Last month, President Biden said that he’s still considering canceling some student loan debt; perhaps fulfilling his campaign promise to eliminate $10,000 per borrower. For anyone losing sleep over the massive pot of outstanding student loan debt in the U.S. economy, that might seem like a good thing. But the reality is that a move like the one being considered would likely result in a worsening of circumstances, with tuition rising more quickly than before and borrowers quickly amassing debts in excess of the level we see today.
The driver of that counterintuitive dynamic is a phenomenon called moral hazard. Moral hazard describes the nature of people to take excessive risks when they are protected from the consequences of their actions. In this case, a student loan cancellation event, like the one being considered, creates an implicit guarantee that future students won’t be on the hook to pay back what they borrow. Students choosing where to enroll, how much to pay and how much to borrow for future semesters will have in mind that the amount they’ll actually pay is likely less than what they signed up for. Economically rational people will respond to that dynamic by choosing more expensive programs of study and borrowing more than they would have otherwise. The result: a pool of outstanding student debt growing even more quickly than before.
In economics parlance, this change in willingness to spend is called an increase in demand. And as any armchair economist knows, increases in demand have an unambiguous effect on prices. A rise in demand will result in a rise in price. We tend to think of colleges and universities as benevolent institutions, but they are also economic entities that must respond to the incentives in front of them in order to survive. So it won’t just be predatory institutions that raise prices in response to this run-up in demand — it will be all of them.
Estimates from the Committee for a Responsible Federal Budget indicate that it would take just three years for the outstanding student loan balance to return to its current level if we were to cancel $10,000 per borrower. That’s without taking into account increased rates of borrowing caused by moral hazard or the subsequently higher tuition costs. In reality, we’d be back where we are today before we know it (though precise estimates are impossible because it would require accurately predicting the intensity of change in student behavior).
For this reason, student loan cancellation alone isn’t an option. Congress should pass legislation to stop the administration from taking this politically motivated step. If that fails, they’ll need to act quickly to stop the ballooning of student debt through more aggressive means. Constraining the availability of student loans, as fraught as that option might be, will be the only option to protect borrowers from amassing further unaffordable debt that taxpayers will be on the hook to pay.
This article was originally published by the American Enterprise Institute. It is republished with AEI’s kind permission.
