How Student Loan Forgiveness Could Increase Inequality
Wharton’s Sylvain Catherine and University of Chicago’s Constantine Yannelis explain How Student Loan Forgiveness Could Increase Inequality
Forgiveness of outstanding student loans has been a recurring theme in policy debates on the roughly $1.6 trillion in such debt that the U.S. government and private lenders hold. Calls for such forgiveness have increased now as the Joe Biden administration prepares to assume office.
However, partial or full student loan forgiveness is “regressive,” according to a recent working paper, titled “The Distributional Effects of Student Loan Forgiveness,” by Wharton finance professor Sylvain Catherine and Constantine Yannelis, professor of finance at the University of Chicago’s Booth School of Business. The paper’s findings are being actively discussed on Twitter.
“Any policy that is a universal loan forgiveness policy or a capped forgiveness policy — say forgiving debt up to $50,000 — is going to give most of the dollars in forgiveness to upper-income individuals,” said Yannelis, who was interviewed along with Catherine on the Wharton Business Daily radio show on SiriusXM.
Moral Hazard
Wharton presents a very good reason but the mortal hazard aspect is an even better one.
I discussed the moral hazard aspect in Biden Is Off to a Bad Start Under Progressive Pressure
Here’s a recap.
Rogue Executive Actions
Biden is already bending to the wishes of Elizabeth Warren and Bernie Sanders to want to forgive student loans.
Schumer held a press conference alongside Democratic Congressmen-elect Ritchie Torres, Mondaire Jones and Jamaal Bowman of New York, during which the group announced they have “come to the conclusion” that Biden can “forgive $50,000 of debt the first day he becomes president.”
Even if legal, this is a terrible idea. It mainly benefits middle-class whites and unfairly so.
Less Education for Your Buck
The above chart is from US College Tuition & Fees vs. Overall Inflation.
Costs accelerated when Congress passed the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005”.
That act, which Republicans wanted and Bush signed made student debt non-dischargeable in bankruptcies.
Disease vs Symptoms
I graduated from the University of Illinois in 1976 with a degree in Civil Engineering. The cost of tuition was $250 a semester when I entered college in 1971.
Some blame states for not contributing to education. Indeed, states would would not raise taxes to cover escalating costs because of voter backlash.
But that is blaming the disease on the symptom. The disease was then and still is high administration costs, public unions, outrageous coaching contracts, unbelievable pensions, and serious lack of competition.
The “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” made matters much worse.
For discussion, please see The Debt Deflation Guarantee Act of 2005.
Huge Moral Hazard
Debt discharge is a huge moral hazard that encourages more overpaying for useless degrees.
It will do nothing to address the cost of higher education.
We need more competition, more accredited schools, more alternatives, and less public union graft.
Forgiving debt fosters less competition and more graft and does nothing to fix any fundamental issues.
Mish
“Debt discharge is a huge moral hazard”
Since 2009 moral hazard has been deleted from the English vocabulary.
The PSLF Public Service Loan Forgiveness Program exists to help people get rid of student debt. Make 120 consecutive qualifying payments while working for a qualifying employer and the balance can disappear after ten years. My wife could potentially vaporize $15,000 in loans via this program, could have been way more (1.5-2x) if she knew about it when she got current job. Small loan in the big scheme but a worthy illustration of how it can help.
“If you are employed by a U.S. federal, state, local, or tribal government or not-for-profit organization, you might be eligible for the Public Service Loan Forgiveness Program. Keep reading to see whether you might qualify.”
Those are good stable jobs too. You know you will have vacation, health care, and a pension. (with the exception of the not-for-profit jobs)
Qualifying employer is the rub, knocks out almost everybody
I’m in favor of the gov’t getting out of the loan business. The housing bubble was caused mostly by the GSEs buying garbage loans from banks. The education bubble would not have happened without Sallie Mae.
Why not have businesses do what the military does. Give education money in exchange for service. Basically indentured servitude.
Should be able to discharge in bankruptcy. No personal debts period should be non-dischargeable in bankrupcy. Students loans are foolish. Delay college for a few years trying a few jobs, travel for a year so income is low, after you are 22 yrs old fill out a FAFSA for grant that pays for tuition and living expenses not based on your parents income, and you can get a free ride to a 4 year high quality instution with no student debt.
