As Interest Rates Double, We Need Less Gov’t, Not More

July 01, 2013

By: Matthew Roy

Interest rates on Stafford federal student loans are set to double today, jumping from 3.4% to 6.8% as the College Cost Reduction and Access Act of 2007 will expire.  Borrowing costs for as many as 7 million students who use federally subsidized Stafford loans will increase abruptly if Congress does not change existing law.  Many have criticized Congress for allowing this rate reset to happen, but few recognize a more serious underlying problem surrounding this issue.  Rather than calling for more knee-jerk legislation, the public should question why the government is so deeply involved with higher education funding in the first place.  Politicians praise their government education loan programs and claim they provide all students the opportunity to earn a degree and find a good job.  The reality is that government loans are a root cause for skyrocketing tuition prices, massive student debt, and high undergraduate unemployment.

Outrage over the Stafford rate change misses the context of the whole student loan market.  Private loans for education are even higher than 6.8% — some are as high as 11%.  So even while doubling the rate overnight is arbitrary, the new rate is still below the market price for loans.

The government holds its rates at lower-than-market levels to encourage more students to continue their education.  Access to a college education not only helps those individuals but improves the entire economy, the argument goes.  Federal aid for students has increased 164% over the past decade and many politicians would be proud to tell their young constituents that the government will distribute over $100 billion in loans in the next fiscal year.  Contrary to this political messaging, students have fared very poorly from government influence on higher education.

What is described as aid to students is actually in the best interest of universities.  While federal loans make it possible for some students to go to college, consider where that money actually ends up and what situation students face following graduation.  Whatever money students receive from the government is immediately transferred to universities.  No outcome could be better for universities than the government offering lower-than-market rates or guaranteeing loans. After all, colleges set their price, meaning they could hike tuition knowing that it’s Uncle Sam, not the student, paying the upfront bill.  Pumping out cheap money, government skews the true costs of attending college and makes students less sensitive to tuition increases.  With more and more students taking the cheap loans, universities are signaled to keep raising their prices.  The students are just middle men, passing money direct from the government to colleges, but they are ultimately responsible for paying all of that money back plus interest one day.

Tuition has increased a whopping 750% over the past 30 years—a growth rate five times faster than inflation over the same period.  Given advancements in technology and growth in online education, this rise in costs makes no sense.  Online instruction, web-based teaching tools, and large auditorium physical classrooms have greatly improved university efficiency, yet costs have only increased.  The seemingly inexplicable rise in price stems from government pouring money into schools.

National student loan debt is now $1 trillion.  Average debt held by each student is $27,000.  Many students take on much larger debts — particularly post-graduate students — into hundreds of thousands of dollars.  Yet they still struggle to find a job after graduation.  As more young people opt for more education using government money, the job market becomes more and more crowded.  To make the problem worse, many of the degrees that universities offer fail to equip students with marketable and desired skills.  College-educated workers struggle to find work after school as a result.  The unemployment rate for recent grads is well above the national average at 7.9%, and this figure doesn’t even account for college-educated people who work part-time or in low skills jobs like retail or food services.

Imagine dealing with financial burden of a mortgage’s worth of debt, but with no house, assets, or even job.  That is the situation government officials created by artificially reducing the interest rate.  The government can offer short-term benefit, but there are long-term unseen costs.  If all student loans were privatized, getting an education would be more limited and costly in the short run. But as demand for education falls, universities would be forced to lower tuition prices offer better education to make their college more attractive.

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