Dancing Around the Edges of Student Loan Reform

Mike Konczal proposes two steps to tackle the student loan crisis and invited feedback on the proposal. Before doing that, I think it’s important to understand the nature of the crisis in order to produce useful solutions to it.

Total student loan debt in the United States is now around $1 trillion. The average balance is $25,000 but it’s common for many students to have a lot more.

The high debt levels are particularly damaging given that it hits young people who have low incomes as they start their careers – if they’re able to start their careers at all given the difficulty of this job market. Student loan debt is a big reason behind the boomerang children phenomenon of college graduates moving back home. It’s also a huge drag on our economy, as young people are paying back debt that could and should otherwise be usefully spent to grow the economy. Young people should be among our most entrepreneurial people, full of innovative ideas based on the fact that they are closer to present day realities than older generations whose worldviews were formed in an era that has passed.

The immediate problem for most young people is that the repayments are not affordable. Why that is the case is extremely important. It’s not because the interest rates are too high. It is because the principal is too high. In that sense the student loan crisis is not very different from the mortgage crisis.

As Konczal points out, however, there is a key difference – one can literally walk away from a mortgage by abandoning the house and letting the bank repossess it. The home is gone but so too is the unaffordable debt. Student loans, however, cannot be discharged in bankruptcy. It is literally a form of indentured servitude, as Konczal himself argued in 2009.

Walking away from a mortgage has seriously negative economic consequences on a macro level, however useful and smart a solution it is on the household level. That’s why one common solution that progressives and many economic observers have called for is principal writedowns. Lowering interest rates won’t solve the problem of negative equity. And getting out of a mortgage is as easy as putting the keys in the mail. So the principal, which is the core of the problem, has to be addressed.

Konczal’s proposal today does not address this central problem. He suggests that we return to the 1989-era student loan rules that loans cannot be discharged through bankruptcy for the first 5 years of the loan, and that we find a way to use the discount window to allow borrowers to refinance their debts at low rates.

Neither solution will provide relief to the indentured. The problem isn’t that the loans will be unaffordable in 5 years, it’s that the repayments are unaffordable now. And the problem isn’t that the interest rates are too high, it’s that the principal levels are too high. Young people are struggling to make the monthly payment not because of high rates but because of high balances.

So any student loan reform proposal that does not include some form of principal writedowns is not likely to be very effective. Konczal is worried about “moral hazard” which, broadly speaking, is a worry we cannot afford to have in this economic crisis. The far greater problem is years of lost economic activity and job creation because people are struggling to pay debts rather than innovating in a Great Reset, and that an entire generation is going to lose wages, equity, and the possibility of career advancement because of their need to repay debts.

The cry among the Occupy protestors, echoing the silent screams of an entire generation, is “forgive student loans now.” They have it right. They understand the problem is the principal balance itself. Let’s tackle that instead.

The best solution is to simply forgive all existing student loan debt. I cannot imagine a more powerful economic stimulus than $1 trillion in debt forgiveness. It would liberate a generation and unleash their creative potential. Not only would they spend money now, helping the economy when it is wobbling between slow growth and recession, but they would be able to start new businesses and innovate new things that can be the basis of a longer term prosperity.

Forgiveness can take several forms. It could be an immediate elimination of the debt. Other, less effective but still potentially useful options include a universal deferment of 5 to 10 years or some kind of mass principal writedown. But why be half-assed about it? If we can free a generation and reboot the economy, we ought to do so.

Student loan forgiveness is only one piece of the puzzle. The underlying problem of skyrocketing college costs has to be addressed. Those costs are rising because of a bipartisan agreement to shift the costs of college from taxpayers (who are usually older) to middle-class parents and their children in school. Free or cheap public college was a key part of building the assets and earning power of the GI, the Silent, and the Boomer generations. We need to return to that model, as Konczal has also argued.

That model included student loans for certain kinds of degrees, though the balances were typically affordable. In a properly functioning social democracy, even medical and law school would be cheap or free. If loans are to be used, they should be used sparingly. Here is where Konczal’s proposals of 5 years of nondischargeability and low rates would become useful – as part of making professional and graduate education more affordable. His proposals are far less useful for the current problem of young people becoming indentured to get their bachelor’s degree.

I won’t speculate why Konczal avoided the issue of principal and did not go down the path of forgiveness. He’s a good guy and a solid progressive. My own belief is that as progressive policy wonks, we’re best off figuring out how we achieve our big, even radical dreams. Occupy protestors want student loan forgiveness. OK then. Let’s figure out what it takes to turn that into reality. In the meantime the government can and should allow anyone who wants to defer their payments for, say, 5 years to do so while we figure this out.

The only thing we have to lose is our indentures.

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5 Responses to Dancing Around the Edges of Student Loan Reform

  1. Ryan says:

    Why not avoid moral hazard altogether, and just give everyone free money? Serious question. My understanding is that fears of inflation put a damper on that path, but I just wonder if that is a worry we can “afford to have in this economic crisis”, as you said.

    • Robert Cruickshank says:

      We’ve done that several times since 2001 with the tax cut “stimulus.” We should consider doing so again when and where necessary. But I also think that the bigger bang for the buck is reversing bad policies made over the last 30 years that produced this crisis – find ways to save people money in the long term. Debt relief is a big part of that. Single-payer health care also puts more money in people’s pockets. So too does direct government hiring.

      From what I can tell, “moral hazard” is too often code for “but people might act irresponsibly in the future if we do this!” (Not saying that’s where you’re coming from, but I’m using the opportunity to make a bigger point.) The best way to encourage people to act responsibly is to give them an environment where they can make better choices. Lower cost of living, less debt, and better wages will also have the effect of reducing moral hazard while also, you know, building a better economy and preserving the middle class.

  2. Pingback: A First Look into Some Distributional Student Loan Data | Rortybomb

  3. rageahol says:

    “In a properly functioning social democracy, even medical and law school would be cheap or free. ”

    I am currently in med school in the US, but also checked out other countries even though i didnt get in anywhere.

    Canada’s schools, even as a foreign student without all the state subsidies etc, is still cheaper than a lot of in-state US school tuitions.

  4. pdxnag says:

    Congress could treat all sorts of debt just like they have student loans. This includes retroactive changes in statute of limitations and bankruptcy.

    I commented here, with links to cases.

    Demand the same treatment from every debtor that Congress has the power to reach — or alternatively let the student loan borrowers go free. The disparity in treatment is an evil.

    Obama’s plan is designed to keep the college professors voting for him and the Democrats. It is very expensive. You need to view the little tweak in repayment terms for new debt as a leveraging trick to increase borrowing — to pay professors even more.

    How does the Federal Reserve plan on getting paid for the 1.6+ trillion in bad debt that they hold as an asset? Do they (i.e., Congress) plan to enhance collections on all that debt, just as with student loans?

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