After the Pause Ends: Solving the Student Debt Problem Responsibly
Regardless of how the student loan pause ends, in the long term there are better ways to deal with student debt than cancelling large chunks of it.
There is no doubt that $1.7 trillion in student debt is a huge problem which has adversely affected the lives of millions of borrowers. But cancelling hundreds of billions of dollars of debt is neither a good nor a fair way to deal with a very real social issue.
Rather than cancel chunks of debt — much of which most borrowers can afford to repay - the better way to deal with student debt is to address directly the following three aspects of the problem. First, far too many borrowers are confused about how to deal with the debt they have accumulated. Second, millions of borrowers were ripped off by attending and borrowing for programs that don’t meet minimal standards. Third, millions of borrowers need help in making their current repayment obligations manageable.
Each of these problems need resolution to achieve an overall responsible policy. Here’s a three-step process that will address the problems we face.
First, provide competent counseling for all borrowers. The current repayment structure is a confusing maze and most borrowers need help navigating it. New rules issued by the Biden administration will help lessen the repayment burden but will add to confusion about what to do, at least initially. To make things better, the federal government should fund a network of student loan counselors in a wide variety of communities and online so that every borrower would be able to consult with a qualified advisor to work out an individualized repayment plan.
The idea here is to apply the notion of health-care triage to student debt by giving all student and parent debtors an opportunity to talk to a competent counselor once they are about to enter repayment to assess their situation. The critical components of a successful counseling effort would include creating a network (not in the schools) with a reputation for fairness on the side of compassion. This would allow borrowers in trouble to feel that this was a realistic option for getting them out of the hole in which they find themselves. It would require giving the counselors the power to improve the position of borrowers with whom they meet. For example, counselors should be able to wipe out that portion of debt that occurred through negative amortization or moving the borrower into the refinancing option.
Ideally, non-profit organizations with focus om borrower needs should lead the way on the counseling function. And if servicing on non-income-based repayments was through approved private sector servicers, that could make for an effective public/private partnership in student loans: the federal government provides the capital, the non-profit sector leads the way on counseling, and responsible private sector organizations are primarily responsible for servicing and collection within government regulations.
Second, forgive the debt of borrowers who can’t repay. The biggest category of student loan defaulters attended schools of poor quality, mostly but not entirely for-profit schools offering short-term training. Making matters worse, these delinquent borrowers are often hounded for repayment while many of the poorly performing schools continue to operate and profit from their misfortune. This situation represents a failure of the government to exercise due diligence as it allowed these loans to be made in the first place. The debts of students who borrowed to attend substandard programs therefore should be fully forgiven and the poorly performing schools should be shut down.
Forgiveness should also apply to the many borrowers who participated in the Public Service Loan Forgiveness program, which promised loan write-offs to borrowers who went to work for the government or a non-profit organization. The rules were far from clear; most of these borrowers thought they were following the rules but eventually found out they were not and were forced to make payments for years, often including accrued interest. This record of government neglect should now result in forgiveness for these borrowers.
Third, allow all borrowers to refinance their student debt into one instrument that is reasonable in cost to the borrower and the taxpayer. The notion that student loan borrowers should be able to repay based on their post-graduation income has been discussed for a long time. A federal income-contingent repayment schedule was first created in 1994 as part of the move to make the federal government the primary college loan lender. In the intervening decades, several additional plans have been added to the mix. The result is a hodgepodge of income-based and other repayment schedules that are confusing and costly to the government and borrowers alike.
A key step in retiring student debt fairly then is to allow all those with student debt to refinance on a single, realistic schedule of payments. This solution comes out of the experience in the housing mortgage market. Over the past half century, the most profound change in housing has been the ability of homeowners to refinance their mortgages without penalty. Applying this principle to student debt would be a huge step in solving the crisis without costing the government money over what is already slated to be spent.
The new refinancing schedule should eliminate interest accumulated through negative amortization. It should also make all borrowers in trouble eligible for loan forgiveness after 20 years so that their student debt burdens don’t persist well into middle age and beyond. Some reasonable measure of income versus debt could be established to determine who qualifies for forgiveness. Borrowers who are not having trouble making their repayments should also have the option of consolidating their student debt into a single obligation but their debt should not be forgiven after 20 years.
Based on international experience, it would also be good if payroll taxes were used in any new repayment scheme as the vehicle for income determination and collection. This is because tax withholding systems seem to have worked well in other countries that have student loan income-based repayments.
On the broader issue of debt cancellation, it is difficult to understand why the federal government is not following the outline offered above. The reality is that forgiving loans that have already defaulted or are likely to default cost the government very little either because these loans have already been written off the books or they are unlikely to result in much repayments. (This is not so true of bank-owned loans where interest subsidies and default cost the government real money. This is one reason it would be good for the government to buy off many privately-held loans.
By contrast, cancelling loans that are likely to be repaid really do cost the government a lot of money to help people who generally do not need the help — a classic example of dead weight loss. Thus, the best and most cost-effective strategy is to forgive the loans of people who aren’t going to be able to repay while offering a reasonable refinancing option for everybody else. This would also make it clear that the federal government bears some of the responsibility for the current student debt issue by not having exhibited due diligence in preventing students at these institutions from qualifying for aid.
Taken together, the three steps described above are a much fairer and cost-effective way of dealing with student debt than broad-scale cancellation.
