The Kids Aren’t Alright: The Policymaking of Student Loan Policy

In August 2009, a college friend posted on his Facebook status "My student loans are due…what should I do?" While we went to a public college with low in-state tuition, three years of out-of-state graduate education was expensive, and student loans were his only option to fund it. The bill came to about $40,000.

His status update elicited dozens of replies. A few of his friends suggested ways to take care of the problem, including loan consolidation, new government repayment options, paying them off with other credit lines or just ignoring them. More interestingly, most of his friends used the opportunity to bemoan their own student loan woes, with debts as much as $100,000.

Obviously, student loan problems are not limited to my friends. Around 18 million people were enrolled in two- and four-year degree and non-degree granting institutions in 2008. According to most estimates, around 60% of all students took out a student loan, averaging over $5,000 a year. Therefore, around 10 million people took out student loans last year, which is almost 3% of the American population. This does not include all the former students who were still paying off loans that are years old.

On March 30, 2010, with legislation that was included in the health care reform bill, President Barack Obama signed new legislation that overhauled the student loan industry in the United States.

Largely eliminating the older Federal Family Education Loan Program (FFEL) that offered private student loans with a federal government guarantee, the 2010 Student Loan Bill empowers the Federal Direct Loan Program (FDLP) to make almost all federally backed student loans directly to the student, or parent, borrower.

The FDLP plans to reduce some of the costs of student loans largely by cutting the private banking industry out. The Congressional Budget Office expects the government to save around $60 billion in 10 years. The Obama administration then plans to use those savings to expand access to Pell Grants, lower the cost of loans, and pay down the federal deficit.

This legislation has provoked plenty of discussion. The political right in the United States is unsupportive of a perceived expansion of federal power. They argue that government control will only perpetuate spiraling college costs.

Many on the left argue that making education more accessible to students is paramount. They point to the cost saving measures of the FDLP, especially when compared to the money funneled to private banks through FFEL, as evidence that school will be more affordable to all, at least in the short run.

As the costs of a university education have spiraled upwards over the last few decades, the task of making school affordable has become an ever more important social and economic policy goal for leaders in Washington.

Hard statistics for increased college costs are difficult to determine, but the cost of tuition (after inflation) has increased about 1.5 to 2% a year for the past 70 years. The cost of attending college since World War II, in real terms, has nearly tripled. The College Board reported that in 2009, the total cost of a year at a community college was $4,552, at a public in-state university was $17,336, and at a private university was $35,374.

Ensuring that all people can afford a college education is important. It offers a degree of social justice, ensures that talented individuals can excel despite their socioeconomic background, and allows the country to remain competitive in a global economy that increasingly requires trained and talented workers. During the 20th century, and especially during the Cold War, the U.S. focused on producing an educated population in its efforts to lead the world and out-perform the Soviet Union.

Despite the social and economic importance of a university education, the U.S. federal government—unlike many other parts of the developed world—has not attempted to make university affordable by stepping in to control costs. Instead, they have focused on offering assistance to pay whatever those costs might be.

Whatever the partisan political debates swirling around FDLP, one thing is certain. As long as it remains a social policy of the federal government to increase the number of citizens with a college education, and as long as the federal government will not dictate what schools can charge—those decisions are made mostly by state governments and trustee boards—then the federal government will remain active in the business of helping students finance their education.

Somewhere between the stories of individuals burdened by student loan debt, policymakers struggling with a massive credit system, and people upset with an increased government role in the economy is the story of how college educations—long seen as a great equalizer—became financed in part through credit. By understanding that story, we better understand the importance of the student loan industry and why many believe it needs to be changed.

Creating the Student Loan Market

Before World War II, college attendance was not nearly as widespread as it is today. The number of people over the age of the age of 25 with bachelor's degrees did not break the 5% mark until after 1950. Today, that figure stands at around 28%. The federal government played a major role in that expansion through the GI Bill, which funneled millions of federal dollars to wartime veterans for housing and education.

Iterations of the GI Bill encouraged around 2 million servicemen from World War II and the Korean War to go to college between 1945 and 1965, and a "Peacetime" GI Bill passed in 1966 helped almost 7 million Vietnam-era veterans go to college through the 1960s and 1970s.

