Obama and Elizabeth Warren Feed the College Beast
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  • 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.

      • 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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