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The high price of student loan forgiveness

August 17, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Student loan debt and government forgiveness

Finance has a way of turning useful tools into dangerous weapons. The U.S. saw this a decade ago with mortgages, and now a similar problem is shaping up with student loans.

A mushrooming of student debt

There is now $1.36 trillion of student debt outstanding, and what is most striking is the pace of increase. This debt has doubled in the past eight years, a rate of growth that is comparable to that of mortgage debt leading up to the housing crisis. On its way to reaching its peak level in mid-2008, mortgage debt roughly doubled over the prior seven years - and we all know how that turned out.

Not surprisingly, this mushrooming of student debt its taking its toll. According to Federal Reserve figures, some 11.8 percent of students with loans are officially considered to be in default.

The price of student loan forgiveness

A populist solution is to simply forgive part or all of the student loan debt. A common assumption behind this proposal is that profiteering banks have taken advantage of students by enticing them into loans they didn't understand and can't afford.

Here are four reasons why student loan forgiveness could be costly:

1. Taxpayers foot the bill

One problem with this is the U.S. government has guaranteed the vast majority of the student loan debt outstanding, so if loans are forgiven or students simply default on them, it is the U.S. taxpayer who will foot the bill, not some deep-pocketed bank. This would amount to a national subsidy of tuition, which is an idea worth discussion. But this solution is expensive enough that it should be planned in advance, not backed into after the fact.

2. Students who already paid back tuition wouldn't benefit

Also, deciding retroactively to broadly subsidize tuition would be patently unfair to those students who worked hard to earn tuition money or pay off their loans.

3. Government loan guarantee programs could disappear

Besides this unfairness, a general student loan repayment amnesty would have a couple of other hazards. It would most likely result in government loan guarantee programs being sharply curtailed in the future. Removing or scaling back government support for student loans would cause bank rates on those loans to skyrocket, especially given how high default rates have been.

4. Less accountability among schools

The other hazard is that simply forgiving student loans would not hold academic institutions accountable for making sure the tuition dollars their students are paying are well spent.

Real student loan reform

A big problem is that the aggressive marketing of some academic programs leads to heavy enrollment in schools or courses of study with low graduation rates, shaky career prospects or both.

To fix this, consider restricting government-backed student loans in the following ways:

  • By degree program. The government agonizes over how to create a workforce with the right skills. Restricting loans to degree programs with reasonable employment prospects would be one way of discouraging students from pursuing credentials for which there is no demand.
  • By school. Schools which consistently graduate a small percentage of their students are essentially conning young people out of their money - or ultimately, the government out of its money. Attendance at those schools should not be eligible for government-backed financing.

Shockingly, the federal government only requires schools to address high loan default rates when 30 percent of their former students are in default. If there is one lesson these schools can teach effectively, it is that the government cannot afford to be so forgiving.

More from MoneyRates.com:

Pay down student loans or save for retirement?

Cosigning a student loan? Not so fast

7 drawbacks of refinancing your debt

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