This article belongs to a feature package on how the American Dream became unaffordable for millions of working-class and middle-class Americans. For more on Reason's autopsy of how things veered off course, read \”How the American Dream Became Unaffordable\” or the other two features within the package, \”How Doctors Broke Health Care\” and \”Can't Afford Your Rent? Blame Herbert Hoover.\”
On the day he signed the Higher Education Act of 1965, President Lyndon B. Johnson declared that the law would \”swing open a brand new door for that young adults of America\” and supply \”a method to deeper personal fulfillment, greater personal productivity, and increased personal reward.\” Johnson wanted Americans to understand that his government would do whatever it could to assist \”every child born in these borders to receive all of the education he can take.\”
Signed at Southwest Texas State College, Johnson's alma mater, the Higher Education Act authorized federal scholarships and federally funded part-time jobs for students who could get into college but couldn't pay it off. But the real catalyst to increase college enrollment was a provision that allowed the federal government to directly lend students money for tuition and to guarantee loans made by other entities. This new lending authority, Johnson said in the signing ceremony, allows the federal government to issue to \”worthy, deserving, capable students\” loans \”free of great interest and free from any payment schedule until after you graduate.\”
The modern approach through which students finance higher education grew on and around these 3 policies-federal scholarships, federal work-study funding, and federally guaranteed loans-like vines around a trellis. Yet half a century later, many young Americans feel that Johnson's signature education initiative has saddled them with excess debt and delayed their graduation into middle-class adulthood.
The Occupy Wall Street protests of 2011 started as a cacophony of disparate complaints from the financial sector but eventually coalesced around college debt. The thought of forgiving student education loans has since moved from poster boards around the streets of Manhattan and D.C. towards the campaign websites of Democratic presidential candidates, with Sen. Bernie Sanders (I -Vt.) promising to wipe out student debt for those borrowers and former Vice President Joe Biden pledging to grow existing loan forgiveness programs.
Johnson wanted future generations to consider the larger Education Act of 1965 like a promise in the federal government: \”Tell them we have opened the street and that we have pulled the gates down and the way is open, and that we expect them to travel it.\” He and also the 89th Congress paved that road using the best intentions, and lots of countless young adults have indeed traveled along it. Why, then, do so many Americans who've took part in our bodies of financing advanced schooling feel like they've been scammed?
Because most of them were.
The first education loan crisis occurred a lot more than Two decades before Occupy Wall Street protesters setup camp in Zuccotti Park. Yet it \”followed a strikingly similar road to the greater recent experience,\” the Brookings Institution's Adam Looney and also the University of Chicago's Constantine Yannelis wrote in a January 2022 working paper titled \”The Consequences of Student Loan Credit Expansions: Evidence From Three Decades of Default Cycles.\”
In the 1980s, a truly alarming number of education loan borrowers began defaulting on their own payments. In 1985, the default rate for federally guaranteed student loans-the number of borrowers who had failed to make a payment within 180 times of the repayment period-jumped to 11.7 percent from 10.7 percent the prior year. The government government's payments to lenders who couldn't collect from student borrowers rose from $749 million to in excess of $1 billion. \”The financial implications…are staggering,\” U.S. Education Secretary William Bennett said in August 1985. Without major policy reforms, he projected the default rate would increase to 13.6 percent by 1990.
He was wrong. The student loan default rate for those borrowers was roughly 22.4 percent in 1990. By 1992, the government government's annual cost for default payments was nearly 5 times what it really have been in 1985. The company then referred to as General Accounting Office (GAO) estimated inside a 1993 are convinced that the Department of Education the year prior had \”paid about $5 billion in default claims and interest subsidies.\”
But the student loan default explosion wasn't occurring across the entire education sector. The Department of Education's data suggested, and the GAO and the Office of Management and Budget would later confirm, that students of for-profit or \”proprietary\” schools-then and today the biggest providers of technical and vocational training to American workers-were defaulting at much higher rates kinds of students, largely due to bad federal incentives.
