Why Student Debt Is So High and Why Forgiving It Doesn't Fix the Problem
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today is episode 402. It's titled, Why Student Loan Debt is So High and Why Forgiving It Doesn't Fix the Problem.

Last month, President Biden announced a plan to forgive some student loan debt via an executive order. At the same time, the administration announced the moratorium on making student loan payments would end. The Biden administration intends to write off $20,000 of loans for individuals that took out Pell Grants and up to $10,000 for other borrowers who didn't take out Pell Grants. This is for borrowers whose income is less than $125,000 a year. Currently,

Currently, there's about $1.6 trillion of federal student loans outstanding in the U.S., about 45.3 million individuals. About 7 million individuals have student loans less than $5,000, and another 7.5 million have student loans less than $10,000, in other words, between $5,000 and $10,000.

Potentially then, 15 million individuals could see their student loans gone, assuming they meet the income threshold. There's been different estimates of how big this total forgiveness bill will be, and it depends on what percentage of students who qualify for forgiveness actually take advantage of the opportunity. The Biden administration expects 75% of qualifying borrowers will seek forgiveness. Estimates for how much the total cost

which is essentially the amount forgiven of debt. Those estimates are between $500 billion and $1 trillion.

When I got my undergraduate and graduate degree in the early 90s, my mother was also attending college for a portion of that time. So her income was low and I qualified for Pell Grants. In the early years of my education, it paid for a sizable portion of my tuition. I also got scholarships, some internships, but I also took out student loans and I left school with about $10,000 in student loan debt. The student loan debt balances are much higher today.

The total amount of student loan debt has grown from $640 billion in 2007 to about $1.6 trillion today. That's a 144% increase. The total amount of student loans has outpaced the growth in the number of borrowers. The number of borrowers went from 28 million to 43 million, so about a 52% increase. But each of those students is taking out more debt.

Between 2007 and 2020, the average amount of outstanding federal student loan debt per borrower increased from $22,680 to $36,510. Those are in real inflation-adjusted terms, and this is data from the Bipartisan Policy Center in Washington, D.C. They're a think tank that fosters bipartisanship by combining the best ideas from both Republicans and Democrats.

Why is it that student loan debt has exploded over the past 15 years or so? There are a number of reasons. Foremost, tuition rates have increased. Real published tuition rates at public four-year institutions has grown 42% between 2006 and 2020.

The average tuition and fees, this is according to U.S. News and World Report, for public in-state tuition is $10,423. If you pay out-of-state tuition, it's just under $23,000. And then if it's a private school, four-year school, $39,723. That's the average tuition. That tuition has increased significantly.

One of the main reasons for that, at least when it comes to state schools, is states are contributing less to higher education costs, even after adjusting for inflation. During the year 2000, states provided on average $8,800 per full-time student, and that's in 2020 dollars. That amount is now $7,805 as of 2020.

It's about $1,000 less per student after adjusting for inflation. As a result, public colleges and universities are more dependent on tuitions and fees to cover their cost. In 1980, your typical college generated only about one-fifth of their revenue from tuition and fees. Today, for four-year public colleges and universities, tuitions and fees provide 52% of

of educational revenues. So more than double based on tuition because states are contributing less.

States prior to 2000, back in the 60s, provided even more support for education. In the 1963-64 school years, when a typical baby boomer was going to college, the average tuition for a four-year university was $243 per year, less than $300. If we adjust that for inflation using 2021 dollars, it would be $2,100.

Today, public in-state tuition is over $10,000, five times more. Now, one could argue, well, maybe education's better now than it was in the 60s, so it should cost more. And I think there's an argument for that. But five times more? And it's five times more partly because states are contributing less to public education?

Another reason that student loan debt has increased is Pell Grants, which is the primary form of federal aid for low-income students. And as I mentioned, I got those grants when I was in school. Back in 2000, it covered 99% of the average cost of in-state tuition and fees. And today, a Pell Grant only covers 60% of those costs, forcing students to take out student loans.

