No, the Interest on Your Student Loan Isn’t Too High. In fact…

It seems like more often than not I’m opening these blog posts with an apology for a multi-week hiatus. Since nobody’s emailed to check on my well-being, I can only infer my readership has gotten on fine without my wonk-Jr. takes on public policy and other matters of high import. Fair enough; but don’t think your demonstrated lack of interest will spare you from a quick update.

Actually, it’s all good news: I’ve been having fun learning R (a statistical language), looking for a new apartment, and testing the limits of a 27-year-old liver. I saw Chance the Rapper and a Pirates game in Pittsburgh, which was awesome. The last article I wrote had some real success and was republished in several places, even earning a shout-out from John Stossel:

The big update is that my stint as a (purely) freelance writer has mercifully drawn to a close; I now write for a non-partisan public policy group. In fact, this very blog was one of my strongest selling points, according to my manager. It just goes to show you, kids: if you toil in anonymity for two years, eventually something will go your way.

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Okay, enough about me. Let’s talk about a topic close to the heart of many millennials: student loans. More specifically, I want to talk about the interest rates charged on undergraduate student loans.

That interest rates are too high is, unsurprisingly, a common gripe among borrowers. If I had a nickle for every twenty-something I’ve overheard complain that the federal government shouldn’t profit off student loans…well, it still wouldn’t cover one month’s interest. However, this sentiment isn’t limited to overqualified baristas; popular politicians like Elizabeth Warren and Bernie Sanders–and even unpopular politicians–have publicly called for loans to be refinanced at lower rates and decried the “profiteering” of the federal government. From Bernie Sanders’ website:

Over the next decade, it has been estimated that the federal government will make a profit of over $110 billion on student loan programs. This is morally wrong and it is bad economics. Sen. Sanders will fight to prevent the federal government from profiteering on the backs of college students and use this money instead to significantly lower student loan interest rates.

Under the Sanders plan, the formula for setting student loan interest rates would go back to where it was in 2006. If this plan were in effect today, interest rates on undergraduate loans would drop from 4.29% to just 2.37%.

It makes no sense that you can get an auto loan today with an interest rate of 2.5%, but millions of college graduates are forced to pay interest rates of 5-7% or more for decades. Under the Sanders plan, Americans would be able to refinance their student loans at today’s low interest rates.

As one of those debt-saddled graduates, and one of the chumps who took loans at a higher rate of interest, I would obviously be amenable to handing over less of my hard-earned money to the federal government. But as a person concerned with the larger picture, I have to say this is a really bad idea. In fact, rates should be higher, not lower.

First of all, the progressive case for loan refinancing or forgiveness only holds up under the lowest level of scrutiny. Such a policy would overwhelmingly benefit borrowers from wealthy families, who hold the majority of student loan debt. Conversely, most defaulters hold relatively small amounts of debt. Fiddling with interest rates shouldn’t be confused with programs that target low-income students, like the Pell Grant, which are another matter entirely and not the subject of my criticism.

More to the point, the federal government probably isn’t making any money on student loans. Contrary to the claims of Senators Warren and Sanders, which rely on estimates from the Government Accountability Office (GAO) and put federal profit on student loans at $135 billion from 2015-2024, the Congressional Box Office (CBO), using fair-value estimation, shows student loans costing the federal government $88 billion over the same period.

The discrepancy between the CBO and GAO figures comes from the former’s inclusion of macroeconomic forecasts. Essentially, the CBO thinks the risk of default on student loans is higher than the GAO does, due to forces beyond individuals’ control.

Evidence suggests it’s unwise to underestimate the risk associated with student loans. According to a study by the liberal think tank Demos, nearly 40% of federal student loan borrowers are in default or more than 90 days delinquent. Add to that the fact that student loans are unsecured (not backed by collateral or repossessable assets, like a car or house), and they start to look like an incredibly risky venture for the federal government, and ultimately, taxpayers.

That conclusion is deeply unpleasant, but not really surprising if you think about it. Ever notice how the interest rates on private student loans–approximately 10% of the market–are much higher? That’s not because private lenders are greedy; it’s because they can’t lend at the rate of the federal government without losing money.

This is all important because the money that finances student loans has to come from somewhere. Be it infrastructure upgrades, federal support for primary education, or Shrimp Fight Club, the money spent on student loans isn’t available for competing priorities. This is even more important when you consider the loss the federal government is taking on these loans, the cost of which is passed onto future taxpayers in the form of higher taxes or lower spending. Since higher education is only one among infinite human desires, we need to decide how much of our finite resources to devote to it. Properly set interest rates are one way (probably the best way) to figure that out.

The irony, of course, is that doing so would require the government to act more like a private lender–the very thing it’s designed not to do! Our student loan system ensures virtually anyone who wants to study has the money to do so, regardless of the likelihood they’ll be able to repay. One of the nasty side effects of this indiscriminate lending is a large amount of distressed borrowers, who now find themselves in the uncomfortable position of digging out from under a mountain of debt they likely shouldn’t have been able to take on.

More so than other forms of government spending, student loans have specific, discernible beneficiaries: the students who get an expensive education financed by the taxpayer at below-market rates. Sure, you can argue there’s some spillover; society does benefit from having more highly-trained workers. But most of the time, highly skilled labor is rewarded with higher wages. That being the case, is it really too much to ask for borrowers to pay a level of interest that reflects the actual cost of issuing their loans?

Yes, this would be discouraging for some: particularly those who want to pursue non-remunerative fields of study. That’s not such a bad thing; higher interest rates would steer people away from obtaining degrees with low salary expectations, which would–by my reckoning–reduce rates of delinquency and default over the long term. They would also help mitigate some of the pain of defaults when they do happen.

But–you might protest–you can’t run the government like a business! And sure, a lot of the time, you’d be right. However, I really think this is one area where doing so is appropriate–even desirable. Hear me out.

When the government can fund itself through profitable investments rather than zero-sum transfers, it should. If we’re going to have a government of any size (and few suggest that we shouldn’t), then we need to pay for it. Which sounds like the preferable way for that to happen: voluntary, productive, and mutually beneficial investments in society; or the forceful appropriation of private resources? I’m not suggesting the former could entirely replace the latter, but when it can, I think it absolutely should.

Astute readers will realize if the government decides to lend profitably, it will have to compete with private lenders, which would cut into its margins and make its presence in the market redundant. So maybe it’s just a pipe dream. But if profitable lending isn’t possible, the federal government should at least try to minimize losses. One way or another, that means higher interest rates.

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