The Long Road to the Student Debt Crisis

By Josh Mitchell (WSJ)

June 7, 2019 12:08 pm ET

A series of well-intentioned government decisions since the 1960s has left us with today’s out-of-control higher education market.

The U.S. student loan system is broken.

How broken? The numbers tell the story. Borrowers currently owe more than $1.5 trillion in student loans, an average of $34,000 per person. Over two million of them have defaulted on their loans in just the past six years, and the number grows by 1,400 a day. After years of projecting big profits from student lending, the federal government now acknowledges that taxpayers stand to lose $31.5 billion on the program over the next decade, and the losses are growing rapidly.

Meanwhile, four in 10 recent college graduates are in jobs that don’t require a degree, according to the New York Federal Reserve. And many American colleges are dropout factories: At more than a third of them, less than half of the students who enroll earn a credential within eight years, according to the think tank Third Way.

The U.S. is shoveling more and more money into a highly inefficient system that, polls find, Americans are increasingly dissatisfied with. College tuition has soared 1,375% since 1978, more than four times the rate of overall inflation, Labor Department data show. The U.S. now spends more on higher education than any other developed country (except Luxembourg)—about $30,000 a student, according to the OECD. Meanwhile, college presidents are being handsomely rewarded for the success of their enterprises: Seventy of them, including a dozen at public colleges, earned over $1 million in 2016-17, according to the Chronicle of Higher Education.

How did we get here?

The student loan system was built in the 1960s on the overarching belief that higher education is a safe and worthy investment for both society and the individual. At the time, the first children born after World War II—the baby boomer generation—were beginning to graduate from high school and enter college. The American economy was becoming more sophisticated and knowledge-based. Education had been a key factor behind the nation’s impressive economic growth and rising living standards, to say nothing of its standing as a global superpower.

At the start of the century, less than a tenth of American workers had a high school diploma, let alone a college degree. But by the 1960s, high school was universally required and college attendance was growing rapidly. Economists started to talk about college as an investment in human capital that drove wage gains for workers and raised the economy’s total productivity.

Officials in the administration of President Lyndon B. Johnson and members of Congress wanted to make sure that everyone shared in the gains. Previously, college had largely been confined to upper-income whites. Now the hope was that colleges would level the playing field for minorities, the poor and the middle class. “It was quite clear to us…this was an economy that was screwing a group of people—or not helping a group of people it should be helping,” said David Mundel, who served as a budget analyst in the Johnson and Nixon administrations. Banks were reluctant to make loans to students, who were viewed as risky prospects, so Johnson successfully pushed Congress to pass the 1965 Higher Education Act, which provided funding for the government to guarantee student loans made by banks, shifting almost all the risk to taxpayers.

But Johnson wanted to come up with a longer-term strategy for financing higher education. He and Congress faced a pivotal decision: Should the bulk of federal money go to schools or directly to students? The task of settling that question fell to a young economist in the administration named Alice Rivlin, who in the late 1960s headed a task force on the issue (before going on to become the first head of the Congressional Budget Office, President Bill Clinton’s top budget official and the vice chair of the Federal Reserve).

The Rivlin panel came down on the side of direct aid to students, essentially endorsing a voucher system—the one that we have today—in which the federal government gives students a combination of loans and grants. Student loans became an entitlement, like Social Security, which students were free to spend at the school of their choice.

In one of her last interviews before she died this spring [2019], Rivlin said that they expected this system to empower minorities and the poor. “It evolved into an almost fixation—among economists anyway—with the idea that higher education added to your future income and therefore loan finance was a sensible thing. You could pay it back out of your future income,” Rivlin told me. “Companies can borrow to buy equipment. People ought to be able to borrow to invest in themselves.”

The so-called Rivlin report came out in January 1969, weeks before the new Nixon administration took over. The Nixon administration and Congress largely followed Rivlin’s blueprint in the Higher Education Act of 1972. That act made permanent the government’s role in guaranteeing student loans made by private banks. It also created Sallie Mae, a quasi-public entity designed to jump-start the student loan market. Sallie Mae borrowed from the Treasury at low rates and used the money to buy student loans from banks, thus freeing up banks to make even more loans to students.

What could go wrong? As it turned out, a lot.

The combination of open access to schools and open access to loans turned the higher education market into a version of the Wild West.

The combination of open access to schools and open access to loans turned the higher education market into a version of the Wild West. Schools of all types, banks, nonprofit guarantee agencies and Wall Street investors competed for federal student-loan dollars. In particular, the system gave colleges an incentive to maximize the tuition they extracted from students and the federal taxpayer by boosting fees and enrollment, which meant relaxing admissions standards.

The federal government didn’t want to put in place any academic criteria to prevent someone from getting aid. The idea emerged that anyone who wanted to go to college should be able to. “We didn’t think about dropouts,” Mr. Mundel said. They didn’t consider the possibility that a large number of students would end up in debt without earning a degree or the higher wages that come with it.

The voucher system, combined with a lack of government oversight, created perverse incentives: Colleges could raise money quickly by admitting academically suspect students while suffering little or no consequences if their students dropped out and defaulted on loans.

