Federal Student Loan Program Is Losing Billions

In 2004, Barack Obama was running for a seat in the U.S. Senate in Illinois. Speaking before a group of students at Lincoln Land Community College in Springfield, Illinois, he voiced an inspirational quote:

“We have an obligation and a responsibility to be investing in our students and our schools. We must make sure that people who have the grades, the desire and the will, but not the money, can still get the best education possible.”

He also offered a specific policy proposal to achieve that lofty goal, promising it would save money for U.S. taxpayers:

“We would save $4.5 billion annually if we made all student loans directly by the government,” Obama told students and faculty members at Lincoln Land Community College.

In 2010, President Obama followed through on his 2004 promise. Under the Health Care and Education Reconciliation Act, the federal government effectively took over the student loan business. Now, instead of guaranteeing loans made by private lenders, the federal government would directly loan billions of dollars to American students seeking a college education.

The Promise Becomes a Penalty

As of 2020, the U.S. government has loaned over $1.3 trillion to U.S. students. If Barack Obama had been right, after 10 years, the federal government would have saved $45 billion. Instead, the Wall Street Journal reports, the U.S. government’s direct student-loan business has cost taxpayers $435 billion.

“Penny wise but pound foolish” is the saying that best describes the outcome of President Obama’s promise.

The WSJ article is behind a paywall, but Brad Polombo of the Foundation for Economic Education excerpts some key passages from it article and explains why the government’s “investment” in students has gone so badly:

“The Education Department, with the help of two private consultants, looked at $1.37 trillion in student loans held by the government at the start of the year,” the Journal reports. “Their conclusion: Borrowers will pay back $935 billion in principal and interest. That would leave taxpayers on the hook for $435 billion.”

“After decades of no-questions-asked lending, the government is realizing that it has a pile of toxic debt on its books,” the report continues. “The government lends more than $100 billion each year to students to cover tuition at more than 6,000 colleges and universities. It ignores factors such as credit scores and field of study, and it doesn’t analyze whether students will earn enough after graduating to cover their debt.”

Think about it like this. In the free market, banks do their best to ensure they lend money to prospective borrowers likely to repay the loan, yielding a net positive return on their investment. Banks that do this successfully stay in business, while those who repeatedly misjudge their borrowers go bust.

Better still, the interests of taxpayers are better protected by that arrangement because the risk associated with losses is kept in the private sector.

A Darker Side to the Story

The WSJ article also recognizes that the U.S. government’s role in making direct student loans directly contributes to the soaring cost of college.

With the federal takeover of student lending, President Obama’s promise of savings for taxpayers almost immediately backfired as greedy university administrators realized they could crank college tuition higher. With Uncle Sam acting as a third-party payer, students have little incentive to make prudent financial decisions about their education, which provided a green light for tuition inflation to soar. Tuition costs have shot up at both for-profit and non-profit institutions whose students have access to federally funded student financial aid programs.

That sounds very familiar. The same factors of government regulation, subsidies and other interventions in health care are responsible for making health care similarly unaffordable for many Americans. And as with health care, much of the extra cash provided by the federal government has gone toward the growth of administrative bloat.

It also creates the situation in which the U.S. government has to borrow more to fund its direct student-loan program because of the rising cost of tuition. That in turn increases the size of the government’s losses when the loans go bad. It’s an ugly, toxic mess that can only get worse without reform.

What Reform Is Needed

A number of politicians are now calling for student loan relief by having the next president forgive up to $50,000 of their federal student loan debt with an executive order. Unfortunately, all that will do is guarantee the losses that U.S. taxpayers will be on the hook for paying without doing anything to fix a broken system. It would also unfairly benefit higher- over lower-income earners.

Truly fixing the system will require the government to act to force bloated academic institutions to return the ill-gotten proceeds of their administrators’ greed. If a student who attended their institution becomes delinquent and defaults on their federal student loan debt, they should have to return to Uncle Sam a significant percentage of the money they collected from the student.

After all, if they’re not willing to guarantee the value of the college educations they provide, how much is that education really worth? If they’re not willing to repay, the U.S. government would be within its rights to cut them off from participation in all other federal funding programs. One way or another, the government could get back the money its owed, without sticking honest taxpayers with the bill.

At the same time, the federal government needs to get out of its money-losing student-loan business and return it to the private sector, where it belongs. Only by doing so can it protect the interests of all Americans and close the door on President Obama’s penny wise but pound foolish investment in education.

Craig Eyermann is a Research Fellow at the Independent Institute.
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