Personal Finance: Student loan crisis: no end in sight

"Increases in financial aid in recent years has enabled colleges and universities blithely to raise their tuition, confident that Federal Loan subsidies would help cushion the increase." - William Bennett, Secretary of Education, 1987

Last week, we saw how millennials are finding it difficult to buy a home, thanks to the crippling burden of student loans. This unfortunate outcome is the inevitable and predictable result of a well-meaning but fatally flawed federal lending program. Intended to equalize opportunity, the system has instead increased inequality, inflated costs, and saddled a generation with debt. So what went wrong?

First, the system essentially ignores ability to repay. Commercial lenders consider income as an essential criterion in making mortgage or auto loan decisions. But federal student loans are based upon the cost of attending a particular institution, and do not factor in potential future earning power. So it is all too common for a student to rack up six-figure debt at a private institution in pursuit of a degree in a field whose compensation structure precludes repayment. Clearly some form of potential income assessment should be applied in limiting the total aid available.

In an effort to address the burgeoning problem of oppressive debt service payments, the Obama administration introduced an income-based repayment plan. The objective was to limit monthly obligations, even if the payments would not fully amortize the loan. Any remaining balance would be forgiven after 25 years.

Two problems arise with income-based repayment. The obvious one is the burden to taxpayers. Since federal loans are now made directly by Uncle Sam, taxpayers pick up the tab for any forgiven balances.

Perhaps less obvious is the inequity associated with beneficiaries of the plan. Basically, the more you borrow, the more you don't have to repay. Consider the well-reported case of the Utah dentist, whose loans for graduate school now total over $1 million. He currently earns $225,000, and carries a $400,000 home mortgage. Thanks to the income-based plan, he pays only $1,600 per month, less than just the interest on the note. At the end of 25 years, his total debt will have ballooned to $2 million, all of which will be handed off to taxpayers. The good news is that his debt forgiveness is taxable, small consolation to the rest of us.

Meanwhile, highly qualified math and science teachers agreeing to work in low-income schools for five years after graduation are allowed to walk away from a maximum of $17,500 for their commitment.

Add to these factors the epidemic of delayed graduation. According to the U.S. Department of Education, 45 percent of undergrad students take six or more years to complete their degrees. That means two extra years of tuition, fees and lost income, often added to the student loan tab. The Campaign for College Opportunity estimates that an average California State University student incurs an additional $111,000 for the delay.

As to the "Bennett hypothesis" quoted at the outset, numerous studies have validated Secretary Bennett's intuition, finding that over half of the increase in college tuition and fees is direct attributable to growing loan availability. Virtually limitless access to student loans has fueled an arms race among institutions to enhance amenities in pursuit of loan dollars. And interestingly, the best students are the least influenced by trappings, while the least academically talented students are most susceptible to swanky apartments and upscale accoutrements, accumulating decades of debt to enjoy what researchers at the National Bureau of Economic Research have called 'college as country club."

Some obvious solutions suggest themselves. Sadly, the will to adopt them is currently lacking.

Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga

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