Student Loan Debt: The Financial Time Bomb Politicians Want to Ignore
Media reports claim this debt prevents economic recovery. Chuck Schumer would erase it with the flick of a pen. Elizabeth Warren would remove it to free students’ ability to buy a house and form a family. Janet Yellen opines paying off student loan debt (SLD) will free up venture capital. Alexandria Ocasio-Cortez claims the proposed Biden plan is inadequate.
The complexities of SLD are simplified for the public by moving details into an abyss of aggregates; “average student debt,” “average unemployment” and “average wages” headline without context. Political and news media calls for money drown out one simple question: Should taxpayers rescue students from their education loans?
The Department of Education (DOE) supervises student loan program revisions. The current proposal is explained on their website: “The U.S. Department of Education will provide up to $20,000 in debt cancellation to Pell Grant recipients with loans held by the Department of Education and up to $10,000 in debt cancellation to non–Pell Grant recipients. Borrowers are eligible for this relief if their individual income is less than $125,000 or $250,000 for households.”
This is a rescue plan for something we do not understand and that cannot be easily and clearly explained. The student loan program is ineptly managed and widely misunderstood. Casual accounting and limited underwriting controls have created a student-as-ATM monster that feeds the universities. If this calamity were a crime scene, there would be a crowd of suspects leaving their DNA behind.
The personal impact of SLD was a topic at Occupy Wall Street in 2011. Married Ivy League graduate students with master’s degrees in fields such as sociology expressed their fears to a reporter, “Do we eat beans for the rest of our lives to pay off $100,000?” In 2022, a TikTok video showed a woman behind a sign reading “B.A. in Fine Arts, $29,000 in debt and no job.”
Federal funding for education has a noble beginning. Demobilization after the end of the Second World War created an army of workers. Large-scale federal funding for education and training began in 1944 with the successful Servicemen’s Readjustment Act, commonly called the GI Bill; it funded education in trades, high school diplomas, and college degrees for veterans.
The National Defense Education Act (NDEA) was passed in 1958 in response to Soviet acceleration of the space race. The act funded programs to “ensure trained manpower of sufficient quality and quantity to meet the national defense needs of the United States” (emphasis mine). NDEA bolstered education in science, mathematics, and modern foreign languages by offering low interest rates for student borrowing.
The intent of the originating acts was to build human and therefore national capital for solving future problems. Total SLD is now reported at $1.74 trillion on the Fed’s G.19 reports. However, the $1.74 trillion in debt is a ghost. The magnitude of student loan receivables is overstated. Keeping the debt sum large creates headlines and a sense of urgency; a figure this large demands congressional action!
Yet portions of this figure are delinquent, in default, or not yet due.
Private lenders hold 8 percent of the student debt, or $131 billion. Parent PLUS loans total $107 billion. The best estimates of graduate student debt show that around 25 percent of all graduate borrowers incur 46 percent of the total debt. Removing graduate student, Parent PLUS, and private loans leaves approximately $750–850 billion in true federal student loan undergraduate debt.
Also, the $800 billion figure is not all due now. Calculations were not adjusted for loans that are not yet in repayment, which begins six months after degree completion, a grace period that covid extended for two years. Being in graduate school part time also suspends payment on bachelor’s degree loans. Debt contracted six to eight years ago has been counted before payment is even due!
What Has Been the Return on Our Investment So Far?
Nationally, only 60 percent of all students enrolled in college finish in six years. Another 11 percent remain enrolled; 28 percent leave and never return. Dropouts keep their debt. Ten percent of graduates are in default when they begin repayment.
Inside Higher Ed summarized a recent New York Federal Reserve report: “About 41 percent of recent college graduates—and 33.8 percent of all college graduates—are underemployed in that they are working in jobs that don’t require a college degree.”
The Education Data Initiative offers observations of graduates. “At a rate of 26.33 percent, Arts and Humanities majors who attended non-selective schools are the most likely to default on their student loans. Student loan borrowers with law degrees are the most likely to fall into delinquency.”
In February 2021, the New York Fed identified employment and underemployment numbers for seventy-two programs of study. Degrees in fine arts, performing arts, social sciences, and anthropology had the lowest wages and the highest unemployment and underemployment.
Included in the SLD totals are subsidized and unsubsidized Direct loans and Parent Plus loans. Undergraduate loans cost 3.73 percent, graduate loans cost 5.28 percent, and Parent PLUS loans disbursed between July 1, 202,1 and June 30, 2022, cost 6.28 percent.
Multiple programs operate under the existing plan for repayment of student debt. These repayment plans create uncertainty in projecting repayment cash flow. These are billed as forgiveness plans; they also mask uncollectable loan dollars.
The two most common plans are the Income-Driven Repayment Plan (IDR) and the Income-Based Repayment Plan (IBR). Both plans allow debtors to pay a percentage based on their discretionary income. As originally implemented, the protected income was based on a 150 multiplier over the poverty wage. Discretionary income is what remains after deducting protected income from gross income. The minimum payment would be 15 percent of this discretionary income.
Barack Obama reduced the percentage to 10 percent and alleged savings of over $60 million when he federalized the student loan program in 2011. The Biden plan further reduces this payment minimum to 5 percent and will use a higher multiplier to reduce discretionary income even further. These plans can then fold into the Public Service Loan Forgiveness (PSFL) plan, expunges the remaining debt after ten years in approved employment.
Given that these changes are being added to existing repayment schemes, they may not be open to legal challenge. Projections of the Biden plan’s costs are a blind dartboard game in a crowded bar. No estimation from the Department of Education has credibility.
These changes send a powerful signal to current and future students: “Incur debt and you may not need to pay it all back.” And if you suspected mismanagement of funds in the past, in July 2022 the Government Accountability Office confirmed a $320 million miscalculation error. Instead of $114 million in positive cash flow from payments, there is $197 million deficit.
Yes, the Student Loan Debt Issue Is an Impending Disaster
The short tenure of the past three COOs responsible for administering the Student Loan Program gives desk-level insight, and perhaps hints for future solutions. In 2017 James Runcie resigned; he was appointed in 2011 to oversee the Obama-era federalization of the student loan program. Prior to the appointment, he was an investment banker. His resignation cited staff cuts and meddling by then secretary of education Betsy Voss. Chief among his complaints was that Voss entertained moving the program to the Treasury Department and her insistence that Runie testify before an oversight panel in Congress.
Appointed COO in 2017, Wayne Johnson resigned in late 2019. Prior to his federal appointment, he was an executive at Deloitte and at Visa. In a telephone call with Yahoo Finance, he described the student loan program as “an abomination in plain sight” and “rotten to the core.” Some of his suggestions simultaneously faced bipartisan support and objections.
In early 2019, Mark Brown stepped in to replace Johnson. Mr. Brown is a retired Air Force General who led the Air Force Air Education and Training Command; he was CFO of the Air Force Materiel Command. He resigned after facing sustained criticism from student debt forgiveness advocates.
In May 2021, Richard Cordray was named the new COO. He had served six years as the director of the Consumer Finance Protection Bureau; previously he was Ohio’s attorney general and the Ohio Democratic Party nominee for governor in 2018.
Examining DNA at this crime scene finds management turnover, a loan-management-as-welfare mindset, willful ignorance on bad debts, and intentional obfuscation of portfolio results.