In my various posts this week, I’ve focused on some of the problems that afflict our current system for financing higher education.  The new approach I’ve suggested would ensure that every American could pay for college on the basis of income-contingent federal loans. 

A comprehensive income-contingent-lending (ICL) program would transform the way we finance education
and training in this country, much as social security transformed
the way we finance retirement. In fact, such a program might be thought of, roughly, as social security in
reverse. Instead of paying-in over one’s
working life to finance retirement (i.e., once one’s human capital is
depleted), an ICL program would allow a young person to build human capital up
front and then spread the cost over his or her working life. Like social security, an ICL program would
allow Americans to cover risks they couldn’t otherwise cover on their own, and
it would take advantage of the withholding system to simplify and streamline
administration.

The ultimate investment
we can make as a society is an investment in the education of our young
people. Sadly, our existing system for
financing higher education is hopelessly inefficient and complex – and this, at
a time when the benefits of higher education have never been more clear. We can do better. A comprehensive ICL program would be like a
GI bill for everyone, but one that would also pay for itself over the long
term. Social security transformed
retirement by changing the way we finance it. It’s time we do the same for education.

In yesterday’s post, I identified a number of problems with
our current system for financing higher education, and I promised that I would
suggest a new approach.

The option I think we should strongly consider is to ensure
that every American can finance college or graduate-school tuition (or the cost
of job training) with a special income-contingent federal loan. The loan would have an extended term (up to
30 years, like a mortgage) and would defer or potentially forgive interest
payments for any year in which the recipient’s household income fell below a
pre-specified trigger.

Income-contingent
lending for education is certainly not a new idea. In the past, its intellectual champions
included both Milton Friedman and James Tobin, two Nobel laureates in economics
from opposite ends of the political spectrum. Among politicians, key supporters have included Congressman Thomas
Petri, Republican from Wisconsin, and former
Senator Bill Bradley, Democrat from New Jersey. The
idea has broad appeal because it addresses an important weakness in our market
system.

Just as limited
liability law encourages investment in financial capital, an income-contingent-loan
program would encourage investment in human capital by limiting the investor’s
downside risk. In my view, it would
represent a vital – and ultimately self-financing – policy innovation for the
information age.

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Over the course of this
week, I want to discuss student loans, including the inadequacies of the
existing system for financing higher education and a potential strategy for
improving it.
 
As I see it, the current
patchwork of programs for covering college tuition makes little sense. The system is maddeningly complex. What’s worse, it does a poor job of managing
risk and assessing need, and it actually discourages household saving. Most student loans, moreover, require
borrowers to bear the heaviest burden when their earning power is lowest. For such a major lifetime expense, it is
imperative that we do better.

I’ll suggest an
alternative approach in my next post. First,
though, I want to focus on the nature of the problem we need to solve.

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The prospects for slashing the interest rates on student loans have dimmed considerably. The Chronicle of Higher Education reported this morning that the president has announced his opposition to the bill currently working its way through the House. A copy of the president’s full statement is here. Although the president did not come out and say he would veto the bill, that appears to be a distinct possibility.

I am all in favor of cutting interest rates on student loans, but I also recognize there is no free lunch here. Someone has to pay. In a post earlier in the week, I raised the question of exactly who will pay for this. Today’s N.Y. Times reports the following:

The rates would drop from 6.8 percent to 3.4 percent in stages over
a five-year period under the House proposal. That would cost nearly $6
billion, according to the Congressional Budget Office.

To
avoid increasing the deficit, the bill’s cost would be offset by
reducing the yield on college loans the government guarantees to
lenders and cutting the guaranteed return banks get when students
default. Banks also would have to pay more in fees.

Cutting through the rhetoric, it appears that the lenders would ultimately bear the costs. Proponents of the interest-rate cut say that the student-lending industry could easily afford it. Its loans are federally subsidized and carry little risk. For example, student loans are generally not dischargeable in bankruptcy. I see that point, but we’re talking about a 50% rate cut. The target interest rate of 3.4% would be below the yield on a 10-year U.S. Treasury note, which stood at 4.7% this morning. Sure, student loans are profitable products for lending institutions, but are the returns so dramatic that the industry could absorb a 50% decrease on its interest rate?

UPDATE (1/19/07): This bill has passed the House on a 356-71 vote. It is now pending before the Senate Committee on Health, Education, Labor, and Pensions. The bill’s status can be tracked through the Library of Congress’ THOMAS service.

Much has been written about the Democrats’ promises to enact new legislation in their first 100 hours of control over the Congress. (Aside–if my students think time passes slowly during my classes, they should see the way the congressional Dems keep time (NYT, reg. req’d).) One of the pieces of legislation is a promise to slash interest rates on student loans by half over the next five years. There have been a number of news stories on this plan, and the story in today’s New York Times (reg. req’d) will get you up-to-date.

I don’t know enough about the student loan program to understand exactly how this is going to work, and I’m too busy or lazy (take your pick) to educate myself on it. Maybe Credit Slips readers will help me out here in the comments. There is no free lunch, to coin a phrase, so who’s paying for this? Debb Thorne posted on student loans a while back, and there is no question that reducing the crushing debt burden on graduating students would be a huge policy win for the middle class. The bankers claim the rate cut will fall on them. Is that right? Is the Democrats’ plan just a big federal subsidy?

This past week, students in my Social Inequality course were asked to read and think about causes and consequences of various types of debt. Given the audience, it’s no surprise that student loans kept coming to the fore. Well over three-quarters of the students indicated that they would graduate with loans–many of them well over $20,000 owed on a Bachelor’s degree in the social sciences, majors that are vital for our society but not notorious for their high salaries. They described an increasingly common pickle–there was no way that they could have attended college without the loans, and they are frightened that they will not be able to repay them, but they knew that without the college degree, their futures were beyond bleak. To say they feel between a rock and a hard place would be an understatement.

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