What would you think of a lender that holds more than one $1 trillion in loans outstanding, targets low income and minority borrowers, has a payment delinquency and default rate in excess of 25 percent, and has postponed repayment on 14 percent of its loans, but is still accruing interest on them? Wouldn’t you think that some government agency—say, the Consumer Financial Protection Bureau, the Federal Reserve, or even Congress—would be investigating this perfect definition of a predatory lender and trying to shut it down?
Well, that hasn’t exactly happened. Why? Because this predatory lender is the federal government.
Over the past decade, student loan debt has dramatically increased as it became conventional wisdom that many young people were foregoing college simply for financial reasons. Indeed, the Department of Education, has made student borrowing ubiquitous. Essentially, the open floodgates of student loan availability has created a “housing bubble” in higher education”—essentially an “education bubble.”
Consider what market bubbles are and how they are formed, behave, and pop. The housing market saw feel-good government programs, in the guise of helping the disadvantaged, dramatically increase home lending to low income and marginally qualified borrowers. This massive influx of available funds for real estate purchases artificially increased housing demand and housing prices. Just a decade ago we were all cheering the rate of home values increasing at double and even triple the rate of inflation.
Over the past ten years or so, college tuition has followed an identical pattern—rising at nearly double the rate of inflation, and according to the College Board, at nearly triple the rate of inflation during the past two or three years. Likewise, the Federal Reserve Bank of New York reports that during the past decade, student loan debt has nearly tripled and the number of students with debt has risen by 70 percent. This is clearly a bubble, and just like the housing market before, the run-up in debt isn’t because of inflation in tuition. Indeed, it’s the cause of it.
The liberal crowd tends to see this the other way around. They think the rise in tuition is cost push, not demand pull. But they couldn’t be farther from the truth. It’s not increases in costs that are driving these tuition increases—professors’ incomes have remained relatively flat in real terms over the past 20 years. Likewise, while college administrative and overhead expenses have increased during that time, their increase stands at only about 3 percent—it’s hardly the cause of such rampant tuition inflation. No, the reason for colleges raising tuition at double and triple the rate of inflation is all about the demand side—the loan availability side. It’s an education bubble just like the housing bubble, and it will likely play out the same way.
Roughly 45 percent of people that enroll in college ultimately drop out without ever attaining a degree. That percentage has remained pretty constant for the last several decades (actually it’s a bit higher now than ten years ago but not by much) and even that minor increase is due to the change in the way the graduation rate is counted. Thirty years ago there were 12.5 million students enrolled in colleges and universities nationwide. Today that number is 20 million. What that means is that as a nation we’ve gone from creating roughly 5.6 million dropouts per year with relatively no student debt, to creating 9 million dropouts per year with over two thirds of them buried under predatory educational debt. These are students that most likely never should have attended college but did so because they were suddenly able to afford it. Or at least on paper.
Additionally, of the students that do graduate from college, millions do so with piles of debt and only prospects of low paying jobs in their field. The media are filled almost daily with anecdotal stories about students graduating from college with six figure debt and entering professions that will have them paying it off for most of their adult life.
The Consumer Financial Protection Bureau, always quick to chase down payday and sub-prime mortgage lenders, says that if a lender does not, “…verify customers’ income and confirm that they can afford to repay the money they borrow,” they are a predatory lender. So how does the government verify a 17 year old’s income right out of high school and confirm that four to six years later when—actually, if—they graduate from college they can afford to pay back their student debt? Clearly with more than a quarter of all student loans in default, the Department of Education isn’t following the bureau’s guideline and by their own definition is a predatory lender.
But there’s another angle on this government college debt racket that rarely gets mentioned. It’s a little known program called the “Parent PLUS” plan. Rather than lending college costs to the students as borrowers—which could be considered an investment in human capital—this program completely bypasses them and lends directly to their parents. And unlike the stalking of students with their high loan default rates, this program preys on people that have verifiable income and the ability to repay. With this program the government has become the idol of every predatory lender in the nation.
The PLUS program is the single most profitable loan program of the more than 120 ways the government lends. It’s even more profitable than SBA loans and Treasury Department advances to the Federal Reserve. Currently, the program makes loans at a 7 percent interest rate with a 4 percent origination fee. This is almost double the rate charged on loans made directly to students, and those are made without any origination fee. Parents of college students would be better off taking a second mortgage on their home than borrowing under this program. Additionally, direct loans don’t begin to accrue interest until the student leaves school whereas with Parent PLUS the interest rate clock begins ticking day one. The White House Budget Office says that even after defaults and bad debts, they expect to collect $1.23 for every $1.00 they lend with Parent PLUS. That’s an astonishingly profitable program.
The largesse of this trillion-dollar boondoggle has far-reaching ramifications—societal and economic. It’s also unsustainable. When and how will it all end? At some point this lending can’t continue. But then what about the millions of students and former students in default on their loans? Expect the government to get the loss reserves they need from taxpayers just like they did in the housing bubble. We all know this education bubble will burst—bubbles always do. And we also know who ends up holding the bag.
Kevin Cochrane teaches economics and business at Colorado Mesa University, and is a Permanent Visiting Professor of Economics at The University of International Relations in Beijing.
