How Big Government Broke Higher Education: The Student Loan Bubble, Explained

by | Feb 22, 2021 | Education

All evidence points to government-subsidization as the real culprit behind rising tuition costs.

In his book Bubbles and Crashes, Brent Goldfarb says a bubble is much like a stock that traders keep buying because others are doing the same thing.

“This usually happens when a company or product has a compelling narrative around it that isn’t backed up by data,” Goldfarb writes. “They’re easy to invest in, there’s a lot of uncertainty about the future value, and it’s often about a lot of novice investors.”

The student loan bubble checks all of these boxes. Americans have been hearing about a student loan “crisis” for over a decade, and there’s a reason for that. Forty-three million Americans hold $1.5 trillion in federal student loan debt. The average debt per borrower is $37,127. Since the late 1970s, tuition has risen at a rate three times that of inflation.

Not only is a college degree getting more expensive, it’s doing so while arguably becoming less valuable.

The Wall Street Journal reports that 43 percent of graduates are underemployed in their first job. Of those, two-thirds remain in jobs that don’t even require a college degree five years later.

Meanwhile, the Washington Post found that only 27 percent of graduates work in a job related to their major. And estimates show that the rate of return on a degree has been decreasing since the Great Recession.

Already, over 1 million people default on their student loans every year. Some studies estimate nearly 40 percent of borrowers could follow their lead by 2023, leading many to warn of the coming student loan bubble.

One trait all bubbles share is an obscured understanding about the value of a commodity relative to its actual worth. In this instance, it’s why you see people paying $100,000 for a degree in graphic design that might pay them $40,000.

Sometimes, the debt is even more. Just ask Shaun Dunn, a 38-year-old 3-D designer who racked up more than $400,00 in student loan debt after attending the Academy of Art University in San Francisco.

“I just feel they were dishonest, saying you’ve got this great future in front of you,” Dunn told the San Francisco Chronicle earlier this year. “But I feel we were ripped off. Bamboozled. Tricked.”

As of February, Dunn had no job, owed $431,607, and was bankrupt.

So, given these circumstances, why do we continue to see young people paying small fortunes to earn these degrees—especially those that offer little prospect of earning potential?

It goes back to Goldfarb’s point on the importance of a compelling narrative in the making of a bubble. Americans have been told the only way to upward mobility, respectability, and the American Dream is through a college degree. We sell this narrative to 18 year-olds (novice investors) and we make it really easy for them to invest in the model (government loans). If we wanted to create a bubble, I’m not sure you could have found a better way to do it.

So what happens if the bubble bursts? In the 2008 financial crisis, millions lost their jobs, their retirement savings, and their homes. That crisis bears many similarities to this one. Students take out and are given loans with little attention paid to their prospective ability to repay the debt.

And what was already a hot mess is reaching a boiling point in the midst of COVID-19 as the government continues to shut down businesses and create skyrocketing unemployment.

This is a crisis for millions of Americans, albeit one temporarily on hold as all federal student loan payments have been paused during the pandemic. There is, of course, an element of personal responsibility here. But these Americans do deserve some sympathy. These are people who were largely trying to do the right thing. They intended to work, not to be leeches on society. Many were taken advantage of and misled by higher education institutions, and they were poorly educated by our public schools that fail to teach basic financial literacy.

We cannot continue to shrug our shoulders at this situation. Unfortunately, most of the proposed solutions would only exacerbate the problem.

For years, progressives have been calling for the “cancellation” of student loans, and they’ve been calling for free tuition in higher education. And lately, the calls for loan cancellation have hit a crescendo as Senator Warren, President-Elect Joe Biden, and many other elected officials have floated the idea.

There are two problems we all want to address. The first is that college has become too expensive, and the second is that people with college degrees increasingly can’t find good jobs.

Instead of targeting the root cause of these two problems, cancelling student loans and taking full government control of higher education would merely devalue college degrees further. It would also allow higher education institutions to continue jacking up the price of a commodity whose actual value is diminishing—all on the taxpayers’ dime

These are the kinds of ideas that created the mess to begin with and are therefore the policies we need to move away from.

In the early 1900s, most professions did not require a college degree.

But in 1944, Congress passed the G.I. Bill, extending tuition and living assistance to veterans. This action exploded enrollment with over 8 million veterans signing up. The sudden boom led to states expanding college services with resources they had in a booming post-war economy.

Next came the National Defense Student Loan program, which did for civilians what the G.I. Bill did for veterans. The Higher Education Act of 1965 then set-up federal scholarships and low-interest loans for students. Finally, in 1978 Congress passed the Middle Income Student Assistance Act, which made all undergraduates eligible for subsidized loans.

A former education secretary warned that government aid for students would lead directly to an increase in college costs (known as the Bennett hypothesis) and his predictions came true. The Federal Reserve found that for every dollar in student aid, tuition increases 65 cents.

Ultimately, costs at public universities rose 213 percent between 1980 and 2018.

Progressives often try to blame these tuition increases on state budgetary cuts, claiming schools have had to raise their rates in response. But the claim doesn’t wash.

In fact, nine states have increased their per-student funding in the past 10 years and across all of them, tuition still increased. Furthermore, a Harvard study comparing higher education programs that accept federal aid to those that do not found that tuition at aid-accepting programs grew much faster.

All evidence points to government-subsidization as the real culprit behind rising tuition costs. And this is exactly what basic economics teaches us to expect.

The law of demand says that at higher prices, buyers will demand less of a product. And the law of supply says that at higher prices, sellers will supply more of a product. These two laws interact to determine the actual price of goods in a free market.

Normally, colleges would see the demand for their product drop if they raised their prices too high—which they have. Very few people could afford $30,000 for one year of school, and private lenders would be unlikely to lend that amount to borrowers for most majors. Therefore, in a free market, schools would have to drop their prices if they wanted to attract more students and stay open.

This isn’t happening because politicians used the federal government to interfere in the market. As is always the case with the government, they break it—you buy it.

There are many free-market solutions to the student loan bubble that are equitable, grounded in sound economics, and within reach.

Employers can simply quit requiring college degrees for many positions and implement skills-based tests in their place. We can elevate trade schools and inform children on alternative career pathways. State lawmakers can remove regulations put in place to intentionally block new competitors from entering the market. Students and colleges can choose pathways that lower the costs of college. And the federal government should consider cutting the interest on student loan payments to give borrowers the ability to pay more of their principal.

But the reality is there’s no incentive for our society to pursue these things as long as there’s an endless sea of taxpayer dollars flowing to the colleges. In order for meaningful change to occur, and for higher education to actually become affordable, the federal student loan program must end.

In his book, Inside American Education, famed economist Thomas Sowell said, “The availability of federal grants and loans to help students meet rising tuition costs virtually ensures that those costs will rise.”

We can’t begin to really clean up this mess until we first cut the water off. Then, we could talk about true free-market reforms.

 

This article was originally published on FEE.org. Read the original article.

Hannah Cox is the Content Manager and Brand Ambassador for the Foundation for Economic Education.

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