Another reason student loans balances have increased, and I didn't realize this, prior to 2010, the federal government provided student loans through what was known as the Federal Family Education Loan. And the loans were issued by private institutions, private capital, and the federal government covered any defaults. So there was some market discipline there.

But during the Great Recession, as college enrollment spiked due to high unemployment, there was concern that there wouldn't be enough capital to fund student loans, particularly as the banks were hit quite substantially due to the great financial crisis. Credit markets had tightened up and it just was more difficult to borrow. And so the government stepped in and started providing the loans directly.

Since July 2010, all federal student loans have been directly issued by the federal government in the U.S. That's a huge change. It's now easier to borrow. It's easier to borrow because there's less paperwork because you don't have to go to different private lenders. And because it's easier to borrow, that encourages students to take out debt.

And then there's an upward spiral because if debt is available, then colleges and universities are encouraged to raise tuition because their students can then afford it because they can finance it. This is especially true for graduate students, which make up much of the student debt.

The grad plus loan program has no annual spending limit, nor are there any underwriting requirements. Any student can borrow any amount of money to go to graduate school. Does that provide any discipline for universities to keep graduate school tuition down? Not really. Which brings up another reason that student loan debt is so high. There's insufficient accountability for universities. There's insufficient accountability for universities.

They don't have enough skin in the game to make sure that their students are successful and they're getting bang for their buck.

There are some measurements that the federal government requires. They do what's known as the cohort default rate. So if a particular educational institution exceeds 40% default on student loans for a single year or a single cohort of students when they enter as freshmen, if that default rate is over 40%, or they have three consecutive cohorts with default rates of 30%, then

They're under probation. The government gets much more involved. But that's not working because due to forbearance programs, deferments, income-driven repayment programs, rarely do the defaults exceed 30%. In 2020, only 12 out of several thousand colleges and universities were sanctioned because of high default rates. So that measure just isn't working because the threshold is too high.

U.S. Department of Education also calculates a financial responsibility score, which is seeking to determine the financial strength of universities and other higher educational institutions.

The idea is to be able to forecast when they're going to get into trouble and they might fail. But the data they use is two years old. And as a result, the Government Accountability Office found that the financial responsibility scores failed to predict half of the colleges that ended up closing between 2010 and 2016.

One idea by the Bipartisan Policy Center to have universities have more skin in the game, more accountability, is to charge them repayment premiums, fees essentially based on the performance of the student loan portfolios for that particular institution. The fees could be calculated on the amount outstanding and the level of defaults.

I mentioned that I have had student loans. I paid them off. But my adult children don't. Our daughter is still in school. Some have gotten scholarships, but LePron and I have helped paid for their undergraduate education. For our daughter-in-law, we provided a student loan on the minimum interest rate that the federal government or the IRS requires us to charge. So very favorable terms. Our children are benefiting from intergenerational wealth.

Not every demographic benefits from that. And as a result, if we look at black and Hispanic students, they borrow more. 86% of blacks and 70% of Hispanics, bachelor degree recipients, took out student loans. That compares to 68% for whites and 44% for Asian students. A greater percentage of black students borrow to take out student loans because they don't have

the intergenerational wealth, but they also borrow more. The average bachelor degree recipient has student loans of $39,500 compared to $29,900 for white borrowers.

Having a high student loan balance impacts your life. Kanava Otto, who's an associate professor of public policy at University of North Carolina, has a book coming out on the student loan crisis among black borrowers. Her research found that having large student loan burden contributed to delays in marriages and it made people less likely to be homeowners. It contributed to high stress, health problems, anxiety, depression, heart disease.

But when student loans were forgiven, other research found that graduates were able to earn more because they were more mobile. They could move to different parts of the country to pursue better work opportunities. And their default rates on other debt was lower after the loan was forgiven.

