The RNC wants to make student loans competitive again. They never were

The RNC wants to make student loans competitive again. They never were

The federal government should not be in the business of originating student loans. In order to bring down college costs and give students access to a multitude of financing options, private sector participation in student financing should be restored. [i]

This plank of the platform has its roots in the recent history of student loans. In 2010, federal legislation scaled back the role of private banks in the federal loan program. Banks now act only as contractors (servicers) for the Department of Education, collecting payments, keeping records, and communicating with borrowers.

Some would like to return to the old system, which they portray as a capitalist Garden of Eden, where banks freely competed for students’ business and offered a range of loans tailored to the tastes of borrowers. The old, competitive market, goes the story, helped to hold down tuition costs, which have since soared out of control as the federal grip on the loan market has tightened.

The only hitch to this story is that it has zero connection to reality. There has never been a large-scale, competitive, private market for student loans in the U.S. Further, economic theory predicts there will never be a large-scale, competitive, private market for student loans. Milton Friedman pointed this out in 1955. Some of his latter-day acolytes seemed to have missed that lecture.

Susan M. Dynarski

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The theory and reality of student loans tie together so tidily that economists frequently use them to explain economic fundamentals in introductory classes. In this article I explain why, in theory, the private market won’t provide student loans (a market failure) and how the history of student loans in the U.S. bears out this prediction.

Economists think of education as an investment, which (by definition) creates costs in the present and benefits in the future. A classic example is a retirement fund: savers skip consumption now so they can have an income when they retire. Another investment is health: we exercise now to build strength and (we hope) lengthen life. Education, too, is an investment: students pay tuition and forgo earnings in the present, in hopes of improved lives later, when they leave school. Health and education both comprise what economists call human capital.

Professor of Public Policy, Education, and Economics – University of Michigan

To pay the costs of education in the present, students need cash. In a business deal, an entrepreneur puts up collateral to get a loan for a potentially profitable venture. But students can’t put themselves up for collateral. In part, this is because it is very difficult for private lenders to place a lien on (or even measure) a person’s earnings.

This is a market failure: there is a good investment to be made, but private lenders won’t make a loan at the right rate of interest. Note that there is a private market for unsecured loans (e.g., credit cards, payday loans) but the interest rates on these loans are far higher than those on secured loans (e.g., car loans, mortgages).

The interest rate on credit cards and payday loans is a reasonable lower bound on rates we would expect to see on private loans to students, if they existed. I stress students in that last sentence because there is a large, competitive, private market in a product misleadingly labeled student loans. These private student loans don’t meet the standard definition of a student loan, because they typically require a creditworthy borrower or cosigner. This rules out most students: it’s pretty unusual for a recent high school graduate to have a credit record that qualifies her as sole signatory on a private loan. These private student loans are unsecured consumer credit with a soothing name, and they potentially lead families to over-borrow. The same critique applies to federal Parent PLUS loans, which are made to the parents of college students. https://getbadcreditloan.com/payday-loans-nc/plymouth/ Because they are not made to students, they too do not meet the economic definition of student loans. A student loan is secured only by the future earnings of the student borrower. Student loans create special risks for the lender.