Student Loans at PRIME Instead of Debt Cancellation
Student debt currently stands at $1.748 trillion, and the total continues to grow. The emergence of student loan debt cancellation, like any debt cancellation – is politically popular – who wouldn’t want free money?
Yet it also creates moral hazard similar to that of tax repatriation or corporate bailouts (i.e. TARP). Moral hazard disincentivizes proper risk-taking and rational economic behavior. Instead, parties take risk (i.e. loans) factoring in the increased likelihood of debt relief and cancellation. It is easy to imagine students who expect these cancellations leading to lower repayment rates, higher rates of default, and higher interest rates. This cycle continues until the market collapses.
Canceling student loan debt addresses a symptom the system, yet two main causes remain: (1) Large subsidizes in the form of guaranteed loans that artificially increase the cost of school (based on guaranteed loans from the US government), and (2) interest rates on student loans.
Guaranteed government access to loans that subsidize the cost of education: Economics tells us that a subsidy in any market will arbitrarily increase the price of that good. The US government has guaranteed loans of up to $12,500 for undergraduate students, and $20,500 per year for graduate students (PLUS loans are available to cover the additional costs given the significant increase in post-secondary education). The availability of these government loans creates an artificial price floor contributing to the high cost of education. These loans, in part, influence the market to “settle” on the cost/value of a year of college education being at least the minimum guaranteed loan amount price.
Interest rates charged on loans by the providers of student loans. These loans vary in amount. 92.24% of all student loan debt is from the federal government.
Solving for Student Loans
In lieu of canceling agreed debts, there are two simpler solutions.
First, decreasing subsidies to allow the price of post-secondary education to settle. These subsidies creates an artificial price floor that distorts the market. However, unwinding costs via this method will hurt students as the market settles, and unfairly penalize those who desire access to education when prices remain high, and subsidies are removed. Since we don’t know the actual market-price of post-secondary education, this path will likely negatively impact students and will not be possible unless executed over dozens of years.
A better, more immediate solution? Allowing students to have access to loans at the Primary Credit Rate (PRIME), similar to financial institutions. Financial institutions borrow money at PRIME from the federal reserve, and use this money “to meet unexpected funding needs.” The cash is usable for up to 90 days, and renewable by a borrower on a daily basis.
Allowing students access to PRIME for current and future loans would immediately save them more money than debt cancellation, while eliminating the risk of moral hazard. It aligns education with economic policy, and gives the people access to their own tax dollars for personal growth and development. The alignment of top-down policy and bottom-up benefit is a win-win for both the market, and the individuals.
A quick review of the numbers (reference data and tables for these calculations are available upon request):
This solution:
Eliminates the moral hazard of debt cancellation.
Balances top-down policy incentives with bottom-up availability of citizens to use their own tax dollars
Properly incentivizes individuals to invest in post-secondary education leading to genuine value growth from investment.
Provides time to solve the underlying cost issue for post-secondary education.
Is higher than the debt cancellation limits of $10,000 announced by the government. On average, students save the following:
• An undergraduate student at a public school saves $13,809.88 • An undergraduate student at a private school saves $32,657.07 • A graduate student who borrowed $40,000 with Grad Loans saves $11,060.59 • A graduate student who borrowed $80,000 with Grad Loans saves $22,121.16 • A graduate student who borrowed $40,000 with Grad Loans saves $13,484.76 • A graduate student who borrowed $40,000 with Grad Loans saves $26,969.51
The numbers are clear: giving access to PRIME to those pursuing education would reduce rates more than the current $10,000 debt cancellation, incentivize more appropriate market behavior, and provide us with time to deal with the true underlying causes. Some caveats and notes:
It is unlikely cheaper loans would materially drive up the cost of college in a competitive environment – the time difference between the loan date and repayment date will help limit impact to loan cost and rate.
If desired, interest rates can be backdated if the US government is the lender (likely not possible with private lenders who’ve taken on risk
A small servicing fee will be required to cover the cost of administering the loan directly and any possible defaults (this is less likely once interest ceases accruing at a exploitive rate)