. They thus present the greatest risk to taxpayers.”

Consider several other perverse incentives of these programs. They encourage schools to raise tuition and fees — they nearly tripled over the last 20 years (rising much faster than wages) – thus reducing access. They also encourage institutions to substitute federal money for their own financial assistance, thus reducing the programs’ net effect. Also, the programs (along with other federal and state rules) may have contributed to the doubling of the administrative staff-student ratio since 1975, during which the faculty-student ratio has changed very little.

Program redesign could reduce some of these perverse incentives. Remarkably, however, little rigorous policy assessment of the loan programs’ effectiveness and tradeoffs has been done — perhaps because of the powerful constituencies that support the status quo, favoring only changes that expand initial access to programs, regardless of the dire longer-term effects on so many students. Secretary DeVos’s mission to further weaken already negligible enforcement against the for-profit sector is only the most recent example.

As more prosperous Americans pull further away from those seeking a chance to educate themselves or their children into the middle class, the federal government must fundamentally reform student loans so that they reduce disadvantage instead of multiplying it.


  • Peter H. Schuck

    Peter H. Schuck is an emeritus professor at Yale Law School. His most recent book is, “One Nation Undecided: Clear Thinking About Five Hard Issues That Divide Us" (Princeton University Press).

11 thoughts on “Five Reasons Why Student Loans Are a Looming Disaster

  1. Blackgriffin – I wouldn’t dismiss Merzetti’s claims so breezily, as the data suggests that the populations cited do disproportionately struggle. Now perhaps you can lay that off on socioeconomic standing, but the outcomes for these populations are often dismal.

    And you raise the notion of intelligence. I think it is a straw man. The problem with so many who embark on education borrowing to the benefit of the academic industrial complex which votes almost exclusively one way (ironic, huh?) is the matter of academic preparation. If not prepared, borrowing under a scheme with largely in- dischargeable debt is incredibly risky. This is seen with the for profit colleges, which have poor outcomes because by and large their students are the least capable and prepared. Some traditional schools have lousy outcomes, too. Look at a school like Boise State and it’s dismal 4 year grad rate. Examples abound.

    In any event, I agree it is a scam, but find so many fail to mention the apparatchik beneficiaries of the scam are the academic class, who vote in lockstep but have little concern for poor and middle class students, err, loan conduits. I was astounded during the Occupy movement to see its leaders fail to mention that the Govt in league with the academy class was the cause of so much misery.

    1. Totally agree – it’s amazing how the academic establishment evades any scrutiny, while recent graduates are struggling financially and angrily marching in the streets…protesting against greed and corruption.

      Over the same period of time tuition rates have risen, a huge chunk of our workforce suddenly found themselves without a job and in need of new skills/training – they and their kids were priced out of education…

      These schools are supposed to be non-profit and receive tons of taxpayer money

      This is one of the biggest scandals in recent history and I hope it soon attracts the outrage (and harsh consequences) it deserves

  2. One thing that stopped financial institutions from writing dodgy mortgages was requiring them to absorb a small portion of the losses when loans went sour.

    Now the government guarantees student loans, and there are no consequences for cynical educational institutions that saddle students with bills they cannot pay. Why not make them share some of the pain? Or, better, try harder to help their students to succeed?

  3. He misses a huge issue created by the student loan bubble. It has caused colleges to go on massive spending sprees, building ever larger and more lavish facilities in order to compete for students. Most of this has been built with “borrowed” money, i.e. the money borrowed by current students. The building costs are often funded by bonds with the expectation that future debt service costs and eventual principal repayment and upkeep and maintenance will be funded by future students, also using borrowed money. It has
    many characteristics of a Ponzi scheme!

    1. It’s actually worse for two reasons:

      First, I don’t know how many other IHEs do this, but what UMass Amherst does is issue bonds guaranteed by the university’s ability to assess mandatory student fees. In other words, the bonds are neither backed by the credit of the institution, nor by any physical asset, but by a promise that UM will charge at least “X” number of students a fee of “Y” dollars per semester.

