The Next Bubble to Burst: Student Loans

The Next Bubble to Burst: Student Loans

When Obama ran for president, I about fell out of my chair reading the Democratic Party's platform ("Renewing America's Promise"). One plank read: "We will make college affordable for all Americans."

Another plank promised: "A world class education for every child."

Anybody who has ever taken an economics course --- or lived in the world, the real world and not inside the Beltway --- knows those two phenomena are incompatible together. Neal McCluskey of The Cato Institute describes the ridiculousness of the federally funded student loan game this way:

"The basic problem is simple: Give everyone $100 to pay for higher education and colleges will raise their prices by $100, negating the value of the aid. And inflation-adjusted aid—most of it federal—has certainly gone up, ballooning from $4,602 per undergraduate in 1990-91 to $12,455 in 2010-11."

McCluskey adds:

"The Associated Press just published a story brilliantly illustrating reality. Of graduates ages 25 and younger, the AP reports, roughly 50 percent are either unemployed or in jobs that don't require a degree. In addition, despite what we hear about the economy's imminent voracious appetite for highly educated workers, the U.S. Department of Labor estimates that just three of the 30 jobs expected to have the greatest growth by 2020 will require a bachelor's degree or higher. Finally, right now a third of bachelor's holders of all ages are in jobs which don't require their credentials."

Richard Vedder, a professor of Economics at Ohio University, writes in Imprimis, a wonderful publication from Hillsdale College (a bastion of higher education that refuses federal funds for intellectual freedom reasons):

"Student loan interest rates are not set by the forces of supply and demand, but by the political process. Normally, interest rates are a price used to allocate scarce resources; but when that price is manipulated by politicians, it leads to distortions in the use of resources. Since student loan interest rates are always set at below-market rates, too much money is borrowed for college."

He also starts his cogent article like this: "FEDERAL STUDENT financial assistance programs are costly, inefficient, byzantine, and fail to serve their desired objectives. In a word, they are dysfunctional, among the worst of many bad federal programs.

"These programs are commonly rationalized on three grounds: on the grounds that assuring more young people a higher education has positive spillover effects for the country; on the grounds that higher education promotes equal economic opportunity (or, as the politicians say, that it is “a ticket to achieving the American Dream”); or on the grounds that too few students would go to college in the absence of federal loan programs, since private markets for loans to college students are defective.

"All three of these arguments are dubious at best. The alleged positive spillover effects of sending more and more Americans to college are very difficult to measure. And as the late Milton Friedman suggested to me shortly before his death, they may be more than offset by negative spillover effects. Consider, for instance, the relationship between spending by state governments on higher education and their rate of economic growth. Controlling for other factors important in growth determination, the relationship between education spending and economic growth is negative or, at best, non-existent. . . . . "

Indeed, trying to get a loan has turned into one big game, a complicated game, as any of our readers who peruses Lynn O'Shaughnessy's college savings newsletter and columns can attest.

As for the housing bubble, yeah, people got greedy, institutions got greedy and lax. But the pricing mechanism for mortgages was screwed up by politicians and the Fed. Lawrence H. White, the F. A. Hayek Professor of Economic History at the University of Missouri-St. Louis, The Cato Journal wrote in 2009:

"Our current financial turmoil began with unusual monetary policy moves by the Federal Reserve System and novel federal regulatory interventions. These poorly chosen public policies distorted interest rates and asset prices, diverted loanable funds into the wrong investments, and twisted normally robust financial institutions into unsustainable positions. There is no doubt that privatemiscalculation and imprudence have made matters worse for more than a few institutions. Such mistakes help to explain which particular firms have run into the most trouble. But to explain industry-wide errors we need to identify price and incentive distortions capable of having industry-wide effects.

"Here I will make two main points. First, the Federal Reserve’s expansionary monetary policy supplied the means for unsustainable housing prices and unsustainable mortgage financing. Elsewhere (White 2008) I have discussed the growth in regulatory mandates and subsidies that exaggerated the demand for riskier mortgages, most importantly the implicit guarantees to FannieMae and Freddie

Mac that combined with HUD’s imposition of 'affordable housing' mandates on Fannie and Freddie to accelerate the creation of a market for securitized subprime mortgages.1 Second, the Federal Reserve has undertaken self-initiated new lending roles that constitute a shadow bailout program more than twice the size of the Treasury’s $700 billion bailout program. There is unfortunately little evidence that the Fed’s new lending has helped to resolve our financial problems, rather than to delay their resolution."


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