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Short Memories: Repeating Policy Mistakes for “Positive Externalities”

About a month ago President Obama delivered the State of the Union Address. In it he pandered to the broad interests of teacher’s unions and educational institutions. He framed the issues as educational reform, affordable education, and transitioning priorities. President Obama calls for more resources for teachers, better pay for high quality teachers, and replacing teachers that are not effective. He ignores the fact that other than providing more taxpayer funds, these reforms are most appropriately under the authority of the state governments. The Senate has not passed a budget since 2009, yet he takes credit for increased educational spending at the state level. Most concerning is the obvious misdiagnosis for the cause of rising costs of college education.

President Obama called for a moratorium on raising the interest rates charged for student loans, the continuation of the tuition tax deduction, and doubling work-study jobs over the next five years. The similarities between this proposed educational policy and the “affordable housing” policy that was the catalyst for the financial crisis and the Great Recession are strikingly similar. Federally subsidized student loans are similar to mortgages owned by Fannie Mae. Both are designed to make credit more available than the market would otherwise bear. The tuition tax deduction and work-study jobs are likewise designed to provide subsidized money in different forms. Each program was implemented to increase access to the education market. Increased access to markets results in greater demand for the good provided, and without matching increases in supply, the price of the education will increase. And that is what we’ve witnessed as tuition continues to sky-rocket.

The premium of a college degree in the labor market is well documented. Historically, this premium has increased and decreased based on a multitude of economic factors, much like housing prices. Also similar to housing, the value of a degree has been consistently trending up for the last three decades. The assumption in education that the value of the degree is always increasing has allowed the educational industry to capture a greater share of consumer surplus as money becomes more easily available for students. The increased availability of student loans allows higher education institutions to extract an increasing amount of the future value of the degree from each student.

Even with increasing costs of attending college, the average net present value of the degree premium is greater than the cost of attendance. The assumption that this will remain true is as flimsy as the financial industry assumption that housing prices will continue to rise. The rate of student loan delinquency and default has already begun to rise. Because student loans are now guaranteed by the Department of Education it is the taxpayers that bear the risk of student loan defaults.

As the Department of Education increases the availability of student loans, the risk of default in each additional student loan increases. This is true even if the value of the degree remains above the cost of attendance, due to uncontrollable variables that effect demand for those degree holders. Quite apparently, some degrees are less risky than others, as demand for certain professions grows at relatively stable rates. Much of the discussion about U.S. labor competitiveness revolves around science, technology, engineering, and mathematical (STEM) degrees, and for good reason. These degrees have traditionally been stable or growing labor markets, and holders of these degrees are widely viewed as innovative and productive workers.

Regrettably, there is no movement by the Obama Administration or Congress to tailor the student loan program to future job prospects. The current policy emphasis is on higher education institutions to accurately reflect earnings potential and job placement rates in recruitment materials for prospective students. This initiative also threatens institutions with revocation of eligibility for student loans if the default rate of graduates reaches a substantially high level. The potential loss of loan eligibility for institutions is a sound policy, but it fails to address the fundamental flaw in the student loan system that allows individual students to borrow amounts that exceed the value of the degree they earn. In the housing crisis many mortgages went were deemed “under water.” How long before the same term is used for the status of college graduates?

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