Student loans: Taking away the free ride for colleges

Alex Pollock:

Looking at the rapid growth of student loans and the escalating price of college from a financial perspective, we see a typical interaction of credit expansion and price, quite similar to what happens in a housing bubble or any other bubble. Pushing credit at a sector makes its prices rise. The rising prices, in the cases of both housing and higher education, lead to cries that since the prices are now unaffordable, there has to be more credit. More (and more heavily subsidized) credit the politicians often enough deliver, and the escalation goes on.

This self-reinforcing dynamic is intensified when there are important parties who get cash from the loans for themselves, but have no risk at all when the loans default. In the most recent housing bubble such parties included lenders who promoted and originated but then sold their mortgage loans. In education, the most important risk-free beneficiaries are the colleges themselves, which keep raising their prices, promote the loans, get the cash from the loans, and don’t have to worry about what happens when the loans they promoted subsequently default.

Interacting credit-price expansions inevitably come to face growing defaults. In a recent paper*, the Federal Reserve Bank of New York observes that “the measured delinquency rate on student debt is the highest of any consumer debt product.” This measured rate of student loans 90 days or more past due is 17%–indeed very high delinquency. But, the New York Fed goes on to say, the real or “effective delinquency rate,” which they calculate by comparing 90 day past dues specifically to those student loans where borrowers are being asked to repay, is over 30%!