To Fix Student Loans, Keep It Simple

In “How To Fix Student Loans—Permanently,” Foundation for Research on Equal Opportunity Senior Fellow Preston Cooper proposes an alternative solution to the Biden administration’s expensive student loan jubilee: financial penalties for colleges and universities whose graduates struggle to make repayments. His solution holds institutions accountable for a portion of unpaid loan repayments. He expects the plan to save the government over $10 billion annually, a portion of which would increase grants for low- and middle-income students. 

Cooper’s solution addresses some of the problems that debt forgiveness ignores. His plan would encourage colleges and universities to cut low–return on investment (ROI) programs, directing low-income students in particular to more profitable fields. It would reduce the debt burden for students, both through steering them into higher-quality programs and by partially repaying delinquent loans. It might also encourage institutions to lower their tuition, so as to avoid repaying their graduates’ loans. 

But Cooper’s plan trades in an obvious remedy for a complicated, unwieldy approach that creates a moral hazard for students. The moral hazard intrinsic to Cooper’s plan is that graduates—even those who enter fields with high economic returns—will have an incentive to underpay their loans, since their alma maters would cover a portion of delinquent and defaulted loans. If all graduates make delayed payments, it would lower the ROI for these high-ROI majors, which would distort the whole system of loan distribution and program evaluation. Moral hazard for students means that loan delinquency might increase, not decrease, under Cooper’s program. 

His system would also dilute the incentive structure that normally holds lenders accountable by passing the buck to schools. While his program marginally improves institutions’ incentives, these institutions have to weigh interests from many different stakeholders—from accreditor diversity metrics to revenues to alumni donations. Colleges and universities often behave inefficiently due to these other priorities.

[Related: “Why the New Student Aid Formula Spells Trouble for Families”]

Instead, the straightforward solution is to allow the government to consider a borrower’s ability to repay his loans, just like any private lender. Most students are unlikely to have a credit history, so the government would consider both a degree’s ROI and a student’s academic merit. A degree’s economic return indicates the likelihood of the student’s ability to repay his loans. Academic merit demonstrates the likelihood of a student staying in the program in the first place. A student may intend to enter a high-ROI field like economics but lack high-school math proficiency. This student may drop out or enter an easier program with a lower financial return upon comparing his abilities to those of other college students. A degree’s ROI will not matter if the student can’t finish the program. 

Allowing the government to assess a borrower’s creditworthiness and adjust loan amounts and interest rates accordingly provides the same incentives for colleges and universities to reduce their costs while preventing moral hazard. It also focuses on the ability of individual students to repay their loans instead of setting an arbitrary threshold at the program level. This gives academically meritorious students the flexibility to choose fields that they enjoy more, even if they are slightly less lucrative. 

Of course, this solution means some majors may be excluded from federal funds more than others. Cooper offers one vague counterargument for picking winners and losers: “it smacks of central planning, which usually ends poorly.” He should be specific about the actual problems with this approach before proposing a system that is vastly more complicated. Federal financial aid is already a form of central planning—the government artificially inflates the demand for higher education by even offering student aid. If we are already engaging in central planning, and do not intend to eliminate the system, then we should do it efficiently.

Image: Adobe Stock


  • Neetu Arnold

    Neetu Arnold is a senior research associate at the National Association of Scholars. Follow her on Twitter @neetu_arnold.

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One thought on “To Fix Student Loans, Keep It Simple”

  1. Wrong answer. The optimal solution is to get the federal government out of the student loan business altogether. The federal government should not be in the student grant business either. If say Vermont wants to give out grants or scholarships to their citizens to attend the University of Vermont, then that’s their business. And their citizens can support or not support that via their votes. But under the current system people living in Alabama and Utah are helping to fund students attending the University of Vermont. Why?

    Although James Madison in 1794 said this in a different context, his words fit perfectly with this issue: “I cannot undertake to lay my finger on that article of the Constitution which granted a right to Congress of expending, on objects of benevolence, the money of their constituents.” Biden’s student loan forgiveness program is immoral. (People who never went to college should not be paying for some girl to get a womens studies degree at Smith College.) But congress was the original culprit when they approved funding of college students.

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