Well, that’s one way to spin that the stock market has gone up and that a few young companies have constituted a large proportion of the gains. Which means tomorrow, when those companies take a hit (cough, Tesla), these evil billionaires will lose enormous sums of money. Hurray.
So woopeedoo. How many dollars did those evil pension funds gain?
‘Billionaires gained one trillion’….because greedy investors have been pushing shares in their respective companies to insane levels…. It s all virtual profit though, they actually won’ t ‘gain’ anything unless they effectively sell shares….
“The disease was then and still is high administration costs, public unions, outrageous coaching contracts, unbelievable pensions, and serious lack of competition.”
No, those are the symptoms. The disease is the money spigot which feeds the beast. The money spigot is primarily government, fortified with fiat currency.
All universities are feeling the shortfall and some are forced to react. The University of Vermont announced that they will emphasise STEM. They consequently cut programs in Liberal Arts notably in some languages and in Native American History.
It looks to me like that’s the exact opposite of the trend….STEM is under fire nearly everywhere these days…
U. Vermont must still be run by faculty, and not managers.
Do we only care about moral hazard now?
Did we care about moral hazard when banks were bailed out in 2008?
Did we care about moral hazard a few months ago when Boeing received billions in bailout dollars after spending their cash on stock buybacks?
Did we care when large corporations with cash reserves that didn’t need more, applied and received PPP funds anyway?
I am very much in favor of people being held to account for the consequences of their actions, but we should at least apply it equally.
Corporate bailouts has turned the idea of moral hazard into a big joke.
This country long ago adopted “privatize the profits but make the risk and losses a public responsibility” because the corporate interests that benefit from that make the laws by proxy / bribes, made PC by calling it “donations”.
Citizens United only accelerated and intensified the long-term trend from “one person, one vote” to “one dollar, one vote”
That is the end result of spending other peoples money. There is no accountability. It is all about knowing people in high places and how much you donate to their causes. 🙂
I have a neighbor who is a lobbies. He was complaining to me that he paid $15k for a golf tournament fundraiser for a state senator. He was thinking he was going to make his lobbyist pitch for his company and industry. Well between holes the Senator would give these donors time to make their pitch. He only gave my neighbor 2 minutes. My neighbor was mad that $15k only bought him 2 minutes. LOL
You have to pay to play. Biden raised the most PAC money ever for a presidential campaign. They are expecting payback.
We have an electoral system that encourages corruption by allowing so many legal ways to put money in politicians and their family’s pockets so we shouldn’t be surprised of the results. Before I hoped that voters would take all that back but now voting doesn’t matter anymore when it comes to national elections.
good point
Did we care about moral hazard when the Germans bombed Pearl Harbor?
The election is already over and we lost!
Germans? Why was the fleet even there after all the warnings that had come in from Intel?
OK we wipe out the debt today but what about next year? Do we do the same thing and every year after that? It’s not even remotely a solution. It’s just a payoff but it doesn’t disadvantage one party-voter over another. However it will piss-off those who paid off theirs turning them into future responsible voters.
its not about bending to the wishes of Warren or Sanders. People saddled with student debt do not purchase homes, start families or businesses .Student debt is a huge tax on our gdp. maybe bien is bending to common sense
“Biden is already bending to the wishes of Elizabeth Warren and Bernie Sanders to want to forgive student loans.”
Surprised? We’re just getting started too…
It would be nice to know what percentage of bankruptcy filings are personal vs business both by count and dollar. I’m sure the business bankruptcies are a small percentage by count but perhaps the larger percentage by dollar.
And of the personal bankrupcies, the same questions for student (potential not actual) and non-student in terms of counts and dollars.
So….it would be nice to have a data driven discussion in the national media, but that isn’t happening.
The default rate for ALL public 4 year colleges is about 7%.
At the link above, you can see that Larry’s Barber College (in Chicago, natch) is above 50%…but Larry is famous in Chicago….as a successful black entrepreneur who gives a lot back to the black community. A philanthropist.