      Hence in addition to the expectation that the debt service costs will be paid by money that future students can/will borrow, the bonds themselves are explicitly guaranteed by student enrollment numbers. That’s fine as long as your enrollment is increasing, but becomes rather problematic should your enrollment numbers ever decline.

      Second, the larger issue is that just about every college in the country expanded over the past 15 years when the Millennials, the so-called “baby boomlet” (children of the baby boomers), were enrolled. But they are now aging out of college and the smaller “Gen X” generation had even fewer children — the number of 18-year-olds is already declining and will rapidly decline even more.

      There simply won’t be enough bodies to fill all the seats and while every IHE seriously believes that it is somehow going to attract a higher percentage of the shrinking pool of potential students, reality is that they can’t all do this…

      A Ponzi scheme fails because the inexorably increasing number of people with new money needed to sustain it eventually exceeds the number of people with new money. This actually is worse because the number of people with new money is shrinking — there are fewer 18-year-olds to take out student loans…

      This is not sustainable….

  4. Another perverse incentive is the rise of for-profit colleges designed to milk unprepared students for the maximum loans while enrolling them in programs that the students are very unlikely to graduate from, and which don’t lead to particularly good jobs if they do. I’m thinking of the places that advertise in subways, and which lay a guilt trip on people to try to get them to enroll.

    They justify themselves by saying that everyone deserves a chance, but there has to be a limit.

    Why I single out the for-profit places: they have a much worse graduation rate than the non-profits. They are also subject to much less accountability than typical non-profits. E.g., non-profits, but not for-profits, typically list all their faculty with their qualifications. Non-profits publish tax returns, fill out the common database, are usually accredited more strictly, etc.

  5. I was in a graduate program for a Masters in Mathematics. The scheme there was to admit a large number of graduate students for mathematics, and let them be Teaching Assistants. This wasn’t to keep costs down, but to provide graduate students to justify having professors teaching graduate classes. They didn’t make much effort to help students graduate with a Masters. But they had their enrolment which allowed faculty staffing at a certain level. We figured it was cheaper to provide instructors than graduate students to teach those classes, because graduate students got benefits instructors didn’t. The faculty did little to help students graduate.

  6. Appoint a special counsel to investigate accademia’s role in rising tuition rates, staff salaries and other possibly inflated costs to pad their income.

  7. A tangential issue here is that student loan debt may serve as an incentive for the parents of expelled students to sue.

    If a student is expelled, not only do all of the loans immediately go into repayment (as if he’d graduated) but he is also required to repay all of that semester’s other financial aid — within 45 days. This is money that neither the student nor the family can afford to pay (or they wouldn’t have been eligible for it in the first place) so this is a significant burden.

    Hence where it once was just spent money being lost when a student was kicked out, it now becomes a case of a massive current expense and hence the economics of retaining counsel becomes quite different — it’s not trying to come up with $20,000 to recover money you have already spent but instead trying to do this instead of paying the $200,000 you can less afford to pay.

    It’s also a more tangible damage — there is a clear economic loss, a bill that will be going to debt collectors.

    If anything will save higher ed, it will be a sufficient number of lawsuits to convince the spineless administrators that doing the right thing is easier than what they are doing now. They know that very few aggrieved students will sue, but if that were to change, we might also see a change in how they view the legal rights of accused students.

  8. Stating the obvious:
    We can suspect, assume, or be absolutely convinced that many victims of the higher education debt machine never belonged in conventional higher education in the first place.
    Looking at the dropout and failure rates of first generation, immigrant, minority enrollees – one can only wonder about their actual academic credibility upon arriving in the higher halls.
    But their debt loads look just as good on the books.

    And in our near future, how many millions have been struck from the ranks of those who can afford to support and consume within our economy?

    1. No, you can’t make such a ridiculous assumption. Plenty of poor kids with no connections are more than intelligent enough to go to college. But getting a degree doesn’t automatically translate into a job that pays enough to afford those outrageously high payments and still live. Doing well in school doesn’t translate into anything these days unless you already have an “in.” The whole college thing is a massive scam to make money off the backs of the poor who can’t go to college any other way.

Leave a Reply

Your email address will not be published. Required fields are marked *