\”While proprietary school students comprised about 22 percent of Government Education loan Program borrowers who received their last loan in academic year 1983, they taken into account 44 percent of defaulters by September 30, 1987,\” read a bipartisan 1990 report from the Senate Permanent Subcommittee on Investigations. \”Over that period, the student default rate for proprietary schools was 39 percent, as contrasted to some 10 % rate for four-year private and public schools.\”
The rate of default was essentially eating the Government Student Loan Program (GSLP) program from the inside. \”The cost of defaults, as a number of all GSLP program costs, rose from about 10 percent in [fiscal year] 1980 to 36 percent in [fiscal year] 1989, and to more than 50 % in [fiscal year] 1990,\” the Senate report said. \”In short, currently more than half of the government's GSLP cost is going to purchase defaulted loans from the past instead of to subsidize education and training for today's students.\”
In their paper, Looney and Yannelis trace the default crisis of the late 1980s and early 1990s to Congress' 1972 reauthorization of the Advanced schooling Act, that allowed for-profit or proprietary colleges to sign up in the GSLP. When it reauthorized the act in 1976, Congress extended eligibility to applicants who had not completed senior high school and encouraged states that hadn't done this already to produce their own \”guaranty agencies,\” which would partner with the federal government to initiate and guarantee student education loans for low-income students.
In hindsight, allowing senior high school dropouts to gain access to federally guaranteed profit order to attend for-profit colleges was disastrous for a many borrowers. But you can easily see the nobility from the idea should you squint. The us government was already subsidizing the training of future teachers, lawyers, doctors, and accountants; how about mechanics, electricians, plumbers, and welders? Didn't they need training, and didn't that training cost money?
Bennett, who served as education secretary from 1985 to 1988, didn't mince words about for-profit schools, telling Congress in 1988 that his department found \”serious, and in some cases pervasive, structural problems within the governance, operation, and delivery of postsecondary vocational-technical education.\”
But he also trained his criticism on state guaranty agencies, that have been meant to function as paternal co-signers for students but became another thing entirely.
First authorized by Johnson's Higher Education Act of 1965, such agencies were supposed to \”partner using the federal government to co-sign the bank loans\” and serve \”as ambassadors in the local level, educating high school students about college opportunity and the accessibility to loans,\” the progressive Century Foundation's Robert Shireman and Tariq Habash wrote in a 2022 report on the legacy of guaranty agencies. These supposedly benevolent bodies would not only share the chance of default using the federal government; they'd supply the Department of Education having a network of partner organizations that may help implement the larger Education Act on the front lines.
\”The idea,\” Shireman and Habash wrote, \”was that by putting their own donated resources on the table, guaranty agencies might have a stake inside a humane and successful loan program, helping low-income students attend quality colleges.\” Ideally, \”they would operate as charities do, with an approach that hinged on more than just the conclusion: when borrowers did default, rather than immediately engaging in aggressive collection tactics, the companies could measure the situation and provide assistance and advice as appropriate.\”
But states weren't eager to undertake the risk of loan defaults, as evidenced because only half of them formed any type of guaranty organization following the passage of the Advanced schooling Act of 1965. To incentivize the development of guaranty agencies in each and every state, Congress in 1976 made the federal government fully responsible for reimbursing lenders in case of default.
\”In essence, the federal government was issuing an empty check to cover the price of operational expansion by any guaranty agency that chose to take advantage of that opportunity,\” Shireman and Habash wrote. \”The system boomed, but instead of having risk-sharing partners, the federal government instead were built with a set of guaranty agencies that, like a sole-source contractor, earned more income with every loan they guaranteed rather than contributing anything more.\”
In its 1993 report, the GAO noted that the structure of state guaranty organizations was fundamentally problematic. They operated with a federal charter like a co-guarantor of student loans, yet they \”assume[d] little financial risk and are not compensated in a way that provides sufficient incentives to prevent defaults.\”
In fact, guaranty organizations were compensated through the authorities in a way that encouraged risky lending, according to the 1990 report from the Permanent Subcommittee on Investigations. To cover their operating costs, guaranty agencies were permitted to charge both student borrowers and also the Education Department a portion of loan values. When students defaulted or died or declared bankruptcy, the training Department reimbursed lenders for 100 % of the default amount, with state guaranty agencies acting essentially as a conduit. Yet when guaranty agencies were able to collect defaulted payments from borrowers, they had to own Department of Education only \”65 percent or 70 percent associated with a monies collected.\” That mixture of incentives led to assembly line lending, not prudence.