It’s shameful scam that nobody writes about. There are many for-profit schools like this one.
At flagship public state colleges (like U of Texas here for instance) defaults are mostly far less than even the four year average default rate.
UT is 2.6%
U of AZ is 4%
U of IL (Urbana) is 1.9%
U of AL is 5%
U of MN (Twin Cities) is 2.2%
The student loan industry doesn’t encourage competition as it is now, so there is already a lack of competition before you even forgive a dime. Tuition doesn’t go down because of competition. It increases as the government raises annual allowances for student loan amounts.
If you get a degree that has some utility, even for government, that may be paid off for you. If you are a lawyer, if you work in the sticks or low income neighborhood as a legal representative you can get your debt paid in 10 years. Same with medical. The problem I have with debt payoff is the student did nothing to deserve it. So past people who paid off debt were punished…and whining millennials get a freebie. They need to do something for humanity to get the free meal
My big problem with your post Mish is you don’t really have a prescription on how to fix the problme from what I can see. The system is unversally believe to be broken? Are we in ageement on that point? If we are how would you fix it?
Me personally I’d get rid of the law that prevents bankruptcy judges from doing what they do and stop the non-sense of making student loans somehow unqiue from every other debt which is subject to our bankruptcy laws.
What we hae now is not workable
The reason they stopped letting people use bankruptcy to discharge student loan debt because it was becoming a problem. People with good jobs and plenty of money started using bankruptcy to escape student loan debt in the 90s. It was becoming a thing.
No, the reason it stoppe was the banks lobbied to have the laws changed. consumers are not able to lobby in the same way
The reason the banks lobbied to have it stopped because it was becoming a problem. If only a few people did use bankruptcy to get rid of student debt then it they would have never passed such a law.
IMHO…this is just another moral hazard. Let students take out student loans but then declare bankruptcy so they do not have to pay them off. So at the end of the day nobody is paying off the student loans except for the consumers because all banking fees will go up to cover all the student loan defaults each year. Those student loan losses will be passed on to the consumer.
But, I think people do not realize that if these loans were allowed to be discharged in bankruptcy than nobody would make a student loan. Maybe that would be a good thing but this would quickly shut out thousands of people from being able to go to college.
What would happen is that banks would stop making the loans which feed the tuition increases. Schools would then have change their habits.
Yep. I agree. With loans being guaranteed, it has been a free for all and big money maker for banks. No risk assigned to many risking loans but guaranteed payback. Loan to anyone and as much as they want.
On reason this system fails is because risk is not being assigned. Kids have to apply for college and get accepted. Maybe there needs to be some risks applied to both the kids and the schools. Schools need to be held accountable too? Maybe if a student loan goes into default, there school also needs to foot some of the bill?
I have no answers, but bankruptcy or student loan forgiveness is not one of them. Otherwise future students will look to those paths as an easy way out.
“I have no answers, but bankruptcy or student loan forgiveness is not one of them. Otherwise future students will look to those paths as an easy way out.”
I should say banks also should be held accountable too. Maybe some form of bankruptcy or if the Government has to bail the loan out they only pay the bank back a portion of the loan.
The whole solution is above my paygrade 😉
It’s not “the kids”….look at the demographics of the defaulters.
Anybody who can fog a mirror can get a student loan…for living expenses while they attend Arkansas Baptist College (default rate 37%) or Vibe barber College in TN (default rate 61%).
Good point. There should be penalties on Colleges. They should have some skin in the game too.
I am long winded today. Going back to accountability. I saved and paid for 2 kids to go through college so they would not have debt. At the end of the day this is over $60k. So forgiving student loan is a bit of a sore spot.
But when I am paying for my kids college. I am doing everything I can to make them accountable and helping them succeed. Checking on their grades, giving them advice about not skipping classes, etc.
In High School there seems to be counselors that sort of do such a thing but in college, many kids are on there own with not much help from the college.
I guess what I am saying is I have skin in the game and I am actively monitoring my investment of my kids. Maybe the banks should hire people to keep track on their student loan investments and provide some educational advice. Maybe not all of the loan should be guaranteed.
