With student-loan interest rates set to spike in July, Democrats in Congress and President Obama are up to their usual tricks, pushing legislation that would keep rates low. Instead of seizing the opportunity to stick up for free markets—and students—and distinguish himself from his opposition, presumptive Republican presidential candidate Mitt Romney is joining the sleight-of-hand game. That’s a mistake that a supporter of free markets shouldn’t have made.
The latest excuse for presidential and congressional grandstanding is a supposed crisis that Congress itself manufactured. In 2007, back when Nancy Pelosi’s Democrats held the House majority, lawmakers passed a bill that gradually cut the interest rate on federally backed student loans in half, from 6.8 percent to 3.4 percent. But Congress let the provision expire after five years. Unless Congress acts again, the rate will abruptly return to 6.8 percent. Harry Reid and Lamar Alexander, top senators from each party, agree that they want to keep the super-low rates, and House Republicans have already passed a bill doing that. The only disagreement is how to pay for the continued subsidy. The Congressional Budget Office said on Wednesday that keeping interest rates at 3.4 percent for the next year would cost nearly $6 billion. Romney, too, wants Congress to keep rates low, as long as it’s done “responsibly.”
If politicians really want to help students, they should give them a real-life lesson in economics. Start with the numbers. Either directly or through guarantees, the federal government had disbursed $848 billion in total student-loan debt as of last September, up 17.5 percent in a year. The Consumer Financial Protection Bureau’s Rohit Chopra estimates that students owe another $152 billion in private loans, taking the total to $1 trillion. Last year, the average debtor—or “student served,” in educational-bureaucracy parlance—took on $10,467 of federally guaranteed debt for just one year of tuition.
Even as everyone else is cutting back, then, students are borrowing more—and eight out of every ten dollars that they’ve borrowed came with some kind of federal string attached. That shouldn’t be surprising: when Washington subsidizes something, it makes more of it. This is true of student-loan debt, just as it was of mortgage debt before the credit crisis that started in 2007. The best thing for students would be for the government, instead of spending another year helping students pretend that they can afford all this debt, to get out of the student-loan market altogether.
Who, then, will lend to students? Banks and investors. Let these lenders demand data from colleges, students, and credit-rating bureaus to assess which schools and programs boast the best graduation rates, the best alumni-donation rates, and the highest graduate incomes. Let these lenders, too, assess students’ own credit, job, and grade histories. The lenders can use this free-market information to decide which schools and students are the best bets. And let the borrowers have this information, too, so that they know the risk they’re taking. Finally, allow students the option of discharging their future student-loan debt through bankruptcy, something that they can’t do now. Such a change would make clear to lenders the real market risk they’re taking.
It’s likely, of course, that such moves would prompt howls of protest from all quarters. Student “advocates” would drag up the usual arguments about how federally subsidized loans help middle-class kids compete with rich kids. Not really: too much federally subsidized borrowing pushes up the cost of college for middle-class kids and encourages them to avoid tough decisions about their futures. Schools would hate the new approach, too. They don’t want a free-market assessment of their success rates. They do want students who can keep blindly borrowing to afford sky-high tuitions. Moreover, schools don’t want middle-class students questioning why they’ve got to pay for a state-of-the art gym and luxury dorm room when all they want is a decent education.
Of course, reforming the student-loan system along these lines would depend on a functional financial system—that is, on banks and big investors that devote most of their energy to the nuts and bolts of borrowing and lending, rather than to jumping through government hoops to assure bailouts in the next financial crisis. If banks and investors can’t do responsible student lending, that’s a sign that the financial system is still broken—a much worse portent for future college graduates than higher interest rates on loans.
Mitt Romney should have seized this opportunity to communicate directly to college students and their parents and explain why more government subsidy is the wrong approach to student-loan financing. If Romney wants to portray himself as the free-market alternative to President Obama, he missed a chance to do it.