The Next Massive Bailout: Student Loans

A few years ago, I began interviewing adults at least 10 years out of college and who had never managed to pay off their student debt. Some were past the age of 50 and headed slowly but surely for personal bankruptcy. Sadly, their stories were as common as they were upsetting.

Not much has changed. Outstanding student loans continue to balloon, and they now total $1.2 trillion nationally, according to the Consumer Financial Protection Bureau. Among students graduating in 2012, 71% had student loans averaging $29,400, according to a report from the Project on Student Debt. So while today’s grads may be part of the most educated generation in history they are also the most indebted twentysomethings the world has ever seen.

This isn’t good. Young people should be buying cars and setting up households—not boomeranging home to Mom and Dad and dedicating their income to loan repayment. Household formation is half the rate it was seven years ago, and most of that is due to the drag of student debt, the CFPB has concluded.

Government is trying to address the problem. There has been talk of refinancing student debt at lower rates. But that discussion has largely stalled. President Obama is pushing for a new funding model, where the amount of student financial aid available to universities is tied to things like their graduation rate and the initial salaries of their graduates. But the rating system, which might eventually hold tuition hikes in check, is at least a year away.

Another new initiative may be backfiring–at least at it relates to keeping college costs contained. Since 2011, student borrowers have been able to choose a plan that limits their amount due to 10% of discretionary income, which is defined as 150% above the poverty level—now at $15,730 a year for a two-member household. That means such a household would owe based on income beyond $23,595. If this household earned, say, $35,000 a year, it would make payments of about $100 a month.

For public employees and those working for a nonprofit, so long as they made regular payments the debt would be considered settled after 10 years regardless of how much was owed or paid back. For private sector employees the debt would be settled after 20 years. This payment plan, which is really more of a debt forgiveness plan, has proved so popular that enrollment is up 40% in six months and now includes 1.3 million Americans owing $72 billion.

Yet there is no free lunch, and we now have what looks like a high stakes game of Whac-A-Mole. Every time we bat down one source of escalating tuition and student debt, another source rises up. Because of the forgiveness feature, students appear more willing to borrow; universities are advertising the forgiveness plan and seem poised to raise tuition to soak up the funds. Just like that we are back where we started—a lot of borrowing and little incentive for colleges to keep tuition hikes down.

And it gets worse. In this popular new arrangement, taxpayers get stuck with the tab. Already the future cost of the forgiveness feature is pegged at $14 billion. To keep students and colleges from running up too big a bill, President Obama is pushing to add a lifetime forgiveness cap of $57,500. That would help. But make no mistake: the next bailout is happening now. It may be more palatable than bailing out banks and car companies. But the costs are mounting.