Those veterans, of course, were overwhelmingly men. A little later, women started attending college in greater numbers. The proportion of 18-24 year old women in college doubled from 20% to 40% between 1970 and 2000. In fact, women made up a majority of college students by 1979.

Minority students also entered college in growing numbers, from just under 2 million in 1980 to over 4 million in 2000. This growth was led by Hispanic and Asian-American students, who saw their numbers on college campuses triple during those two decades. (Very recent studies on the college attendance of ethnic minorities, however, show some setbacks to these gains.)

This explosion in college attendance—along with periods of postwar inflation, increased staffing costs, state-level taxation policies, and several other factors—has contributed to increasing tuition and other costs of enrollment. The supply of seats in traditional, non-profit universities has grown, but not at the same rate as demand. This has increased tuition at those institutions and fostered the creation of new types of for-profit colleges and universities that hold courses online to help keep costs down.

As larger numbers of people enrolled in colleges, the consumer credit market also grew and more people became comfortable using credit. However, without much precedent for lending to young adults with no collateral, most private lenders in the credit market were slow to enter the student loan market. They did so only after the federal government set up frameworks and guarantees to protect them. In this way, credit became a principal way students paid for college.

The federal government started those frameworks in 1958 through the National Defense Education Act, part of which established what would become Perkins Loans, a need-based government loan system that pinned interest rates at 5% and gave former GIs and other eligible students affordable loans for college.

Cold War fears that American students were falling behind in science and engineering fostered increased federal interest in what congressional and educational leaders coined "postsecondary education," to incorporate all types of education after high school. These fears led many otherwise fiscal conservatives to support a large-scale federal government intervention into student loans.

In 1965, the Higher Education Act established a basis for the federal government to offer more student financial assistance through the Federal Family Education Loan Program (FFEL). The federal government expanded Perkins Loans and introduced Stafford Loans, where the federal government guaranteed and encouraged student loans by paying the interest that accrued during a student's time in college and paid the difference between a set low rate and the market rate once the student graduated.

The government made a number of partnerships with private companies to service these loans, and this partnership was how private student loan creditors got into the market. Private lenders were more than willing to join in this partnership because of the government guarantee and the rising tide of individuals looking to fund increasingly expensive college educations. Over 60 million Americans have paid for college with these loans in the past 45 years.

In 1972, the federal government reauthorized the Higher Education Act from 1965 and created the ubiquitous student loan firm, Student Loan Marketing Association (Sallie Mae), a government sponsored enterprise (GSE). Sallie Mae served as the agent for government backed student loans, collecting payments and offering customer services as a GSE until 2004, when it privatized its operations, but continued to service government backed student loans.

In general, this partnership has proven profitable for the private companies involved. In 2008, for instance, Sallie Mae collected $2.75 billion in interest on private loans (ones not backed by federal guarantee) and another $2.16 billion in interest on Stafford and other government-backed loans.

In the late 1980s, the U.S. Congress and the U.S. Department of Education pushed for a system of direct loans, where the federal government would loan directly to students or universities, who would serve as intermediaries. After President George H. W. Bush's vetoes, President Bill Clinton signed the Federal Direct Loan Program (FDLP) into law in 1993. It allowed the Department of Education to make loans directly and bypass the GSEs and other lenders who managed the loans.

However, through the 1990s, colleges and students did not go after FDLP financing since heavy lobbying of private student loan managers succeeded in continuing the old system of using GSE and private creditors to service government secured loans.

When the credit market melted down recently, the decades-old attempt to change the student loan system to one that offered direct government loans received new life. While most lenders servicing federal student loans were not in real danger of shutting down, they had a limited ability to weather the late 2000s recession because of relatively high rates of underpayment and low locked-in interest rates. Some of them suffered bad publicity through aggressive collection tactics and continuing to post profits during the recession.

The Obama administration assumes that by taking over student lending, the federal government will be less affected by future credit problems by saving the costs of paying middlemen to service the loans. For better or worse, the government wants colleges and students to trust it to absorb the risk associated with young adults borrowing tens of thousands of dollars to go to school.

Paying for a College Education

No one ever questions the economic benefits of securing a college education. For the past decade, college administrators and test preparation companies have claimed that, over a lifetime, a college education is worth $1,000,000 in wages (compared to those with just a high school education). A major benefit, even if a student takes out thousands in loans to realize it. A student would have to invest around $100,000 at the age of 18 to make up that difference.

