America’s Growing Student Debt Mountain

People keep talking about the high burden of college debt, which now surpasses credit card debt. And the federal government is doing something to help.

Unfortunately, what it is doing makes the problem worse.

Student loan debt has risen more than any other category, according to a February report by the Federal Reserve Bank of New York. That’s surprising because college enrollments (and also enrollments in many graduate and professional schools) have been declining.

So why is that student debt mountain still growing?

Instead of paying their debts down, many graduates are either keeping their loan balances steady or even allowing them to increase. About 17 percent of student borrowers are currently delinquent, but many more who aren’t officially delinquent have avoided that only by taking advantage of Uncle Sam’s generosity with taxpayer money.

One of the “generous” features of federal loans permits students to defer their payments. They can simply claim that they impose “economic hardship” or they can return to school. Just by enrolling half-time, the student can qualify for more loans and can use the money not just to pay for tuition, but to help cover living expenses.

That reflects political reality. Politicians win more votes by being nice to college students than by watching out for the taxpayers.

Another feature of Uncle Sam’s generosity is the Pay As You Earn (PAYE) program.

Students who take out federal loans can sign up for that program, which allows them to repay the government not by set monthly amounts until the balance has been paid in full, but instead by paying only ten percent of their discretionary income each month. “Discretionary income” is the amount by which the student’s earnings exceed 150 percent of the official poverty level; for someone earning a modest income of $30,000 per year, that would mean paying no more than $150 per month on the loans.

Compare that with the payment that a student who has a loan balance of $35,200 (the average amount for 2013 graduates) would have to make under the old standard repayment schedule: $405 per month. It’s easy to see why many college grads who are not doing well in the labor market jump at the chance to cut down their payments, even though it means that their total debt keeps increasing.

Furthermore, under PAYE the government forgives the remaining balance of the loan after 20 years if the individual works in the private sector—but a mere 10 years if he or she is employed in a “public sector” job. The theory is that it’s good to encourage young people to go into supposedly selfless but underpaid government or non-profit jobs. And the favoritism toward the public sector is compounded by the fact that the amount of debt forgiven is not subject to income tax, as it is for those who work in the private sector.

Again, compare the government’s “generosity” with the hard-hearted private lenders. If you borrow money for a car, a house, or on your credit cards, short of going bankrupt, there is no “forgiveness” after any period of time. No mortgage holder tells borrowers, “Pay what you can afford to for twenty years and then we’ll let you off the hook.” Just imagine the results if they did. Home buyers would have little reason to keep their borrowing costs down to what they expect to be able to afford.

The government’s program has that effect on the way students look at the cost of higher education. Instead of trying to minimize the cost or at least keep it in line with their prospective future earnings, they are apt to think, “I’ll go to an expensive, prestigious school and borrow a lot; if I don’t land the high-paying job I hope for, then I’ll look for a public sector job and escape from most of the debt.”

A recent Wall Street Journal article provided an example of precisely that reasoning. The author of the piece mentions Max Norris, a recent graduate of the University of California’s Hastings College of Law, who said, “My intent the whole time in going through law school was to take advantage of this program.” After graduating, Norris took a job as a lawyer with the state of California, which pays $60,000 per year. After working for the state for 10 years, he’ll qualify to have about $225,000 in student loan debt forgiven, thanks to PAYE.

Very nice for Mr. Norris, but it means that federal taxpayers will have paid for much of his education.

His case also undermines the idea that going into government employment is a sacrifice and needs encouragement. As a young lawyer, he is already making the median income in the state, along with high job security and great benefits. Looking at government employment generally, Andrew Biggs of American Enterprise Institute has found that government workers are not paid less than are similar workers in the private sector; if anything, they’re paid somewhat more.

Thus, the government’s vicarious generosity is luring young people into unrealistically large college costs and debts, as well as into the kinds of public sector jobs that qualify them for early loan forgiveness. Even the liberal Brookings Institution sees a problem here, concluding, “Loan forgiveness creates incentives for students to borrow too much to attend college, potentially contributing to rising college prices for everyone.”

Those unintended consequences are bad for future students, for taxpayers and for the health of the economy, since the disfavored for-profit sector is where the nation’s wealth is produced.

But aside from the adverse economic consequences and burden on the taxpayers, the government’s loan policy appears to be working beautifully. Starting in the election year of 2012, the Obama Administration began advertising PAYE to students, much as it promoted food stamps and other government benefits. In the last six months, the number of students taking advantage of the government’s easy repayment terms and debt forgiveness has increased by nearly 40 percent.

America has a history of seeing government programs grow and grow in cost as politicians make them increasingly generous. Social Security is one example; federal student loans is clearly another.

Easy terms and loan forgiveness will help marginally to keep the higher education bubble inflated. In particular, it appears that these policies are at least stanching the exodus from law schools. But the unaffordability of many colleges and universities under the former student loan rules is telling us something important—that their cost is way out of line with the benefits.

The government’s “kinder and gentler” student loan policies obscure that information from students and taxpayers. They are a mistake.