Last week ProPublica reported that Freddie Mac and Fannie Mae had run new analyses on the effects of widespread mortgage principal write-downs,. They found that such action would not only would this help keep many Americans in their homes, it would also, counterintuitively, help Fannie and Freddie’s bottom line. Foreclosures are expensive, lengthy processes, where lenders often get stuck with a house of seriously diminished value. By writing down the outstanding principal on the loan, Fannie and Freddie can likely keep people in their homes: the costs of the write-downs outweighing the benefits of seeing a mortgage paid down to completion.
This raises a pressing question: would the same be true of student loan forgiveness?
Student loan debt is structured differently from mortgages. Mortgages typically have a strict 30-year repayment period. More importantly, after a few months of not paying your mortgage, your lender may start foreclosure proceedings — taking the asset, your home, as collateral. Student loans, by contrast, do not have a strict amortization schedule and the asset — your education — cannot be stripped away from you and sold. If only! Accordingly, those who have student debt may not file for bankruptcy to restructure or discharge student debt, except for in rare instances.
This adds a wrinkle to the debate over student loans, the aggregate debt of which just crossed the $1 trillion mark in recent months.
Washington acknowledges the problem
As the debt level has risen, so has the debate over what to do about it. Rep. Hansen Clarke of Detroit, introduced a bill to forgive student loan debt in exchange for a certain percentage of income paid over the course of a decade.
A statement from the newly-minted Consumer FInancial Protection Bureau acknowledged that the growth of the amount of student debt could damage our already fragile economic recovery.
“Excessive student debt can slow the recovery of the housing market,” wrote Rohit Chopra, the CFPB’s student loan ombudsman, in a blog post on the agency’s website. “Student loan borrowers are sending big payments every month to their loan servicers, rather than becoming first-time homebuyers. This debt can also put added stress on the borrowing capacity of the household and government sector.”
Chopra, speaking at the Consumer Bankers Association convention in Texas, told an audience of industry insiders that excessive student debt could be hurt banks in the long-run, reports American Banker. “If these borrowers are so over leveraged that it carries throughout their entire adult life, this is a big problem,” he said, according to AB.
Given all this it would seem to follow that converse might be true: that lower amounts of student debt would make the economy recover faster, banks perform better, etc. But economists fail to see the appeal of forgiving student debt.
A post by Justin Wolfers on the Freakonomics blog from late 2011 trashed the notion that reductions in student debt would be a meaningful form of stimulus. He makes a frustratingly convincing five-point case I have taken the liberty of summarizing here:
1. College grads are not deserving of a redistributive wealth policy of this sort because they’re the most capable of improving their lot.
2. From a macroeconomic standpoint it’s unwise, because debt forgiveness doesn’t necessarily lead to more dollars spent in the way that cash stimulus does.
3. It won’t increase access to education, whereas upfront subsidy would (we recently made this same point).
4. This could lead to a slippery-slope effect where all sorts of debt holders come to the government seeking forgiveness.
5. The rhetoric surrounding the policy suggests only worst possible alternatives — corporate subsidies and bailouts — instead of the actual alternatives like giving money to the poor.
Points one through three are especially difficult to refute, while four and five are somewhat speculative and cheap — some billionaires and millionaires have been bailed out already by the government, so it’s not a petty political point to mention this. Nor would student debt holders be the group making this slope slippery.
An appeal to common sense
Robert Applebaum, a lawyer and self-styled advocate for student loan debt forgiveness, would tend to disagree.
“Don’t even get me started on that Freakonomics article,” he wrote in an email. “Wolfers has no idea what he’s talking about. First of all, he’s from Australia, where education is free up front and you repay it based on a percentage of your income. Second of all, he makes the assumption that all college grads make enough money to pay off their student loans. Not true. Middle class wages have gone down over the past decade, not up. College grads can’t keep up with the payments.”
“[Wolfers] talks about opportunity costs,” wrote Applebaum, “but ignores the opportunity cost of saddling entire generations of educated Americans with so much debt. As a result of these debts, they’re not starting businesses or families, investing, inventing, consuming or buying homes.”
That Wolfers makes no mention of the differential between wage growth and tuition inflation speaks to Applebaum’s retort.
Applebaum also pointed to the White House’s official response to a “We The People” petition he started on their website. In it, Roberto Rodriguez, Special Assistant to the President for Education Policy, explicitly states: “We agree that reducing the burden of student loans is an effective way to stimulate the economy and save taxpayer dollars.”
Unfortunately, the Obama administration’s wishes do not always line up with their actions, as Bloomberg Businessweek reported. Certainly one might expect private lenders to use aggressive tactics to get their loans repaid, but federal student loans that go to collection should do so in a manner befitting the president’s stated policies, right? That ain’t happening, says the Bloomberg story. The U.S. Department of Educations uses private collection agencies to rehabilitate loans in default. Frequently this involves aggressive tactics on the collectors’ part, and intentional ignorance of federal programs that have lowered monthly minimums for some federal borrowers.
When giving charity, it is said that the left hand should not know what the right hand does. This isn’t the case with federal policy, however; the Obama administration should strive to be more consistent. The same could be said for how they choose to deal with overhangs of consumer debt: homeowners are getting principal reduction because it helps the economy and it’s supposedly good for Americans to own homes. Why not students? The same principles apply.