The Arizona Desert Lamp

Crowded out

Posted in Politics by Connor Mendenhall on 12 February 2009

Kathy Kristof takes a look at the student loan market in the Feb. 2 issue of Forbes magazine and finds that the world of college finance ain’t that pretty at all. As she puts it, student loans are just one component in

…an unfolding education hoax on the middle class that’s just as insidious, and nearly as sweeping, as the housing debacle. The ingredients are strikingly similar, too: Misguided easy-money policies that are encouraging the masses to go into debt; a self-serving establishment trading in half-truths that exaggerate the value of its product; plus a Wall Street money machine dabbling in outright fraud as it foists unaffordable debt on the most vulnerable marks.

Harsh, but true. I wrote about the coming student loan collapse last year, when the $30 billion Bear Stearns bailout still seemed like a massive bit of economic intervention. As Kristof points out, there are plenty of parallels between student loans and subprime mortgages:

Borrowing has doubled over the past decade, to roughly $85 billion in new student loans in the 2007-08 academic year, bringing total student debt owed to well over half a trillion dollars. The average borrower went $19,200 into debt for a diploma in 2004, a 58% increase after inflation since 1993, according to the Project on Student Debt.

The proportion of students who graduate with more than $40,000 in debt jumped sixfold during that period, to 7.7% of the 1 million grads in 2004, or 77,500 people. Most will struggle for more than a decade to work it off, assuming relatively low 6.8% interest rates, the Project on Student Debt says.

For many, the terms are far worse. A decade ago nearly all student lending was of the low-cost, federally guaranteed variety, most of it with 6% to 8% interest kicking in only after a student left school. As costs outpaced such financing over the past decade, the share of student loans from “private” lenders rose from 7% to 23% of the market, or $20 billion in the 2007–08 academic year.

The rise of private student lending closely paralleled the subprime mortgage boom, which went from 8% of home loan originations in 2003 to 20% in 2006, before the housing meltdown sent that mortgage sector over a cliff. Private student loans resemble subprime mortgages in other ways, too. As banks and brokers did with subprime home loans, colleges and the lenders in cahoots with them commonly market private student loans alongside lower-cost alternatives, blurring the differences.

But Kristof misses an equally important point: Just like the subprime crisis was largely the unintended consequence of public policy that meant to promote ownership of physical capital but wound up distorting price signals and encouraging loads of bad loans, today’s shaky student loan market owes a lot to “diploma on every wall” policies that distort the market for human capital. Worse, it’s way easier to appraise the value of a home than a four year concentration in comparative phallocentrisms, and students bear the brunt of this information asymmetry. I have to wonder, though: is anyone surprised that a market in which 77 percent of all lending is crowded out by government or government-subsidized programs encourages cutthroat, risky, and occasionally unethical practices among private lenders competing for the rest?

(via Reason)


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