The bank and the school should take a hit if a student stops paying. Maybe the school should not be paid up front. They should get their tuition paid over time as the loan is paid off?
All accountability and risk is levied on a student who many times is reading fluffy marketing material without knowing what their future earnings will be.
I paid for the undergrad educations of all four of my kids. I paid for one year of grad school for my eldest. She was still the cheapest, because she only need one year of grad school and she went local….and she didn’t screw around getting her undergrad college done. The others were all on the six year plan.
The other three wanted to attend expensive grad schools….one in NY…one in Chicago…..one here at an expensive private school of Chinese Medicine…..and they had to take on debt for that. One paid it off very quickly. One will get it done fairly soon. The last one still wants to go to med school and will probably graduate owing over 300K. I have very mixed feelings about that one.
I think college should be free, and you should get to go or not based on the number of open spots and your academic performance. Why waste resources on the dims, so many of whom are wealthy?
from a societal standpoint. I can see a bigger argument for free tuition and getting ri of social security. en education or vocational skill means higher gdp and income for a lifetime. society benefits far more
Why is public school K through 12 free? Would the same arguments used back when that was first instituted be applicable in today’s world, given the changing education requirements for becoming successful in such a radically changed economy?
Back then people graduating high school had a better education than a lot of people graduating from college now. Standards have been inflated away. I have even seen workbooks from grandparents from the attic who were only allowed to continue to grade 6 or 7, but the level of attainment in many ways surpassed my kids at grade 12 (and they were good students)!
Do you mean like the way thousands of extremely wealthy business people like Trump have made a “thing” out of using bankruptcy to escape their own debts.
Shameful indeed …
And I have to LOL at the invocation of the “moral hazard” argument … not that it’s not true, but the now eternal and unlimited “Fed Put” has always been many orders of magnitude a greater “moral hazard” than anything introduced by forgiving student loan debt.
The hypocrisy displayed in these arguments is beyond the pale.
I get what your saying. What is moral hazard? It does seem to be flying out the door huh. I don’t have an answer, but people know that when loaning money to a company, there is a risk of default. The higher the risk then the higher the interest rate?
Anyone can take out a student loan. If we allow them to default then we need to start assigning risk levels. That is what a bank would do when making a business loan.
So to apply the same logic as Trump declaring bankruptcy, do we apply a risk per student. A student with an 4.0 grade point average gets a 4% interest rate on their loan. A 3.0 grade point average gets a 6% rate. and a 2.5 GPA gets an 8% loan rate?
I read that up to 10-20% of freshman do not continue past 1 year. I have two relatives who qualified for a $5k pell grant to go to a trade school and yet neither finished the 1st year of trade school. Guess what, they had to pay back a free grant. LOL It was not even a loan. All they had to do is finish the year….even with a grade of a “D” and they would have not had to pay back the grant.
Yet they complain when their wages were garnered.
Sure, there are plenty of irresponsible people out there … and a whole lot of them are owners of or executives of publically-owned companies. And I believe there are far more sociopaths in those positions than there are among the general population … it’s almost an unspoken job requirement.
LOL….
Extend free education to 2 years of community college … and Mathgame for President.
I get it … you’re just setting me up for assassination …. character or otherwise? ;>)
Hahaha no, I don’t often praise, butbwhen I do it’s sincere.
I will add a solution
Student loans have no collateral and if students can get out of the debt via bankruptcy, many would file soon after graduation. That’s what used to frequently happen.
Exactly. I knew many people who did that. I frequently worked 2 jobs in college and got through with almost zero debt. Sort of regretted it as I used Spring Break and Summer to work and save money. Some of my friends went on Spring Break, Skiing, or traveled to Europe and then just filed bankruptcy after college. Back then not that many people had credit cards or borrowed to buy cars so credit scores were not a big deal in getting a loan.
Mr. Johnson said repayment trends suggest much of the debt will likely never be repaid, and he is calling for moving toward a system that gets the government out of student lending.
“We run through the process of putting this debt burden on somebody…but it rides on their credit files — it rides on their back — for decades,” he said, adding, “The time has come for us to end and stop the insanity.”