Now, there are some existing debt forgiveness programs in the U.S. They're income-dependent repayment plans, or IDRs. And a large, surprisingly large percent of students or student loan borrowers are enrolled. In 2020, it was just about 50% of students were enrolled in these IDR plans.

and typically the plans, the borrower pays 10 to 20 percent of their discretionary income, and then any unpaid balance after 20 to 25 years, depending on the program, is forgiven. Those are effective and have been effective. Now, it does cost the government more money. The Congressional Budget Office estimates that the government loses 17 cents

for every dollar dispersed in student loans that is repaid through...

an IDR plan. And that compares to the government earns 13 cents for every dollar dispersed in student loans that are repaid through standard fixed payment options. And that makes sense because sort of a self-selecting group, because if you have a high student loan balance, can't afford to make the payment, you're going to enter the IDR plan and hopefully it'll eventually be forgiven. But the reality is the default rates on these IDR plans are also higher.

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The federal government has two methods that it uses to determine the cost of a student loan. The one method is it takes the cost, how much was issued, and then it takes the cost of the student loan.

and then subtracts out the present value or the value in today's dollars of the projected repayments on the loan. Whenever you do a present value calculation, you need to use some interest rate to figure out what those future payments would be worth today. And the one method they use is they use the interest rate on U.S. Treasury bonds.

Another method is known as the fair value accounting. Costs are done in the same way what was dispersed, but that present value calculation uses market interest rates.

So not the risk-free government bond rate, but a higher interest rate. And as a result, because of the higher interest rate, the present value or the value in today's dollars of those future repayments is lower than it is under the first method. Under that first method, then, the CBO estimates that the federal government's direct student loan portfolio will, in aggregate, save $16 billion between 2021 and

In other words, the repayments will be more than what was dispersed because of the interest. Under the second method, though, using market rates, the CBO estimates that the direct student loan program will cost $226 billion in aggregate between 2021 and 2022.

What the federal government does then is each year they estimate, they redo their calculation based on repayments, based on how much it was dispersed, and then estimate should they take an additional cost for the student loan program. And they've definitely done that in

In 2021, that re-estimate led to an additional $52 billion in cost. And in 2020, it was $63 billion in cost. And the reason why costs are increasing is more students are entering into these income-dependent repayment plans, the IDRs. I mentioned it's 50% of the student borrowers are in the program now, and those programs cost money, 17 cents per every dollar dispersed.

In some ways, though, the government's involvement is investing or helping students improve their human capital. Students earn meaningful returns on their investment, and then so does society. We have a more educated populace that is smart, innovative,

innovative, creating ideas, educated, that benefits society. So we shouldn't think about student loans and the government evolving, even with these IDR plans costing the government money. It might be an accounting cost, but the benefit to society is incalculable.

My issue with canceling student loan debt just one time is it's just one time. It doesn't solve the problem. It doesn't give universities or provide universities have more skin in the game. It doesn't require some type of repayment premium based on the performance of the university. Now, hopefully those programs will be put in place, but it certainly, if you got your student loan forgiven, good for you.

It will give you more flexibility, recognizing that tuition over the past decade or two has been significantly higher. So when I went to school and those older than me went to school, the government was much more involved in funding education. That was a gift that we got. Pell Grants paid more.

Now it has changed, and there's been certainly unintended consequences of the government getting more involved in directly funding student debt, an upward spiral as debt has been more available. And maybe one of the solutions is government gets more involved in capping what universities can charge. Now, that can also lead to unintended consequences, like we discussed back in Episode 399, government action leading to unexpected results requiring other government actions.

So I'm not upset by any means of Biden's program, this one-time windfall, just because students over the past decade or two have been paying much more for university. Now, where it's a challenge is for those starting school today because they don't get that benefit. And it doesn't really solve the long-term problem.

One of the questions I've gotten, and we covered this in a Plus episode a few weeks ago, is the cancellation inflationary. It's canceling upwards of $500 billion of student loans. What does that do to the economy? It immediately increases the deficit by $500 billion. That cost needs to be incurred today. So it's an expense. It's an accounting expense.

Because the value of the student loans is the value today. It's the present value of those future loan payments. And that is essentially an asset on the government's balance sheet, which is wiped away.