By the late '80s, the government government's efforts to teach more low-income students had resulted in a mad dash to lend as many poor people just as much money as possible. Bennett sought to reduce taxpayer exposure to the federally guaranteed student loan market by submitting a host of reforms to Congress, a few of which were later enacted. New rules and regulations went by Congress in 1989 and 1990 capped the quantity of revenue proprietary colleges could derive from federal student aid programs at 85 %; the guaranty agencies were given the job of paying a bigger share of default costs; and schools whose students had default rates above 30 percent were barred from receiving federal aid.
These policy changes shrunk both for-profit college sector and the student loan default rate, according to Looney and Yannelis. When Congress loosened the rules within the mid-1990s and again in early 2000s, the number of for-profit colleges increased, as did the default rate.
All told, Looney and Yannelis estimate this process-federal credit expansion, default rate increase; federal credit contraction, default rate decrease-has happened three times, most abundant in recent credit contraction cycle occurring just like Occupy Wall Street was finding its footing. Considering that we're now a duration of relatively tight credit for advanced schooling, it should come as no real surprise that default rates are down.
The unintended consequences of federally guaranteed loans to students of for-profit institutions has been a major policy topic for decades now. But what about the attendees of traditional educational institutions, for example public colleges and nonprofit private universities? Have they been fleeced too?
Bennett argued in a 1987 New York Times op-ed, \”Our Greedy Colleges,\” that federal aid was actually making all types of college more costly. \”In 1978, subsidies became open to a greatly expanded number of students,\” he wrote. \”In 1980, college tuitions began rising year after year for a price that exceeded inflation. Federal student aid policies do not cause college price inflation, but there's little doubt that they help make it possible.\”
The \”Bennett Hypothesis\” is a source of conflict among advanced schooling policy makers and economists, largely since it is been so desperately to test. What's not in dispute is the fact that college costs have raised dramatically during the last 30 years. Between 1981 and 1995, the typical tuition and gross fees for full-time undergraduate students across all institution types increased 88.7 percent; between 1996 and 2022, the increase was 70 %. In short, every type of institution is significantly more costly now of computer was three decades ago in the current dollars, though public institutions remain the most affordable.
How a lot of that cost increase was driven by federal aid? It's difficult to find out. The present consensus is the fact that private colleges, both nonprofit and for-profit, react to federal aid by reducing the discounts they provide to students. Less federal aid, bigger discount; more federal aid, smaller discount.
Proving causation is tougher. David O. Lucca, Taylor Nadauld, and Karen Shen noted in a 2022 report for that Federal Reserve Bank of New York that researchers \”only have reliable time series data on the sticker-price of tuition as opposed to the net tuition paid by students after comprising scholarships or discounts to lower-income students.\” Their paper, which checked out the outcome of credit expansions on tuition increases, found that \”expensive, private, or sub-four-year programs are related to larger tuition responses to loan maximum changes.\”
The difficulties of proving the Bennett Hypothesis reflect the complexness of determining exactly how much college costs, particularly at private nonprofit institutions. As Lucca et al. note, the actual price of college is often not the same as the advertised cost of college. This phenomenon is another consequence of federal intervention in the higher education market.
To determine the price of attending any particular school, students can't just look at the coming academic year's \”sticker price,\” which at private nonprofit institutions can exceed the median U.S. household income, and which very few students pay entirely. Instead, applicants must complete a totally free Application for Federal Student Aid (FAFSA), that the authorities uses to determine a student's \”expected family contribution\” as well as what types of federal aid the student is entitled to. That details are shared with the schools the student designated in her own FAFSA application. The colleges then determine how much \”institutional aid\”-essentially, merit- and need-based discounts off the sticker price-to offer the person. Eventually, students receive a tailored aid package from their selected schools informing them just how much it will actually cost these to attend.