Not all students who go to college do so with thousands of dollars of debt. In some cases, parents step in to pay for college—incurring a different kind of social debt to the student—directly or by using private or public—529 Plans—college financial plans, the use of which has increased in the past two decades.

Some students are lucky enough to live and go to college in a state that wants to keep them there. Florida's Bright Future Scholarships and Georgia's HOPE Scholarships are perhaps the best known of these programs, but similar programs exist across the country, including states with historically poor education systems like Arkansas and Mississippi.

These programs pick up some or all of the cost of tuition at any public university in the state for students meeting certain criteria including grades, volunteerism, and/or test scores. However, these programs are merit-based, ignoring some college students who need student loans to afford college even while paying for students who probably can afford it.

Scholarships and grants make up another way for college students to secure education funding. While the level of federal grants, including Pell Grants, is not as high as federally backed loans, they are directed towards students who cannot afford a college education.

University-based scholarships also make college more affordable for some students, but these are not always based on need. The increased competition for top students has encouraged many universities to increase merit-based aid to secure the enrollment of these more attractive students. Paradoxically, the schools with the best ability to fund students are also generally the ones whose student body needs less help to afford their tuition.

Many students do not have the family resources, the good luck to live in a state with generous educational assistance, or the high academic abilities to receive funding through any of these paths. Some attempt to work during college to offset their educational costs, but very few jobs will pay $20,000 a year to an 18-year old who wants to work part time.

Accounting for Student Loans

The growth of student loans, driven by increased enrollment, increased cost of an education, and the increased propensity of creditors to grant them because of government securitization, is often front page news, but it is difficult to determine just how much student lending is out there.

Student loans inhabit a unique place in consumer credit. Usually, student loans are quite large, but at the same time have no physical collateral like a mortgage (or even a car loan). Student loans are generally the second largest debt that someone incurs behind a mortgage, but many (although not all) take on this debt at the young age of 18. Even with a parent's co-signature, the students are usually beholden to the debt when they graduate.

Ten million students in 2008 were willing to yoke themselves to an average total debt of over $20,000 at the age of 22 (or 23, or 24) regardless of their ability to begin repayment within 6 months of graduation.

That amount, $20,000 over a roughly four year college career, has grown steadily for the past 20 years. It has increased at a rate that far outpaced any measure of inflation, but is similar to the growth in consumer credit during the same period, which is around 9% a year. It has more than tripled in 15 years, for an average yearly increase of around 7.6%, a pace that is strikingly close to average increases in tuition across the country.

Using less standardized, but still solid data from the American Council on Education, the level of student loan debt per graduate grew from $6,449 in 1993, to $15,375 in 2000, to $21,000 in 2008.

These numbers do not tell the whole story, however. While the level of federally subsidized loans and grants are pretty well known, the level of private student loans is more difficult to document. Private loans make up about 23% of the total student loan market. Sallie Mae makes both types of loans; its private loan portfolio is about half the size of its federal loan portfolio. However, Sallie Mae makes student loans at about 9% interest, 5% more than federally backed loans.

Accounting for private loans is also tricky because many, although not all, private loans were guaranteed by the federal government. In addition, private lenders might be more aggressive in pursuing payments from borrowers because the borrower has fewer options for repayment.

Another factor that hides the real level of student loan debt is credit card use. As the number of college students with credit cards increases, so does their level of credit card debt. At least some of these students are using these credit cards to pay educational expenses, but these charges (estimated at roughly an average $1,000 a year for students who use credit cards for educational costs) are not being included in most student loan estimations. If they were, then $25,000 for a four-year education would be closer to the mark. This debt, of course, comes with higher interest rates and a lack of subsidies.

Burdens and Benefits

The question of whether student debt levels are excessive has been on the public policy agenda for three decades. Between 1976 and 1980, the volume of federally guaranteed student loans more than tripled, and serious talk of "overburdening a generation" arose in the public media.

However, just how overburdened that generation became is difficult to ascertain. Unlike my college friend, members of that generation are not always open about their student loan problems or the long-term effects—both positive and negative—of a university education funded through loans.

