A Look into Student Loan Debt and Policy Solutions (by request)

101 Request: What are some policy solutions for the student debt crisis, and how would these impact the student debt investment market?

Today’s piece is about U.S. student loan debt as part of this site’s quest to answer reader questions (or at least point in the direction of answers).

Reader Katie B. wanted to know more about what solutions are out there that would address this monstrous amount of debt, plus some info on the student debt investment market.

If you have a question yourself, visit our contact page here.

U.S. Student Debt

The latest numbers show that, this year, collective student loan debt in the U.S. is somewhere around $1.6 trillion. That’s spread out among 44.7 million borrowers, which is about 18% of the population aged 18 years and older.

That’s a huge amount of debt, so large that the collective amount is second only to mortgage loan debt. (Collective student loan debt surpassed credit card debt in 2018.)

Statistically, the average amount of debt per borrower is almost $33,000, with monthly payments averaging $393. On the bright side, the default rate for borrowers has been declining over the past few years, though it’s still around 10% as of 2016. It’s a similar rate and trend for loan delinquency.

Policy Solutions

This is a huge and growing burden in the U.S., and its impact is not just felt by the borrowers themselves. Borrowers are much less likely to make big purchases like houses, which are decisions that can hurt a local community’s economy. Plus, earning a degree doesn’t always guarantee higher pay, meaning a graduate might have to juggle massive debt, modest pay, and growing costs of living.

A lot of lawmakers and experts have acknowledged this is a heavy weight on students and the economy, and they’ve proposed plans that take approaches different in scope and method.

Some attack broader issues in higher education affordability, seeking to lower the need for loans in the first place. Here are a few, a mix of popular measures and far-reaching proposals:

  • Increase the size and number of scholarships available.
  • Cap tuition costs at universities. Tuition increases are due partially to growing costs in running colleges. So, to do this, states and the federal government might need to increase grant amounts to compensate while the schools themselves would need to determine how to cut some costs. That could mean cuts to staff and faculty; taking this approach would require case-by-case negotiation between a school and the grantor-government.
  • Adopt the U.K’s model. Higher ed was largely free in the U.K. up until 1998. Although this is no longer the case, U.K. graduates don’t feel the same squeeze from debt as U.S. grads do despite having more debt on average. That’s because the U.K. model includes three important components to repayment plans, two of which the U.S. doesn’t include: Graduates are in deferment until they meet a certain income threshold, interest is determined by the borrowers annual income, and monthly payments are similarly indexed to their income.
  • Make college tuition-free or debt-free. You won’t need loans at all if the school you attend is free. This can focus solely on tuition (tuition-free) or include all college attendance costs like room and board (debt-free). One way to do this involves federal-state partnerships: the fed would go dollar-for-dollar with states, matching how much states put toward their state schools. Doing this wouldn’t directly impact private colleges and universities, but by lowering or eliminating the cost at state schools, where most students attend now, it could dilute the pricing power private schools have and force them to consider freezing or lowering their own costs.

Here are three smaller solutions working solely within the student loan system:

  • Cap interest rates for loan repayments. Federal loan rates differ depending on the type of loan, while private loans depend on a borrowers credit score. The rates are typically higher than those for mortgage loans. In either case, interest compounds what is owed very quickly. (Interest rates are a common part of student loan horror stories.) By capping rates and changing how they compound, an individual borrower’s debt wouldn’t grow exponentially.
  • Offer more programs that allow debt forgiveness and improve existing ones (like PSLF). Some specific job areas are eligible for loan forgiveness programs; expanding this pool would reach more borrowers and help lift their debt burden. While we’re at it, it might be good to improve existing ones. The Public Service Loan Forgiveness Program, for graduates pursuing careers in the public interest (like working for qualifying nonprofits, in government, in public safety, or social work), is a prime example. If a borrower enrolls in the program and makes on-time payments for ten years, their remaining debt is forgiven. The program is a great idea on paper, but it’s been mired by bureaucratic mismanagement.
  • Overall, simplify the loan process. Taking out loans requires a mountain of paperwork, and there are countless pitfalls hidden throughout the loan process. Any measure to make this simpler and less confusing for borrowers would, at the very least, cut through the doubts they may have.

