Friday, December 18, 2009

The Federal Student Loan Program: It Seemed Like a Good Idea

When the federal student loan program was started, I assume no one thought it would one day produce a class of well educated but generally unemployable young adults. The idea probably seemed like a reasonable compromise between a system where only those who could afford higher education (or were willing to sacrifice in order to afford it) and a costly system where the government would entirely subsidize the cost of attendance.

Under a student loan regime, students would have easy access to federal loans and would then repay the money with interest with the money they earned from their higher paying jobs. Unlike a system of government subsidies (or nationalized higher education), the government would not have to pay for every twenty something to go to college and eventually be forced to engage in some form of rationing to curtail the otherwise unchecked demand. The system could also be seen as more "equitable" than the then existing laissez-faire model.

Sadly, the law of unintended consequences eventually reared its head. I assume for a while the system worked as planned: students borrowed, got better jobs, and paid back their loans. The problem is that thanks to the lower cost (at least in the short term) of deferring payment to attend college, the number of people pursuing higher education increased.

This not only diminished the value of having a degree but also increased the demand for higher education. The higher the demand, the higher the price a supplier can charge its consumers. The easy credit in addition to the chorus echoing from society that "education is the key" has driven higher education prices into the stratosphere.

As the cost of education has increased, government loans often were not enough to cover all expenses. In order to take advantage of the public loans, student often have to also resort to borrowing private loans, which usually have less favorable terms than the federal loans. (Within the last few years, graduate students have been able to borrow the entire cost of their education by using GradPLUS loans.)

This flood of abundant credit has also encouraged another economically inefficient practice: Rent Seeking. Rent seeking takes place when an entity seeks to profit by taking advantage of the (usually artificial) economic environment rather than through the production of actual wealth. As long as schools can convince students to attend their institutions, they can tap into an almost limitless supply of these government backed loans (and often residual private loans).

Law schools have particularly benefited from this student loan system. Law schools are relatively inexpensive to run when compared to other graduate programs (there is no need for expensive labs unlike for the sciences and medicine). There are few barriers to entry - no upper level mathematics or science requirements. Law has a relatively revered role in the American intellectual tradition and has been commonly seen as the path to wealth for those who were neither mathematically nor scientifically inclined. Like other graduate programs, the devalued undergraduate degree (particularly in the humanities) has made the law degree more attractive.

The rent seeking phenomena has been particularly evident with the rise of a multitude of new law schools. One for profit company has opened three new law schools within the past several years. Drexel, Liberty, and LaVerne all have relatively new law schools. The UMass system is looking to acquire a currently unaccredited law school while the SUNY system is mulling the addition of a new law campus at Binghampton.

The ability to draw from this reservoir of easy credit is at the heart of the problem. New schools enter an already saturated system and current schools charge ever increasing prices for degrees that are ever decreasing in value because there's very little capping demand.

Things have become even better for the law schools. Private lenders can lend with impunity because their debtors no longer have any protection in bankruptcy (except in the most extreme circumstances). The GradPLUS program makes it possible to borrow the entire cost of a legal education from the government will minimal barriers.

What's more, while the Income Based Repayment (IBR) plan has been a great relief to borrowers, it's also something law schools most likely applaud as well. Not only does it slightly mute some of the resentment against them from recent graduates, but it also shifts the burden from the borrowers to the tax payers.

Under the IBR, borrowers need only pay 15% of their adjusted gross income less 150% of the poverty line every year (for all public loans - including GradPLUS). After 25 years, the remaining debt is forgiven (though possibly taxed). If a borrower works in the public sector or non-profit sector for 10 years, his loan is discharged after 120th payment.

Dissecting the new repayment policy is best left for another post, but for all those who shrug their shoulders at the law students who "should have done more research" before they borrowed so much money, now the law schools are coming after you. The law schools will now be reaping "profits" (I know they're "non-profit") not only off the backs of their students but also off of the backs future tax payers.

Like a typical rent seeker, they don't really add any value to the economy. Instead, they are scavengers and parasites simply taking advantage of a federal program gone awry. It's not like there is more demand for attorneys or an increased number of jobs to warrant either more schools or higher prices for receiving J.D.'s.

If we can't agree that the law schools are crooked, can't we at least agree that they are economically inefficient?


  1. The federal loans were not enough for me or my family, so we had to take out some extra private loans for my bachelor's degree. In retrospect, that was a mistake. Fortunately, I had substantial free money financial aid, and I do not have a life ruining amount of debt. I have a job, but I don't like paying an extra $170 a month for those private loans!

    I think another important part of why American higher education is so expensive is because colleges and universities are in the business of feeding and housing studnets, not to mention the other facilities on campus. My university has 3 gyms, theatre buildlings, museums and spends hundreds of thousands in landscaping a year. Is that all really necessary? I don't think so.

  2. Students loans are no different than ARRA, TARP, the Community Reinvestment Act, and the current health care bill being debated in the Senate. In the end, the fat cats win and the masses are stuck with the tab.

  3. Privatize the profits, and socialize the costs. This is what colleges and universities do best. And these gluttons do so under the ruse of providing "education."

    Well, we have more people with advanced degrees than ever before in this country - and the jobs are low-paying. Where is the trade-off?


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