Mr. Johnson said he arrived at his position to cancel student debt after he joined the administration and had a firsthand look at problems, including the high level of defaults and the difficulties of administering a program to erase loans for public-sector workers.
What a crazy nation the US of A is ….Students in most european countries don’ t have debt, worst case they owe some money to friends or relatives, that’s all! I don t think your students are smarter than ours are they, despite all that debt ?
It that why European tech companies are also-rans?
‘Also rans’…..I learned a new word today….But, are they? Two decades ago maybe….Those days are gone…in case you hadn t noticed yet….
My kids grew up here in Paris but when they applied for college they applied to American ones. I asked them why and they said it came down to opportunity.
the grass is always greener on the other side… of the pond….I guess…
The whole narrative is a lie.
Although the media (I heard the typical pitch yesterday on public radio) tells a story about “unmanageable student loans that are crushing young people with debt” the actual numbers don’t reflect that.
The typical defaulter is not a college grad at all, but rather someone who borrowed around $10K to attend a trade school of some kind. It doesn’t matter much whether he/she graduated or not. They just can’t get work that pays enough to let then service a modest amount of debt.
The defaulter is also much more likely to be closer to middle age, and a person of color, too, for what it’s worth. Look it up. Many of these for-profit trade schools and “colleges”are also minority owned businesses that make a ton of money for somebody. The student loan mill is a scam, at that level. It’s not that different than the mortgage scams that were perpetuated in the early 2000’s subprime mortgage scandal.
Let me quote from the 2015 Brookings Institution paper:
“These data show that to the extent that there is a crisis, it is concentrated among borrowers who attended for-profit schools and, to a lesser extent, 2-year institutions and certain other nonselective institutions. We refer to these borrowers as “nontraditional” because, as students, they tend to be older, often enroll less than full time, and are living independently of their parents, and also because historically there were relatively few for-profit students and because 2-year students rarely borrowed. “
“As a result, in 2000 these borrowers represented a small share of all federal student loan bor- rowers and an even smaller share of loan balances.”
“However, during and soon after the recession, the number of nontraditional borrowers grew to represent almost half of all new borrowers. They experienced poor labor market outcomes, had few family resources, and owed high debt burdens relative to their earnings. Their default rates sky- rocketed.”
“Of all the students who left school, started to repay federal loans in 2011, and had fallen into default by 2013, about 70 percent were non- traditional borrowers.”
“In contrast, the majority of undergraduate and graduate borrowers from 4-year public and private (nonprofit) institutions, or “traditional borrowers,” have experienced strong labor market outcomes and low rates of default, despite having the largest loan balances and facing the severe headwinds of the recent recession. While the number of traditional borrow- ers also increased rapidly over time, recent borrowers’ family backgrounds and labor market outcomes are not much different from their peers’ in ear- lier years, especially for graduate students and undergraduates at relatively selective institutions.”
“In fact, traditional borrowers earned more, on average, in 2013 than their peers had in 2002. recent borrowers in 2002.”
I predict that there will be forgiveness, but it will only be at that $10K level that’s been kicked around….just enough to wash away most of the the defaults. They will do it for all the loans, so the people who are paying their loans back will get a break…..but I’m fine with that….because the interest rates should have never been so high in the first place.
In my view the the rates are part of the problem. They should be much lower. Why does the government need to charge a high rate of interest?
Fwiw, tuition is still way too high in states (like mine) with no public unions. At real colleges I mean.
I think the management layer is a big part of the problem….and that management layer is problematic in many ways, because they have way too much say in how universities are run these days. Bu that’s another story.
Another interesting factoid…..2/3 of student loans now are made to women.
You can clearly see (if you look critically) that the economic crashes of 2000 and 2008 pushed a lot of broke-ass people into taking out student loans to live on when they had no job prospects.
Many of them made terrible choices about where to spend the money…and ended up no better off in terms of earning potential…just a bunch of debt they couldn’t pay.
You can think of it as a poor man’s bailout….and now……with foregiveness closing the circle, it will amount to something like a back door UBI.
But it gets sold as “college grads can’t make it with all this debt.” It’s just a complete false narrative.
“You can think of it as a poor man’s bailout….and now……with foregiveness closing the circle, it will amount to something like a back door UBI.”
