Killing a parasite, part 2 — How to implement student debt cancellation, by @Gaius_Publius

Once upon a time in America, baby boomers paid for college with the money they made from their summer jobs. Then, over the course of the next few decades, public funding for higher education was slashed. These radical cuts forced universities to raise tuition year after year, which in turn forced the millennial generation to take on crushing educational debt loads, and everyone lived unhappily ever after.

This is the story college administrators like to tell when they’re asked to explain why, over the past 35 years, college tuition at public universities has nearly quadrupled, to $9,139 in 2014 dollars. It is a fairy tale in the worst sense, in that it is not merely false, but rather almost the inverse of the truth.

In fact, public investment in higher education in America is vastly larger today, in inflation-adjusted dollars, than it was during the supposed golden age of public funding in the 1960s. Such spending has increased at a much faster rate than government spending in general. For example, the military’s budget is about 1.8 times higher today than it was in 1960, while legislative appropriations to higher education are more than 10 times higher.

In other words, far from being caused by funding cuts, the astonishing rise in college tuition correlates closely with a huge increase in public subsidies for higher education.

The Federal Student Aid (FSA) loan portfolio balances were $896 billion at the end of 2012. The FSA managed $473 billion under the Federal Direct Student Loan Program at the end of 2012. New loans originated under the program during 2012 totaled $106.7 billion. Loan portfolio balances managed by the FSA for the Federal Family Education Loan Program are slowly and steadily shrinking as new loans offered to students by the U.S. Department of Education originate under the FDSL program. Most of the growth in FDSL loan portfolio balances can be attributed to new loan originations, while being the sole government program for student loans. Another contributor to the rapid escalation in loan balances is due to the cost of higher education increasing rapidly, faster than inflation. Students are spending and borrowing more to finance their higher-priced, higher education.

As of the 2015 GAO audit, the total of the Federal Student Aid loan portfolio was one trillion dollars. [Footnotes removed]

Following the passage of the Health Care and Education Reconciliation Act of 2010, the Federal Direct Loan Program is the sole government-backed loan program in the United States. Guaranteed loans—loans originated and funded by private lenders but guaranteed by the government—were eliminated because of a perception that they benefited private student loan companies at the expense of taxpayers, but did not help reduce costs for students.

• The current portfolio of student loans held by the ED would be cancelled or, equivalently, borrowers would simply be allowed to stop making payments and any principal due on a given date would be cancelled at that time (that is, the loan would effectively be cancelled in stages as payments come due). As of the second quarter of 2016, the ED’s outstanding loans totaled $986.19 billion.

• The federal government would either purchase and then cancel, or, equivalently, take over the payments on student debt currently held by the private sector. As with the ED’s loans, if the government purchases the privately held loans it can choose to cancel them immediately or as borrowers’ payments come due. The government-guaranteed loans are $266.69 billion, while nonguaranteed privately issued loans are $101.58 billion, both as of the second quarter of 2016. Having the government assume these payments or purchase and cancel the loans is preferable to cancellation by private investors. The latter would require the private sector to write down nearly $370 billion in both assets and equity, which could be highly destabilizing (or worse) for the affected sectors.

The Distributional Consequences of Student Debt, Student Debt Cancellation, and Debt-Free College

...[T]he main controversy over student debt generally and debt cancellation in particular has not been its macroeconomic impact, but rather the implications for people in different income and wealth quantiles and the impact on inequality. The controversy arises from the factual observation that among borrowers, those with the largest amount of debt outstanding tend to have the highest incomes, and those who spend the most on college (and who therefore—so the story goes—have the most to gain from the option of free college) come from the highest-earning families....

The widespread criticism of ambitious policies to address the student debt crisis, based on their supposedly regressive impact, is overdrawn. In some cases, it misinterprets the evidence about who is most burdened by student debt and who would benefit most from relief. In this section, we consider the evidence about the distribution of debt and debt burdens in the population and the evolution of those distributions over time. Our main point is that, while the largest loan balances are indeed held by comparatively high-earning households, the extent to which student debt is held by the rich has diminished significantly. Moreover, the argument that the distribution of the burden of student debt has not, in fact, changed very much, even as the total amount of debt outstanding has increased dramatically, fails to consider the significant changes in the population of people with any student debt at all. These issues of interpretation extend beyond accurately assessing the distributional impact of the policies we model—they point to larger problems with the assumptions behind existing higher education, student debt, and labor market policies. The student debt crisis is one of several linked manifestations of those problems. Others are wage stagnation, underemployment, and increasing inequality of household wealth.

Student debt was once disproportionately associated with graduate school and with relatively well-off households, in part because it was possible to graduate from community college or a four-year public institution with little or no debt, and in even larger part because many people did not need to obtain any higher education credentials in order to access the labor market. What has happened in recent decades, and especially since the mid-2000s, is a vast expansion of student borrowing, such that the preponderant share of younger cohorts newly entering the labor market carry student debt. This expansion is due in part to much higher tuition, mostly thanks to state-level cutbacks in funding for higher education, and in part because it is simply far more difficult to access the labor market now without higher education credentials. And that “credentialization,” in turn, is due to the underperformance of the labor market since 2000 and especially since the financial crisis and the Great Recession that began in 2008. Since 2000, the most important federal labor market policy has been the extension of student debt and the encouragement of a larger share of the population to obtain debt-financed higher education credentials, on the theory that underemployment and stagnant wages were caused by a “skills gap” that could be remedied through debt-financed higher education. The most obvious and acute effect of that policy was the growth of the high-priced for-profit higher education sector, but it was also evident in rising enrollment across all types of institutions, even as tuition rose. The “skills gap” was a false diagnosis of the labor market’s problems, and hence the prescription of more debt-financed credentials not only failed to solve the problem, it also created its own problem in the form of unsustainable debt.

The primary theoretical criticism of debt cancellation plans focuses on the reaccumulation of debt following the cancellation, in particular the potential for problems of moral hazard to arise. From this perspective, debt relief today could change the incentives of future student debtors who may increase borrowing with the expectation that the loans will be forgiven, causing an even faster accumulation of debt and increasing the negative consequences at the household, local, and macroeconomic levels. The perverse incentives for unsustainable borrowing in this scenario are the result of inappropriate policy institutions that absolve borrowers of their debts while perpetuating the necessity of increasing debt. In order to avoid problems of moral hazard, any restructuring of student debt—including our debt cancellation proposal—should be accompanied by strong and appropriate policies that enforce the consequences of borrowing and address the market failures that lead to undesirable social costs. In combination with debt cancellation, publicly funded free or debt-free college would provide the institutional reform.

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