The market was suddenly flooded with cheap money, which led to a surge in the ranks of college-going students. Colleges responded to higher demand by raising prices, leading Congress to increase loan limits and grants. This cycle continued throughout the 1980s and 1990s, as Sallie Mae and private banks that fronted students the money for the federal student loan program made big profits—and schools collected more money.

By 2000, higher education had become an opaque and dysfunctional market. Students and families have had to accept it as an article of faith that taking on big college debt is still worth it, since official data has been hard to come by. Only last month did the federal government release, for the first time, data showing the average debt burden of students leaving particular programs within a school. Previously, the government only published school-wide debt statistics.

The severe recession that began in 2007 led to a boom in college and graduate-school enrollment, as workers who couldn’t find jobs went into higher education. President Barack Obama’s administration tried to address many of higher education’s problems through regulation. For example, it put in place rules designed to force for-profit trade schools to shut down if too many of their students defaulted on loans. But Mr. Obama doubled down on the basic idea that college is a safe investment for students and the country. In his first speech to Congress, in February 2009, he said that his budget would invest in education, in part through student loans, and asked every American to spend at least a year in college. “Every American will need to get more than a high school diploma,” he said.

His administration cut out the middlemen by killing off the Guaranteed Student Loan Program, the one created under Presidents Johnson and Nixon that relied on banks, in favor of a direct loan program, in which money came from the Treasury. But the government’s loose lending policy, with few questions asked, remained in place.

The Obama administration also heavily promoted income-based repayment programs, which set borrowers’ monthly payments at 10% of their discretionary income and then forgave a portion of their debt after 20 to 25 years of payments. This severed the link between the value of students’ education and how much they could borrow, providing a huge incentive for schools to raise tuition, since taxpayers would pick up more of the tab. Enrollment in these programs is one big reason that the government’s costs for student loans are exploding.

In several important ways, the student loan system has achieved the objectives set out by policy makers a half-century ago. More Americans gained access to college: The number of full-time workers with bachelor’s degrees has risen from 7.6 million in 1980 to 19.5 million today. The share of Americans age 25 and older with a bachelor’s degree reached 34.2% in 2017, double what it was in 1980, Education Department data show. And for the typical borrower, higher education is an investment that pays off: The college premium—the amount graduates earn over workers without degrees—remains at an all-time high. About 40% of all student debt goes to finance graduate degrees, including law and medical degrees, which typically lead to high salaries.

But those averages obscure big problems. Many groups are benefiting unevenly, or not at all, from college degrees. “The extent of the returns depended on several demographic characteristics—most notably, when people were born and their races or ethnicities,” the Federal Reserve Bank of St. Louis reported earlier this year. “In particular, the financial benefits one can expect from a college degree appear to be lower among people born in the 1980s, and they remain unequal across racial and ethnic groups.”

Many households and employers no longer seem to think that college is ‘worth it.’

Worse, millions of students took out loans but never earned a degree. High college dropout rates continue. And many households and employers no longer seem to think that college is “worth it.” Companies including Google, Apple and IBM have dropped the requirement that job applicants have college degrees: They no longer think that a degree is automatically needed to succeed.

Where do we go from here?

Members of both parties acknowledge that the system is broken, but they have offered very different sorts of fixes. Some Democrats endorse the idea of free college, or at least a system in which the government directly subsidizes public colleges. Sen. Elizabeth Warren (D., Mass.), as part of her campaign for her party’s presidential nomination, has called for canceling up to $640 billion in student debt. She and Sen. Bernie Sanders (I., Vt.), who is also running for president, have endorsed tuition-free college.

Meanwhile, Republicans have favored a system that would shift student-loan financing to the private sector. Under its president Mitch Daniels, the former Indiana governor, Purdue University has tested a plan for income share agreements, in which students receive funding from investors to cover tuition in exchange for a share of their income for a period of time after graduation.

Each approach has its benefits and risks. Free college would relieve financial burdens on students and households, likely boosting enrollment and, perhaps, graduation rates. Surveys show that resistance to college costs are a big reason why students either don’t go to college or drop out early. But such a plan might well bring new problems. Schools would become subject to even more political control, potentially undermining the quality of the educational experience. Costs could continue to rise and strain government budgets. And without other reforms, low graduation rates could persist.

Income share agreements could lower costs and improve outcomes by tying loan amounts to objective judgments of how much the student is likely to earn from her degree. Educational quality could also benefit: Investors would presumably advance students money only for schools that were doing a decent job of teaching them. The risks are that some borrowers could end up paying far more under such a scheme than the current plan and that investors might not lend to students they consider too risky.

In any case, these changes would only apply to prospective students. They wouldn’t do anything to help people currently struggling under the burden of student debt. In February, I asked Rivlin what she thought about the system she helped to create 50 years ago. Her response: “We unleashed a monster.”

Write to Joshua Mitchell at joshua.mitchell@wsj.com

Appeared in the June 8, 2019, print edition as 'The Long Road To the Student Debt Crisis Where Student Loans Went Wrong.'

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