Reflections on the Student Debt Crisis

To my son and other members of the high school class of 2013:

While I have given thousands of speeches in my career, I have never been asked to give a commencement address. This is a huge disappointment; what do all of those ex-presidents, scholars and humanitarians have that I don’t have?

I am tired of waiting for my opportunity to arise, and I feel that I have something important I want to say to all of you. So these pages will become my pulpit.

First of all, congratulations. Graduation represents the culmination of a lot of hard work, and you should be immensely proud. For parents, it is enormously gratifying to appreciate the evolution of our children from toddlers to poised, intelligent young men and women.

But I have to serve as both your biggest booster and your Chief Reality Officer. While not diminishing what you’ve done, I feel obligated to get you ready for what’s to come. You are entering college at a time when the cost of school is creating a tremendous debt burden for families and society. The debates over whether the returns on education justify the investment, and how school should be paid for, are raging.

In contemplating these very important questions, policy-makers must take care not to make lasting changes to address circumstances that may be cyclical. Over the long term, higher education still produces substantial returns to students and society alike. It therefore deserves continued (and substantial) public support.

On the surface, college in the United States appears to have become significantly more expensive. The compound annual growth in listed costs for private institutions is 4.1% since 2001; for public institutions, where costs have almost doubled in the past decade, this figure is a staggering 6.3%. For reference, overall inflation is just 2.5% over the same interval.

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Supply and demand have both played a hand in this evolution. Educational supply curves have been pressed by rising costs for faculty and facilities; the impact of reduced support from state government has also had an impact. On the demand side, recent high school graduating classes have been among the largest in American history, and students’ interest in attending the best schools has allowed those colleges some pricing power.

But the actual cost of attendance has risen much more slowly. As shown above, schools have become more generous with grants over the past few years. The Brookings Institution’sHamilton Projectestimates that median net tuition has escalated by less than 10% over the past 10 years – a much more modest increase. But there are certainly classes of families that receive less aid, and have to shoulder a larger burden.

College enrollment has certainly risen during the past decade, but indebtedness has escalated much more rapidly. The central reason, therefore, for the increasing use of debt is that many families have seen their ability to pay for school compromised. A number of workers have faced job interruptions in recent years; median household income has been stagnant for an extended period; and the housing correction diminished home equity as a source of saving for school.

To fill the gap, students borrowed…a lot. There are nearly $1 trillion in student loans outstanding; where all other types of lending stepped back in the wake of the 2008 financial crisis, student debt accelerated. Approximately 43% of 25-year-olds have student debt, up from 25% a decade ago. The average debt load has nearly doubled during that time, to more than $20,000. Unfortunately, rates of student loan delinquency have also accelerated, with more than 11% of borrowers more than 90 days past due.

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The consequences of this situation are significant. These debt levels take a long time to work off, delaying big-ticket purchases. Young people are much more likely to rent or live at home during their 20s, which has an important impact on the housing industry. As prospective entrepreneurs work off educational leverage, it may impair business formation and risk-taking. Debt may also affect decisions to marry and raise children.

A significant portion of the country’s student debt burden is actually carried by middle-aged borrowers, many of whom re-entered school in the wake of the recession to refresh their skills or learn new ones. For this cohort, paying off loans means delaying retirement.

The poor state of student finances has led many to take a hard look at the cost/benefit equation surrounding higher education and the manner in which college is financed in this country. And on these points, opinions diverge.

Funding for student loans comes from a shifting mix of public and private sources. Prior to the 2008, the federal government preferred to offer guarantees to back loans made by banks and the Student Loan Marketing Association (SLMA), which then packaged them for sale to investors. As capital began to dry up during the financial crisis, the government became more directly involved in extending credit for higher education.

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Federal student loans are not underwritten in the traditional way; the student’s ability to repay (measured either by family assets or income prospects) does not enter the equation. Interest rates and repayment terms are generally standardized for all borrowers, with some preference made to lower-income applicants.

On one side of the reform debate are those who think that student lending terms should be more generous. Congress is considering rolling back some of the increase in loan rates that took effect July 1, potentially tying them to Treasury rates and introducing lifetime caps. Policy-makers are also contemplating broadening the menu of repayment plans available, including one that would cap payments as a percentage of a borrower’s income.

Student debt forgiveness also is offered at times to those who agree to teach or do certain forms of public service. There should certainly be room to offer some relief; contrary to popular belief, student lending is far from a drag on federal coffers. A recent study by the Congressional Budget Office suggested that federal student lending programs will produce $50 billion of net revenue this fiscal year. Rising defaults may eventually diminish this total, but it seems unlikely that the program will fall into loss.

On the other side, some have suggested that the government should return the underwriting of student debt to the private sector. Interest rates should be pegged to risk, they say, and the potential income from the applicant’s major field of study should be considered. Curtailing the flow of easy money to institutions of higher learning might pressure them to curb their costs and seek ways to deliver more affordable education.

But as we consider the proper size and channel for student lending programs, we should be careful about rushing to judgment. First, now might not be the best time to form long-term conclusions. As with the labor market as a whole, employment conditions for recent college grads have not been the best over the past few years. Jobless rates are elevated, part-time positions are prevalent and starting wages are modest. As economic growth improves, though, one might expect opportunities and pay both to improve for entry-level workers.

Second, getting that sheepskin still confers a significant financial advantage. Measuring the returns to education has been a focus of study for many years. And while it is almost impossible to precisely isolate this impact, the income differentials among different levels of schooling are persistent and, if anything, getting larger.

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It is certainly true that returns to certain fields of study are greater than others, and some observers would recommend concentrating financing on those majors in highest demand by employers. But there are certainly humanities majors who succeed in tangential fields, benefitting from the breadth of intellectual challenge that exposure to more liberal arts can provide. It’s not clear that we want to turn colleges into trade schools.

Further, the pecuniary benefits of higher levels of education do not accrue solely to those earning advanced degrees. Economists have identified “spillover effects,” where higher concentrations of educated people lift everyone’s productivity (presumably because of their ability to innovate or organize work effectively). One researcher estimated that a 1% increase in overall college graduation rates raises the wages of high school dropouts by almost 2%.

Finally, gains from schooling are not exclusively monetary. Better-educated populations are typically healthier, have lower crime rates and lower public services costs. Education is a key vehicle for promoting economic mobility, which studies suggest has been diminishing. And it has long been held that better-educated citizens are better informed and make better choices on public issues.

Admittedly, not all educational investments are good ones. Authorities have done an increasingly effective job of clamping down on “diploma mills” that take in lots of loan proceeds and produce relatively few graduates ready for the workforce. Abuses of the system do occur and should be policed vigorously. And four-year programs are not for everyone, everywhere; the nation’s community colleges are filling a productive and important niche for young and senior students alike.

But in the main, students and society benefit substantially from the investments made in education. A better-prepared workforce improves our chances of remaining economically vital and competitive. And while liberal arts classes have come in for some criticism of late, the value of having creative and versatile thinkers lifts both our economy and our culture.

Those concerned about the degree to which grants and favorable loan terms subsidize U.S. education should note that the extent of support programs in the United States pales when compared to the support offered to college students elsewhere in the world. And ultimately, these are the students with whom our graduates will compete in the marketplace. While public costs may be rising, they must be considered against the benefits that will be achieved.

In conclusion, graduates: your parents, your university and your government are about to make a substantial investment in you. History suggests that the returns on this investment will be significant. But it is also up to you to make the most of this great opportunity. So please seek to find an appropriate balance between study and dormitory hijinks. Your future, and ours, depends on it.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

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