Who is it helping,
When student debts are relieved?
Maybe all of us.

This week the government announced that Americans holding Federal undergraduate student loans will have up to $10,000 of that debt canceled. If the person holding that loan qualified for a Pell Grant, then the amount of debt forgiven increases to $20,000.

It seems that it’s impossible to sneeze without it being either a Right Wing or Left Wing sneeze and getting blasted with ferocious outrage from whichever wing opposes sneezes these days. This week’s FiKu is not intended to stir up controversy.

What I would prefer to do is first acknowledge that this is happening before slapping an opinion of goodness or badness on it. As with any legislative change, it is being enacted for someone’s benefit. It might not be you, but there is someone out there for whom this was a happy announcement.

The point of this FiKu is to take an (hopefully) uncynical look at who this might be helping, and why.

First, some backstory.

Inflation has been a hot topic this year. It’s been a hot topic in higher education for decades. The average annual rate of inflation for public colleges between 2000 and 2018 was 5.3%. The rate of inflation is now around 8%. At the rate of 5.3%, a college whose year 2000 tuition, room/board, books, and fees (aka the Total Cost of Attendance, or COA) was $15,000, would today cost $46,721.40.

Fortunately, financial aid is here to help.

Families can qualify for need-based financial aid if they have very low income and financial assets relative to the cost of a given school. If siblings are attending college at the same time, current regulations say that further relief can be found through the sibling discount.

However, the government recently removed the sibling discount. This change was passed as part of the Consolidated Appropriations Act of 2021 and will go into effect starting in 2023. This will make college more expensive for nearly every family with siblings born less than four years apart.

Students receive two broad types of financial aid: gift aid and non-gift aid. Gift aid is scholarships and grants. These are awarded based on financial need or academic, artistic, or athletic merit. Gift aid is just that – a gift. There are no requirements for repayment.

Non-gift aid is a fancy way of saying loans. Student loans come in three broad types: Federal, State, and Private. The only kinds of loans that have ever qualified for forgiveness are Federal loans.

Undergraduate students likely have no credit or poor credit. They are generally in their late teens and have little to no credit history, which is a significant factor in determining someone’s credit score. Federal student loans are one of the only types of debt an 18 year old can take without a parent co-signer. If an average 18 year old freshman student was to apply for a credit card, it would likely have a very low credit limit, and/or require a cosigner with good credit.

The Federal Direct Loan for Students, however, has a maximum debt limit of $27,000 for a four year degree and requires no cosigner. The interest on this loan is remarkably low considering that it is unsecured debt and the borrower’s lack of credit. Interest rates generally hover in the 4-5% range. Before interest was frozen at 0%, it was at 4.99%. Not coincidentally, the average balance of the $1.75 trillion balance of student loan debt in the USA is $28,950.

If a student takes the maximum Federal Direct Student Loan for all four years of college (it is issued incrementally on an annual basis), and makes no interest payments along the way, they can generally expect a balance between $33,000-$35,000 by the time payments begin 6 months after graduation.

Who collects the interest on Federal student loans? The Federal Government does. Depending on the year, Federal Student Loans rank as either the #1 or #2 largest financial asset held by the Federal Government.

Over many years, matters have been further complicated by student loan servicing quality issues. In order to service the millions of outstanding student loans, the government outsources loan servicing to companies like Navient. Navient’s servicing of federal loans was spotlighted in a podcast by Michael Lewis (author of Moneyball, The Big Short, and many other excellent non-fiction books) called “The Seven Minute Rule.”

The name of the episode came from a mandate at Navient that service calls take no more than seven minutes, including reading required disclosures. Poor servicing was a component in the 99% rejection rate for applicants for Public Service Loan Forgiveness (PSLF) in the first year eligible applicants could apply for forgiveness.

The result of all of this has been a large burden faced by young people in today’s America that was not on the table for previous generations.

How have people reacted to having so much student debt? Recent college graduates with student loan debt are statistically less likely to buy real estate, get married, have children, and build wealth. If they do get married, student loan borrowers are more likely to divorce.

You can look at government financial regulations as incentives for behavior that benefits the economy of the United States. As a capitalist economy, we value the act of participating in capital markets by starting businesses, buying stocks, funding startups, buying real estate, etc. This is why capital gains taxes are generally more favorable than ordinary income taxes.

For over a decade, the Federal Government has created incentives for people to attend college and use Federal Loans to do so. The Student Loan Interest Deduction is a fiscal policy that helps to incentivize people to attend college, as is the American Opportunity Tax Credit, and The Lifetime Learning Credit.

Public Service Loan Forgiveness, Pay As You Earn, and Revised Pay As You Earn Federal loan programs have been in place for over 10 years and each contain forgiveness provisions. Loan forgiveness makes college more accessible and has been an incentive for borrowers to use Federal loans rather than State or Private options. The forgiveness program also rewards borrowers who make the lowest possible payment for 20 years until the balance is forgiven.

One way of looking at the current loan forgiveness package is an advance on loan forgiveness many of these borrowers would have already received.

Not unlike the pandemic relief that buoyed the economy during the height of the COVID pandemic in 2020, the current loan forgiveness legislation may be intended to help young people take the risks required to beneficially participate in the economy. To be a capitalist economy, we need young people building wealth through capital markets, which theoretically creates downstream benefits for the whole country. Every dollar spent on federal debt is a dollar that isn’t fueling economic growth.

It is possible that student debt relief results in a long term benefit for the whole country. It may prove to be a taxpayer funded train wreck. Time will tell.