Commentary: Arbitrarily Low College Loan Interest Rates Harm Students, Taxpayers

A government policy of subsidizing loans and encouraging people to borrow huge amounts that many won’t be able to repay has run-up $1 trillion worth of questionable debt.

A growing number of experts fear that borrowers are paying more than the market can support, and some economists are warning of a bubble that could trigger a larger financial crisis. A spokesman for the President’s Consumer Financial Protection Bureau says the industry is likely “too big to fail.”

Unfortunately, these are not headlines from the 2008 home mortgage meltdown. They instead describe current reports about the state of student higher education lending.

Last week, Republicans and Democrats in Congress agreed to a new round of student loan subsidies, capping the federal loan interest rate at the 3.4% set by Congress in 2007. For a number of reasons, this is likely to harm many students, taxpayers and potentially the U.S. economy itself.

The artificially low student loan rate is an implicit subsidy that encourages many to take on debt they would have avoided otherwise. This includes high school graduates who would have entered the work force without the subsidy, students in four-year bachelor degree programs who might have chosen instead to attend community college, and others who would be better served by some form of trade school.

The policy defies a commonsense understanding shared by experts and laypeople that college is not for everyone. A policy of subsidized, below-market interest rates has other unintended consequences. It reduces the incentive for students and parents to save for college. Some students enter college earlier and with less preparation, lacking specific academic goals but attending anyway. This contributes to a four-year graduation rate of just 33 percent at Michigan’s state universities, and a six-year rate of just 61 percent.

In addition, it’s no coincidence that as the level of government loans, grants and other subsidies has pumped ever more dollars into the higher education system, the schools have increased their tuition rates to capture the extra money. No law of nature accounts for college costs rising at rates well beyond the level of inflation; this is largely a product of huge increases in government subsidies. The infusion of government money has led to large increases in the number of administrators per student, and allowed very expensive professors to teach even fewer classes.

Essentially, we have created a perverse cycle in which politicians increase the level of college subsidies, universities respond by raising their prices to capture the extra money, and the politicians react by further increasing the subsidies, causing prices to go even higher. As with housing, this has created a bubble that threatens to derail an already lackluster recovery from the collapse of the subsidized home mortgage market in 2008.

The economist Thomas Sowell once wrote, “There are no solutions; only trade-offs.” As in the housing market, the trade-offs for government subsidies and mandates for student loans would leave us all worse off.