Here’s an idea to solve the college debt crisis: Student Loan Bonds
Politicians should approach solutions to the student debt crisis as they've approached economic crises in the past, when fixing problems was more important than scoring points.
With the student loan payment suspension ending and the Supreme Court ruling that President Joe Biden’s loan forgiveness program was unconstitutional, the student loan crisis is back on the front burner.
Borrowers will once again be making payments, which may require major changes in spending habits that are likely to slow economic growth. Estimates of the resulting decline in spending range from $75 billion to nearly $200 billion. That would slow economic growth between one-quarter percentage point to as much as 2 percentage points.
But there are potential solutions to the crisis that would not include loan forgiveness. It just takes viewing the issue in an economic context and approaching solutions as politicians did in the past, when fixing problems was more important than scoring points.
The realities of recent grads being saddled with debt
The numbers on student loan debt are startling. Over 45 million people have student loans. Over the past 15 years, due in large part to skyrocketing educational costs, the total outstanding has tripled to nearly $1.8 trillion. The typical loan is in excess of $25,000. In recent years, over half of students graduating from four-year colleges entered the workforce with student loan debt.
How did the financial stress reach this extreme level? As noted, educational expenses — and therefore borrowing levels — have skyrocketed. But there is also the reality that these loans are made to students, and payments begin just six months after graduation.
It is not unusual that new graduates have difficulty getting jobs that pay enough to afford living expenses and loan payments, especially in challenging economic times. That creates financially stretched borrowers who are put in a bind: Missing payments or not fully paying the principal and/or interest can result in loan levels increasing, which leads to increasing repayment costs. The cycle becomes difficult to break.
Still, students borrowed the money, and they should pay it back. Why should the government help out? Because there are economic consequences, as noted, and critically, student loans are treated differently from personal and business loans by the law, the tax system, and government policy.
It is nearly impossible for student loans to be discharged through bankruptcy. Student loan borrowers must repay their loans no matter how long it takes. That is not true of most other loans to individuals. And if a business gets in financial trouble, it can discharge its debt through bankruptcy.
Then there is the issue that student and business loans are viewed differently by legislators, even though the borrowing occurs for the same fundamental economic reason.
Students go to college, trade schools, or other training programs to increase their skills and productivity. That should allow them to secure better jobs at higher wages.
In economic terms, they are investing in human capital, improving worker, and therefore business, productivity. Similarly, companies borrow money to invest in plant, equipment, and intellectual products to increase corporate productivity, lower costs, and make more money.
Conceptually, there is no difference between individuals investing in human capital and businesses investing in physical capital. The goal is to increase productivity and earnings.
Unfortunately, politicians don’t want to be bothered by economic realities. They have passed laws that treat spending on human capital completely differently from spending on physical capital. Businesses benefit from large numbers of tax incentives, accounting gimmicks, and grants and subsidies that encourage capital investment by reducing costs. Those don’t exist for individuals.
That is wrong. Government should be encouraging — not discouraging — investment in human capital.
How can we ease the student loan debt problem?
One option to help borrowers is for politicians to amend the bankruptcy laws to treat individuals more like businesses when it comes to human capital investments. They might create similar tax advantages that would allow students to lower the before and/or after-tax cost of student loans.
A second option is to mirror the lending strategy started during the George H.W. Bush administration to ease the debt burdens of poorer, largely Latin American countries. Bush’s Treasury Secretary Nicholas Brady, a holdover from the Reagan administration, developed a plan to restructure the debt of foreign nations through the use of securities backed by the U.S. Treasury. They were called Brady Bonds.
Here is my proposal: Create Student Loan Bonds. The Treasury would issue special 30-year bonds at market rates. Using the funds raised, the Treasury would offer to refinance the current student loans. Students would pay off their outstanding debt and replace it with new 30-year student loans.
The key is that the student-loan borrowing rate would likely be lowered as it is based on the rate charged to the U.S. government, not the student borrower. Payments would also fall because they’d be spread out over a longer period of time. Default risk would still exist, but the lower payments would lessen the potential for default.
Consider this: Given where the 30-year Treasury bond has been yielding, a borrowing rate of about 5% would be possible. This would include added charges for servicing and covering default risk. The monthly payments on a $10,000, 5%, 30-year loan would run about $54, the cost of a daily small cup of coffee at Wawa. A $25,000 loan would be about $134 per month while a $50,000 loan would run $268 per month. These are doable numbers.
Critically, this proposal addresses the legal issues and political opposition to Biden’s loan forgiveness plan. Borrowers still have to pay back their loans. There is no free lunch. In return, debtors have more time to pay down the loans with rates and monthly payments likely to be significantly lower than those on their current loans.
Yes, there is still some default risk that could cost taxpayers money, but that is true now and some loans are currently forgiven. The overall expense to the Treasury of this plan should be significantly lower than any alternative being proposed and a lot lower than doing nothing.
Joel L. Naroff is the president and founder of Naroff Economics consulting firm in Margate.