Here’s one measure I’ll share that’s in its own category: baby bonds. A baby bond is a small endowment given to a person upon their birth, and it would accrue interest based on the person’s family income. When the person becomes an adult, they can then use that endowment for whatever they’d like, like putting it toward education costs or purchasing a house.

Lawmakers’ Plans, Legislation

We have seen a lot of legislation over the years. Proposals have been especially farther reaching over the last five years, due in part to Senator Bernie Sanders’ (I-Vt.) inclusion of debt-free college within his candidate platform in the 2016 and 2020 presidential primaries. Here is a good run-down of his 2020 plan, which calls for eliminating the cost of college and forgiving all existing debt.

We also have a plan from Sen. Elizabeth Warren (D-Mass.) that would do much of the same as Sanders’ 2020 plan, just with a cap for debt forgiveness for higher earners. Sen. Brian Schatz (D-Hawaii) and Rep. Mark Pocan (D-Va.) proposed a debt-free college plan last year that utilizes the federal-state partnership I outlined earlier. And there are smaller yet still significant plans from the last few years, like plans making community college tuition-free from Pocan and from Sen. Tammy Baldwin (D-Wis.) and Rep. Bobby Scott (D-Va.).

I list all of these measures and plans to show there is no shortage of ideas to address this. Some would cost a lot, like Sanders’ and Warren’s, though both of these would mean tax hikes only on the wealthiest Americans. In any case, we absolutely have the resources to at least make college more affordable, and it’s worth it. Shrinking or eliminating existing and future college debt would be a significant economic stimulus. We just have to come to use the wealth we’ve accrued over the years to do this.

Student Debt and the Investment Market

Before wrapping up, let’s pivot briefly to something else: student loan asset-backed securities (SLABS).

Basically, SLABS are bundles of student debt that investors can purchase. While looking into this, I kept running into this theme: The growing collective student debt is reason enough for some investors to show interest—there’s seemingly infinite growth potential in this market, since college is becoming more expensive and more necessary for some careers.

In her 101 Request, Katie B. mentioned:

It seems like an icky investment but any policy [change involving student debt] that happens will affect this potential investment market. 

I’m not an expert on investments, but I would agree with this assessment.

Policies that would lower overall debt, lower interest rates, or otherwise shorten the length of loan repayments would have an impact on the SLABS market. Some of investors’ biggest reasons for interest in SLABS circles around how long borrowers take to pay off their loans and how much they pay on top of the principle amount. Success in erasing present and future debt might even lead to this market’s demise.

This isn’t to argue that we should not pursue policy changes to the student loan system. This is just to show that policy proposals and the SLABS market are clearly linked.

I would also venture that this cause and effect might even be a good thing. For one thing and as Katie B. pointed out in her request, SLABS can feel like an icky investment. Plus, the indefinite growth potential that has attracted investors to SLABS is a double-edged sword. Because of this bubble’s size and increasing potential to burst, SLABS are sometimes compared to the subprime mortgage market heading into the mid-2000s.

I think it would be nice to avoid another crisis like that one!

There’s agreement in some corners that we need to properly address the student debt in this country, but there’s less consensus on how. Plus, some changes could impact the SLABS market in the future.

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Related reading:

  • Left-leaning think tank Center for American Progress reviews some considerations to take when crafting a plan for the student debt crisis.
  • In an op-ed for TIME last summer, senators John Thune (R-SD) and Mark Warner (D-Va.) explain their bipartisan plan to allow employers to contribute more money to their employees who are out of school and repaying their loans.
  • In an op-ed for The New York Times, Dr. Claire Bond Potter explains how we got the current tuition and debt model and why we need to change it now. (Pay wall.)
  • In light of the current pandemic-recession, senators Warren and Chuck Schumer (D-NY) urged President Trump to use executive action to cancel up to $50,000 in debt for borrowers.
  • The Urban Institute talks more about the role baby bonds could have in addressing income inequality.
  • If you’re interested in learning about SLABS more, check out pieces from Investopedia and InvestorJunkie.

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