Forbes. April 19, 2014.
This week Shahein Nasiripour at The Huffington Post reported on the huge projected profit from the government run student loan program. The article mostly focuses on how wrong it is for the government to be profiting from lending money to college students and whether these projected profits could be used to lower the interest rates charged to students. A better view of the situation, however, is offered by Jordan Weissmann over at Slate, who points out that most of the projected profits over the next decade will come from loans to graduate students. Realizing that it is doctors, lawyers, and MBAs who will be producing these profits puts things in a rather different light. However, the relevant point is that all these issues are raised only because the government got involved in what should be a private sector business.
According to the latest projections from the CBO, the federal government will earn about $127 billion over the next ten years from its recently acquired role as the direct provider of most student loans. The breakdown of these profits (CBO makes you do the math from tables that are here) is roughly three-quarters from loans to graduate students, one-quarter from loans to parents, and a slight loss in loans to undergraduate students. The reason for the difference is that undergraduate students meeting federal limits on family income and assets qualify for subsidized student loans. This means that even after making some unsubsidized undergraduate student loans, the federal government is close to breakeven across all undergraduate loans made.
These latest numbers show exactly how tenuous the case is for the government to be involved in the student loan business. The basic argument in favor of government involvement is that the private sector will not loan money to students because their future earnings and, therefore, their ability to pay are too speculative. This first led to the government providing guarantees to private lenders and then to the government under President Obama eliminating the middleman and making the loans itself.
However, the CBO numbers seem to offer some evidence that the private sector might be more interested in this market than big government types think. After all, the need to take high risk loans and bundle them together to reduce the overall risk in a credit pool is exactly what modern financial institutions are designed to do. Potential profits of $12-13 billion per year are enough to get a lot of people interested in a business opportunity. Yes, individual student loans may be risky, but thousands of them should be much safer.
I can already hear the howls about how well the idea of bundling risky loans together worked in the mortgage market, so before everybody screams too much about that, note that this is rather different. Home prices fell which led many people to voluntarily stop repayment. If student loans keep their status as protected from bankruptcy so that borrowers have to repay them (or try to) no matter what, there is less risk than with mortgages. Also, it seems highly unlikely that the entire pool of student loan borrowers will lose their jobs at the same time.
Further, many of the mortgage backed securities bundled risky mortgages with other risky mortgages. Financial institutions may have learned enough to bundle riskier student loan debt with safer student loan debt (like loans to medical students and parents). Certainly, they will do this if the market, meaning the people who are going to buy these bundles, demands it. For example, there are plenty of credit card companies able to raise funds to loan to risky cardholders.
Besides, who cares if these loans or bundles of these loans would be risky or if lenders might lose money? Investors and lenders lose money on risky investments all the time. They do this on the assumption that on average they will make money. That is how both the stock market and the credit markets work. The question is not whether some people will lose money some of the time. The question is will people be willing to enter this market and loan money to students.
Graduate students and parents certainly to be potential borrowers for whom the lenders can easily assess credit worthiness. Undergraduate borrowers would be more difficult, as their credit histories are short to non-existent, but I suspect lenders could build reasonable credit models based on school, major, and a few other characteristics.
Would some people be turned down for student loans under a private system? Yes, some surely would be. Is this a bad thing? Probably not. After all, the current system allows the government to lend money to people with no examination of the probability they will be able to pay the money back. Funnily enough, the federal government now requires mortgage lenders to ensure that borrowers have the ability to repay their mortgage loans, yet it does not impose a similar requirement on itself in the student loan market.
Are student loans different in a sense that we should allow borrowers to place themselves under debt burdens they cannot carry? I don’t think so. If some students cannot borrow money for college because they will likely be unable to repay their debts, the student is probably better off without the loan. If such a system means some students are encouraged to study a subject expected to produce earnings upon graduation rather than a subject which is not, society will not only survive but likely benefit.
An argument can be made for government to provide a good or service when society demands it but the economics are such that the free market cannot provide it. Usually, these cases are where no profit can be earned from the activity. If the government can earn a profit from student loans, so could the private sector.
Rather than calling for the government to lower interest rates to eliminate the profit, we should be calling on the government to get out of the student loan business and let investors earn the profits. The federal government running a for-profit business in order to subsidize other activities simply makes no sense.