In terms of the actual cash, the average student loan pays $3,000 a year. So there's about $60 billion that will not be coming to the federal government in the years ahead, each year, 0.3% of GDP. But now that the moratorium on student loan payments has been released, Capital Economics estimates that there'll be an additional $90 billion of payments coming.

from those borrowers that were able to defer their payments. Now they have to start making payments again. So $60 billion won't be coming in. Now we have $90 billion coming in. So that's potentially somewhat contractionary because those students, borrowers, now can't spend that money on something else. They have to pay back their student loan.

I had a listener ask me about this cost, $500 billion. How does that compare to other government programs? In 2021, the U.S. government spent $51 billion just that year in payments to U.S. farmers through direct government payments, crop disaster payments, and conservation programs.

The U.S. government is involved in guaranteeing mortgages against defaults. And as a result, and we've done episodes how mortgage rates in the U.S. potentially are lower than they would be if the government wasn't guaranteeing those mortgages and buying up all those mortgages.

Figuring out what the cost of that is is a little more difficult. But with this half a trillion dollars program to forgive student loans increases the deficit, it isn't inflationary in the traditional sense.

Inflation is caused by money creation from banks making new loans, and money is also created when the government runs a budget deficit. At the same time, central banks monetize that budget deficit by buying bonds, either in the open market or funding the government directly.

Now we're in a process of quantitative tightening. So the U.S. Federal Reserve is not buying up bonds. It's reducing its bond portfolio. And writing off a half trillion dollars of student debt doesn't create new money that flows into the system. It's money that was already there. What could, though, be more inflationary is how those students react.

If a student had $10,000 written off of their student loans, will they then go out and take out a $10,000 car loan or a $40,000 car loan? Because now they can afford it. If we see bank lending increase to students that now got debt forgiveness, that could be inflationary. So we'll have to see. But just canceling the debt in and of itself is not inflationary because it doesn't create new money flowing into the system. It's

straining capacity to produce goods and services.

We've done episodes in the past on how getting a degree, a university degree, is an investment in human capital, and it does increase earnings power. I'll link to a paper by Douglas Weber, who is an economist. He's now with the Federal Reserve. He estimated, based on census data, the lifetime earnings bump for getting a degree and looked at different types of degrees. He

His estimate is the median lifetime earnings in 2019 of someone with a high school degree, just high school only, is $1.3 million. But someone, and this is one of the lower paying careers, if someone had a degree in education, their lifetime earnings increased to $2.1 million, a $700,000 increase. A history major, median earnings, $2.7 million.

That's $1.4 million higher than a high school degree. Lifetime earnings for an accounting degree, estimate $3.2 million. Nursing, $3.3 million. And the highest, according to his estimates, is chemical engineering. Lifetime earnings of $4.6 million. So when you think about that payback,

A student going to university, a public in-state university, pays $50,000 over the four years, expected to earn anywhere between $700,000 and over $3 million of what someone that just went to high school is going to earn for a $50,000 investment in human capital. That's an incredibly good return.

Now, if you start looking at private schools, $200,000 investment, still there's a return, even if it's funded with student loans. I am glad the federal government is involved in student loans, helping to increase human capital. But I wish there was more focus on income-dependent repayment plans or even income share agreements like we discussed in episode 307, which are privately funded currently where one can borrow a

against their future earnings. I think those are great ideas. I think there should be more accountability on the part of universities. They should be charged some type of premium based on the performance of their student loans portfolio. And I think the data that the government gets on...

the financial strength of universities is critical. It should be gotten more quickly and just a better assessment. And maybe the government does get involved on tuition rates. Tuition rates haven't been increasing as high in the last five to six years as they were sort of from that 2007, the 2015 period. So there are some market dynamics that are compelling universities not to increase tuition as much. But clearly the involvement of the government in student loans has...

has fostered higher tuition rates and more student borrowing because states aren't involved in providing as much education. And then there is an incentive to borrow money. I did it, and I didn't give a whole lot of thought to the student loans I took out. I needed to go to school. I needed to pay the tuition at that time, and I borrowed money. But I recognize that my children are in a much better situation than I was.

So having programs for those that don't have those same benefits and have an income dependent, I think is appropriate because overall it will benefit society. That's episode 402. Thanks for listening.

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