As Washington slides ever closer to the "fiscal cliff," "financial vortex," or whatever will be the next term du jour, and our national focus finally shifts to fixing that which has heretofore been deemed "unfixable," perhaps 2013 is the year we try to fix our very broken student loan system.
In the first quarter of 1999, Americans owed $90 billion on student loans. It now exceeds $1 trillion. That's not a bubble, dear friends, that's a black hole.
The laissez-faire environment that allowed this extreme growth (1,100 percent) has more in common with the repeal of the Glass-Steagall Act or the zoning plan of the greater Houston area than it does with a properly functioning free market system.
The Confidence Game
Higher education has become a confidence game, with banks and slick marketing machines playing shill in a scam where the "mark" is the dream of American prosperity, parental aspirations and an army of kids conned into believing that an appreciation of Shakespeare will magically result in higher net worth.
At the risk of sounding like Rick Santorum (which in my world is a fate far worse than death), just because there's plenty of dough doesn't mean everyone should go to college. Among those who are gifted in a college sort of way, the lack of financial literacy that prevails among prospective students is dangerous. Kids are not being prepared for the challenges of life -- including the acquisition of a job, housing and all the rest -- so much as they are being prepped for the rigors of witty banter at a cocktail party.
We face a moral hazard. Money is too easy to get. Kids aren't taught about the realities of the workplace. They get hard-to-market degrees, rack up a lot of debt and then can't find jobs that pay enough to justify the expenditure. It's deadly, too. The government farms out delinquent student debt to collection agencies -- those boiler room guys who specialize in intimidation. The result: suffocating debt and an increase in suicide among jobless graduates.
You Want a Piece of Me?
Last week Congressman Tom Petri introduced a plan to tackle student debt. The Wisconsin Republican's solution will be quite familiar to people from Commonwealth countries, including the U.K., New Zealand and Australia. It allows automatic withdrawals from a borrowers' paycheck (capped at 15 percent of a borrower's income) to be managed directly by the Education Department and the Internal Revenue Service. In fairly short order, this practice would ease the demand for the services of collection agencies, saving an estimated $1 billion in commission payments that would otherwise go to those dastardly denizens of the deep.
"This doesn't mean leaving taxpayers on the hook if a student borrows too much," Petri told Bloomberg News. "It does mean providing much stronger protections against the kind of financial ruin that is all too prevalent in our current system."
Rep. Petri's heart is in the right place, but he's missed the mark. The only thing that will prevent the financial ruin associated with the current system is to end the conditions that make it possible.
Seeking an Honorable Discharge
One of the fundamental problems is that since the law was amended in 2005, student debt cannot be discharged through bankruptcy.
That Bush-era modification of bankruptcy laws turned the basic precepts of debt upside down. With most loans, a borrower with a low credit score pays a higher interest rate to compensate the lender for the increased risk of default. But there is almost no risk of default when it comes to a student loan, because bankruptcy very rarely results in the discharge of the debt. So, lenders can throw lots of money at degree-seekers, whether or not they are suited for their educational pursuits (and whether or not those pursuits will yield the return that justifies the expenditure), and the bank-friendly 2005 bankruptcy law guarantees they'll get paid anyway. (If you're thinking, "That's not a credit market. That's legalized theft," you'd be right.) Petri's proposal serves to further deepen that rut.
The Company Store
Colleges and universities charge higher and higher tuition each year because there is an endless flow of federal loans and federally insured private loans protected by bankruptcy laws that are so lender-favorable they'd make a Feudal baron blush. With these ironclad guarantees that loans will be repaid, institutions keep the money spigots open, which in turn gives schools zero incentive to cut costs while creating optimal conditions for tuitions to increase exponentially.
I agree with the Obama administration, it's time to start treating student loans like any other type of debt and allow them to be erased by bankruptcy. That said, the administration's recommendations, which came by way of the Education Department and the Consumer Financial Protection Bureau this July, only apply to 15 percent of the total outstanding debt -- about $150 million in private student loan debt held by private lenders like SLM Corp.'s Sallie Mae and Wells Fargo. Why shouldn't the other 85 percent be treated the same way?
Freeing the Market to be a Free Market
If the federal government and private lenders choose to make student loans, they should also accept the risks inherent in lending. Maybe that means creating academic benchmarks that qualify would-be college students for vocation-specific educational loans. That's for them to determine. For sure it means stripping the immunity currently enjoyed by these institutions from borrower bankruptcies. The result of this simple change will re-introduce free market fundamentals, which will cause an adjustment to the cost of credit. Some students will pay higher interest rates on the money they borrow -- but they will also be more careful about what sort of credits they use it for. They will also be pickier about where they spend that money. These factors should exert downward pressure on tuition.
Colleges have adopted a corporate model of competition, building condo-like dormitories and outrageous student centers, installing state-of-the-art technology and Nobel Prize-winning labs at schools where no Nobel-level faculty can be lured, even with teetering mountains of cash and prizes used to lure the next best thing. It's the academic version of an arms race, and it will continue making college an engine for financial ruin for millions of young Americans until we, as a nation, start insisting on a reality principle -- that there should be some relationship between expenditure and the return on investment for students.
Investing in Public Education
One way to do that is to bring price competition back to the higher education marketplace by investing more in public universities. States are slashing funding for higher education, forcing schools to plug the holes by boosting tuition. Re-funding public universities will make them less dependent on tuition for operating and capital costs -- and with that more able to hold the line on tuition hikes; creating a more competitive environment.
The most effective way to tame student debt is a simple supply and demand approach. We need to slow the flow of money. Low interest rates fueled the mortgage boom. Cheap student loans are "funding" the indentured scholarship of lifelong student loan debt. Let schools use other sources of money, including endowments and alumni donations, to compete for market share by building lavish swimming pools or expanding into new disciplines.
[Related Article: Disabled Student Loan Borrowers Get New Options]
Rep. Petri should be commended for advancing an idea that has already proven to be effective in the UK and elsewhere. The Commonwealth has another practice that would help our public universities reset the floor on college prices: national benchmarks that qualify students for a publicly-funded college education. In the absence of that sort of paradigm shift, we should at least consider going to the root of the problem. It's not about debt collectors and new creative ways to keep debt-saddled graduates from committing suicide. It's about addressing the conditions that made debt collectors and all the rest a reality.
Pretending the laws of supply and demand don't apply to college education is a recipe for disaster. The marketplace is wiser than the boardroom (and makes Washington look positively brain dead). It's time to return student loans to the discipline of the free market. Only then can tomorrow's graduates enjoy the futures they've been promised.
Adam Levin is chairman and cofounder of Credit.com and Identity Theft 911. His experience as former director of the New Jersey Division of Consumer Affairs gives him unique insight into consumer privacy, legislation and financial advocacy. He is a nationally recognized expert on identity theft and credit.