In 2022, economist Lesley J. Turner checked out the outcome of need-based Pell Grants on the final cost students paid. Across the entire higher education sector, she estimated that between 11 and 20 % of Pell Grant aid is \”passed through\” to schools, and therefore the schools try to capture part of the aid without charging students less out-of-pocket for his or her educations. While Bennett claimed that types of schools capture aid without lowering costs, Turner found that the phenomenon occurs especially at private nonprofit institutions. Some selective private nonprofit schools, Turner found, manage to capture as much as 75 percent of Pell Grants. In short, needy students attending these schools cannot increase their purchasing power by the amount of the Pell Grants they receive.
My own experience is instructive. Once i filled out and submitted my FAFSA in spring 2004, the private nonprofit university I finished up attending explained to me that I could be receiving a merit-based along with a need-based scholarship in the university, a merit-based scholarship from the state of Florida, along with a need-based Pell Grant from the federal government. The rest of the amount I owed in tuition and fees that first year was roughly as much as I had been permitted to borrow in federal loans as a first-year university student. The following year, my alma mater increased its tuition and fees, but my Pell Grant dropped slightly with the federal schedule. Instead of increase my discount, my university kept my discount exactly the same and informed me that I owed slightly more-but still roughly as much as I had been permitted to borrow in federal Stafford loans as a second-year university student. This process repeated within my second and third years, when, due to tuition increases, I additionally became entitled to one more need-based federal Perkins loan.
There are, obviously, alternative theories to explain why the rise in college costs has far outpaced inflation. Inside a 2022 report, the Congressional Research Service suggested that colleges might have \”ineffective centralized charge of costs, suffer from various types of productivity issues, and also have institutional orientations and incentives targeted toward raising and spending considerable amounts to boost students' experiences instead of orientations toward using resources efficiently.\” But even when additional factors are driving up costs, federal aid makes those cost increases possible. Meaning financial aid for private nonprofit students looks nearly the same as health care, wherein the client, the third-party payer, and the service provider all have varying amounts of information and the sticker price is never the actual price.
Just as expensive healthcare keeps you alive, expensive college increases your earning potential. In 2022, researchers Christopher R. Tamborini, ChangHwan Kim, and Arthur Sakamoto published a paper in Demography that measured the 50-year lifetime earnings gap between senior high school graduates and bachelor's degree holders at $896,000 for men and $630,000 for ladies. Given that only two percent of scholars borrow a lot more than $50,000 for an undergraduate degree, most of us are getting a great return on our education.
But let's say you borrowed money for college and did not obtain a degree? Let's say you borrowed more than you can afford to pay back? In other arenas, people who lose everything on a bad bet have the option of discharging the money they owe and beginning again by your bankruptcy filing. Student loan debts, however, are \”presumptively nondischargeable.\” That means that you can get rid of them by personal bankruptcy, but many people can't.
The Bankruptcy Reform Act of 1978 prohibited borrowers from discharging student education loans in bankruptcy for that first five years of repayment. Later amendments changed that to seven years, and then towards the entire life of the loan. In 2005, the Higher Education Reconciliation Act made even private loans nondischargeable in bankruptcy.
In a 2012 piece for Reuters, the progressive writer Maureen Tkacik highlighted fearmongering within the 1970s, when Los Angeles Times reporter Linda Mathews wrote about \”underground newspapers urging students to use bankruptcy to prevent paying loans.\” The Wall Street Journal and The New York Times also published pieces warning of a looming generation of college-educated deadbeats who'd rather plead poor before a personal bankruptcy judge than pay anything for his or her own education.