A 2000 National Post Secondary Student Aid study found that an estimated 39% of student borrowers are graduating with "unmanageable debt," which is defined as debt in excess of 8% of borrowers' gross monthly income. In addition, 55% of African-American student borrowers and 58% of Hispanic student borrowers graduated with similar unmanageable debt burdens. While these populations have historically made less than whites, their college educations cost the same.

In 1988, Nellie Mae, a company similar to Sallie Mae, issued a report on its first qualitative survey of student borrowers in repayment. The study concluded that about one-third of the borrowers felt significantly burdened by their loans. However, an overwhelming majority of them also believed that student loans significantly increased their access to and choice among postsecondary institutions.

Now if my friend, who was lucky enough to graduate, defaults on his student loan, what can the creditor get out of him? There is no real direct connection between the thousands of dollars borrowed for education and a debtor's car or house, but federal and state law give student loan organizations as much legal support as possible to secure repayment.

In 2003, there were 5.6 million Americans in student loan defaults, roughly 5% of all Americans between the ages of 20 and 49. And those in default find themselves caught in the strange legal status of student loans.

First, it is nearly impossible to discharge a student loan debt in bankruptcy. This means that even if the bankrupt debtor's creditors agree to a repayment plan or to a part of his liquidated assets, these agreements almost never include the student loan creditor. Sometimes people declare bankruptcy just so they can continue to repay their student loans at the expense of the rest of their debts.

Second, unlike other non-collateralized loans, which credit card companies and banks must write off after nonpayment for seven years, student loan companies can come after unpaid accounts as long as the debtor lives. Student loans are almost never sold off to collection agencies designed to squeeze as much as possible before that seven year window runs out, because the clock never stops running.

Put more bluntly: in most states, two crimes have a statute of limitations of more than seven years. One is not paying student loans, the other is murder.

One way that the current administration is helping students is through a new repayment plan, called Income Based Repayment (IBR). The IBR plan allows students to pay a certain percentage of their current income, even if it is lower than the minimum payment, without penalty. Interest does not accrue on the unpaid principle, so this allows the debtor to keep making smaller payments without making his payments higher in the long run. If the debtor pays lower payments using the IBR formula (these forms must be redone at least every year) for 20 years, they will not owe any remaining debt. This time period is shorter for students who enter public service.

Future Students, Future Loans

As the approximately 18 million university students in the U.S. now return to the classroom for the 2010-2011 school year, they all assume—by and large correctly—that the benefits they will receive from attending college, be they economic, social, or cultural, will outweigh the costs. But those students might be paying those costs for years to come, mortgaging their futures in the process.

Americans across the political spectrum also believe, generally correctly, that higher education is the main way that most people can improve their lives. College administrators and testing agencies make sure that everyone knows that a college education is worth a cool million dollars over one's lifetime.

Of course, by relying on an economic accounting based on lifetime incomes, we run the risk of miscalculating what a college education really means. Personal growth and intellectual engagement cannot be quantified, and the benefits they grant to students are not directly related to their ability earn a larger paycheck.

At the same time, there is almost nowhere more fun and enriching for an 18-22 year old to spend his or her time than an American university. This, along with increasing college enrollments, show that the demand for a spot on a college roster is mostly independent of tuition price changes.

In the past few years, however, the growth of student loans and the collapse of the credit market have encouraged individual students and the American public to take a longer look at college funding systems and whether or not the cost is worth the price. They have examined how students fund their pricey college education, the student's ability to repay the loans, or why they choose loans at all. The new FDLP looks to address those concerns by putting the government, instead of independent and private creditors, as the agent between consumers (college students) and colleges.

If the student loan system is going to be reconfigured, certain realities need to be kept at the forefront. 1) College costs have expanded much more quickly than personal income. 2) The rules about collecting those loans heavily favor lenders. And 3) the billions of dollars made with government guarantees are largely kept by private corporations. Only by addressing all of these points will any new configuration of the student loan system work.

The new government plan is designed to help millions of students go to school and strengthen the citizenry of the United States, the original reason that the government began student loans 70 years ago. It also represents the latest attempt to pay for democratizing higher education and improving America's global competitiveness. By stepping into the student loan market, the federal government promises to serve as a benevolent agent to allow students to make the choice on funding higher education under the best terms possible.