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Obama and Elizabeth Warren Feed the College Beast


College students may see their debt rise sharply overnight, as the interest rate for Stafford Loans is set to double to 6.8 percent on July 1st. Fortunately, students have some friends in high places: The Obama administration, House Republicans, and various senators have each proposed plans that would forestall the rate jump. (Inside Higher Ed has a more detailed account of these policies.)

The proposals put forward by Obama, House Republicans, and Senators Jack Reed (D-RI) and Dick Durbin (D-IL) would tie student loans to the market rate (either the 10-year or the 91-day Treasury rate), though each with its own variation. The boldest plan, from new Senator Elizabeth Warren (D-MA), would reduce student loan rates to .75 percent (the rate at which banks borrow from the Federal Reserve) for one year.

These proposals would offer students some relief, but none of them address the core problem that rising college tuition rates are closely linked to the increased availability of government loans. Stafford loans have been around for just over forty years, and over the past thirty, college tuition and fees surged 1,120 percent—four times faster than the consumer price index, more than medical or food prices. And this isn’t all due to a rising cost of teaching: Colleges have used their newfound wealth to bloat their administrative ranks and spend lavishly on construction projects.

These new student loan proposals, particularly Warren’s, will only feed the higher education beast. Perhaps lawmakers should give more thought to policies that would increase price competition among universities and drive down costs.

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  • Felipe Pait

    This post ignores the power of compound interest. Stafford loans have long terms. At current rates, accrued interest can represent a large fraction of the total repayment. I would not be surprised if the needier students spend on interest a comparable amount to tuition.

    College tuition pays for a variety of services, some crucial, some arguably superfluous. On the other hand, interest on government-guaranteed loans pays for absolutely nothing of value. The cost of money is as you mention .75%, and the risk is absorbed by government insurance. The interest premium is wasted in the form of bank profit and bureaucracy. Senator Warren’s proposal to curb this form of waste is correct.

    For the editors: this post seems to have started from a conclusion and proceeded to manhandle the facts. Dear Prof Mead, I think you need to have your editors work more slowly and more carefully.

    • retrophoebia

      Er, WRM’s argument has nothing to do with what the interest goes for. The argument is that low interest rates are price distortions in the higher ed market. When you artificially lower prices (such as with gov’t sets low interest rates for college loans), you get supply variations that wouldn’t otherwise exist–such as the glut in college education and rising tuition that we’re seeing at the moment.

      The interest on a loan is correlated to the risk of giving the loan. That’s why we have FICO scores, etc. On academic loans, the risk/return correlation is virtually non-existent, as loans are a) non-dischargeable, and b) guaranteed to students attending accredited colleges. If the government adopted a more market-oriented approach, interest rates would likely be quite a bit higher than 6.8%, given that student loan default rates are breaking into double-digits. You might also consider whether the interest rate on gov’t loans should cover the risk to the taxpayer of subsidizing bad loans in addition to the cost of administering the loan.

      Further, suggesting that “the interest premium is wasted in the form of bank profit”… that’s straight Das Kapital, if I recall my economics theory correctly. I suggest a quick refresher on the role of profits in a free market system, and how that fits into WRM’s suggestion that letting interest rates go up would incentivize colleges to cut costs and thus lower tuition rates.

      • Felipe Pait

        Lower interest than the market rate could be a price distortion. An interest rate several points above the market interest rate, without any risk, is a distortion, but in the opposite direction than the one you point.

        The loans have a government guarantee. The interest rate is a guaranteed remuneration to the banks, but not for a product or service. This is not a free market. The banks are just passing on federal funds.

        Your argument about a glut in education may reflect a deeply held belief, but is unsupported.

  • Diggsc

    A stimulus bill for the Ivy League? You betcha!

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