Agreed. Almost like a back door bail out for the jobless middle aged from the last downturn.
“But it gets sold as “college grads can’t make it with all this debt.” It’s just a complete false narrative.”
Maybe. Problem is, students wouldn’t be paying nearly as much for their education if the government (especially Federal government) was just completely out of the marketplace.
If the government really wanted to help, they would do like Mish stated above and enable “more competition, more accredited schools, more alternatives, and less public union graft.”
Higher education is in a period of rapid change.
Some of it is good……if you want to know anything about anything, you can probably learn it for free on YouTube. College is already way too much about getting a credential anyway…..and now that problem will be worse.
But I think a path exists for smart autodidacts to skip college. Tech, in particular, is about having the skills…not necessarily having a liberal arts degree.
And some credentials that were once worth having…..like a science PhD that once would have guaranteed you a career path in academia……universities now fill the real teaching positions with foreign grad students who work for peanuts…..and American PhD’s wait tables.
Even every podunk state college now has to have these important positions like “Vice President of Inclusion and Diversity”….do a google image search on that one and try to find ONE of those who is not black, hispanic, or female. At UT here that position pays over 300K per year….and what I see is that it’s more or less a lever arm for students to tell the university how to run itself…..like how to deal with issues like whether or not to get rid of statues students find offensive…..
“A fool thinks himself to be wise, but a wise man knows himself to be a fool.”
As You Like It
William Shakespeare
Debt focuses the mind and forces you to really think. Having debt early in life helps you move from the the first part of the sentence to the last part. Learning about debt firsthand in life is much better than discovering about it in midlife.
“Neither a borrower nor a lender be…”
The wisest thing the foolish Polinius said.
There is no virtue in taking on debt. Debt doesn’t help transform a fool into a wise one! Paying from one’s own labor will help “focus the mind” better than someone else’s labor (money).
Leverage works if you know how to use it. Debt is neither good nor bad but bad use of it is. It’s better to learn the dangers first before discovering how it use it.
In my book of investing advice (which so far I keep not getting around to writing) I have a whole chapter on debt.
To me it’s a very interesting subject.
You still see people on sites like this one…even today, who parrot what they got from somebody…..somebody who taught them that carrying any kind of debt is to be avoided.
When I was much younger, I read many books that recommended getting debt free…..some of the most famous money books are all about that…..The Richest Man In Babylon…The Wealthy Barber…
I believe that some debts are always bad……unproductive debt, taken on to buy luxury cars, boats, and other toys that depreciate so fast that they lose value as soon as you drive off the lot.
Credit card debt at usurious interest is the surest way to be a debt slave forever.
But over the past thirty years, taking on some debt and using it to lever up real estate investments has been one of the best strategies you could possibly use to grow wealth.
One of my old mentors, Robert Kiyosaki (I met Robert in1990, way before Rich Dad) is pretty good at teaching people how to use debt. He is like Trump….he lives off borrowed equity and therefore owes little income tax. I don’t do that…but I might someday if I ever quit working.
If one is unemployed and stone broke, it ought to be extremely easy to discharge a $10,000 student loan in bankruptcy court. Some of the persons in this group cannot even afford a lawyer to help them through bankruptcy.
Discharging debts by the AOC’s of this world by making plumbers and hair-dressers pay taxes … shameful.
They should make it possible to discharge the debt in bankruptcy, but the universities and colleges should absorb the fall instead of the tax-payer.
Wont new student debt start accumulating on day 2 of the biden administration?
Thanks for an excellent article. What we could do is to allow bankruptcy for any student debtor who cannot get income-based repayment and is drowning in payments. That is a relatively small number who are really suffering.
For most student debtors, the monthly payments are about what they would incur for a modest new car, $300 to $400 a month. If they have a good job, they can handle this. If they cannot find a good job, they can get income-based repayment in most cases. (although the process of doing so can be needlessly complicated.) If they cannot get income based repayment, let them declare bankruptcy.
If Biden really could forgive the first $50,000 in debts, that would cut government revenues from loan repayments by at least $50 billion a year, and for many years. That would argue that Congress must be involved.