A GAO report commissioned by Congress supported the claim that student loan borrowers were not abusing bankruptcy, but \”the evidence of a lower than 1% discharge rate of federally insured student education loans in bankruptcy didn't block the nondischargeability provision from entering the Bankruptcy Code,\” University of Michigan law professor John A. E. Pottow wrote in 2005. In the end, the fact that borrowers weren't then fleecing the federal government didn't mean they wouldn't eventually try. Rep. Allen E. Ertel, a Democrat from Pennsylvania, claimed throughout the 1970s bankruptcy debate that your time and effort to preserve dischargeability was \”almost created specifically to encourage fraud.\”
So why has Congress continued to create education loan debt presumptively nondischargeable? The two main objectives, according to a 2022 report in the Congressional Research Service, are protecting the availability of student loans for future generations and protecting the \”public fisc,\” i.e., the federal purse, in the forgiveness of debt owed to, or guaranteed by, the government. In addition, there's little to no collateral for creditors to liquidate in case of bankruptcy. My diploma is not worth what it really cost to print it, and my degree is nontransferable. Human capital isn't like other kinds of capital-think of a factory or even a patent, which a bank could seize then sell when the borrower didn't pay.
But there are two excellent good reasons to reinstate dischargeability. The most libertarian reason is that bankruptcy is a market signal, and the higher education sector badly needs more of those. Treating student loan debt like any other kind of debt would make lenders more cautious; schools will have to show both banks and potential students that they can equip the second to settle the previous, which makes it harder for students to indebt themselves.
That said, if we did require banks to assess a borrower's credit risk and an institution's ability to help students find work that will permit them to meet their obligations, it would likely result in restricted credit access for low-income and minority borrowers. This type of market might offer them no credit whatsoever or interest rates significantly greater than those open to their less risky peers. That isn't an ideal future.
But exactly the same students who might lose use of funding in an exclusively private credit market are also the ones who are suffering most under the current system. As University of Michigan economist Susan Dynarski noted inside a 2022 piece for The Ny Times, students who've the smallest debt loads also provide the greatest default rates. \”Defaults are concentrated among the countless students who give up without a degree, plus they tend to have smaller debts,\” she wrote. \”That is where the serious problem with student debt is. Students who attended a two- or four-year college without earning a diploma are desperate for well-paying work to pay off the debt they accumulated.\”
Preventing those borrowers from discharging their loans in bankruptcy isn't enhancing the American economy, but neither is lending them money to finance degrees they can't complete. Those students require a different path to increasing their earning potential.
The gainfully employed college graduate that has to obstruct purchasing a home or starting a family by a number of years because of student loans from undergraduate school may not appear to be a sympathetic character. He's a job, after all, and is likely making more money than he would be if he hadn't attended college. The significant adult who borrowed money to attend a sham for-profit school can also be not blameless. But the status quo will not hold forever, and also the alternative to what we should have finally is not necessarily a free marketplace for higher ed.
If elected president, Sanders would \”cancel the whole $1.6 trillion in outstanding student debt for the 45 million borrowers who're weighed down through the crushing burden of student debt,\” based on his campaign website. His plan requires canceling all debt currently held or guaranteed through the federal government in addition to purchasing and canceling all private student loan debt. Biden has proposed a less ambitious debt forgiveness plan along with a doubling of the maximum value of the Pell Grant per student. Both candidates want to use federal funds to supply 2 yrs (Biden) or four years (Sanders) of free public college.
Voters seem open to further federalizing higher education funding. A Quinnipiac University national poll released in April 2022 discovered that 57 percent support a debt forgiveness plan proposed by Sen. Elizabeth Warren (D -Mass.) that is more radical than Biden's but less radical than Sanders'. (Support fell to 44 percent when pollsters inquired about funding the Warren plan with \”a new tax on the wealthy.\”)
The Democratic Party, meanwhile, is highly receptive. In a 2022 survey in the New America Foundation, only 17 percent of Democrats strongly agreed and just 28 percent somewhat agreed with the statement, \”Americans can get a high-quality education after high school that's also affordable.\” When asked \”who ought to be more accountable for funding higher education,\” 80 % of Democrats chose \”the government, since it is great for society.\” Only 19 percent chose \”students, because they personally benefit.\”
American colleges are not going to endorse reforms that will require them to do more with less. Despite the mountain of evidence that it is programs have made college more costly for that middle class and jeopardized the financial security of nontraditional students and the working poor, the us government won't cede its role atop the machine. But current and future debtors are available. And convincing these to endorse a radical market-based proposal on the radical socialist one begins with acknowledging our current system did them dirty.
