“Free Money”

February 3rd, 2010

In President Obama’s State of the Union Address (SOTU) last week, there were a number of statements that irked me, but one statement that clearly shows the liberal/progressive mindset is where he said “And let’s tell another one million students that when they graduate, they will be required to pay only ten percent of their income on student loans, and all of their debt will be forgiven after twenty years – and forgiven after ten years if they choose a career in public service. Because in the United States of America, no one should go broke because they chose to go to college.”

Now, the idle or idealistic mind might look at this and think “Isn’t this a great idea!” I must admit I sort of agree with some of the arguments that might come out in favor of this plan, however I still believe it falls flat. Student loans are not a terribly lucrative business compared to other forms of loans. Currently they are often government subsidized such that the interest rates are low and students who get them don’t have to pay anything while they’re in school, and can even get payments deferred without penalty if they come under hard times. To me, this is already a pretty good deal. I, as a student, don’t even have to have stellar credit, large quantities of disposable income or even wonderful grades to get such a loan. I just go, get a loan and pay it back in good times.

What’s the problem with that? I don’t know the statistics on people who actually go bankrupt because of student loans, but my gut feeling tells me the majority of those entering bankruptcy who have student loans are doing so because of a mortgage, car loan, or credit card debt that pushed them to the brink, not their student loans. In fact a brief search of the Internet, seems to indicate that even in bankruptcy student loans cannot be discharged unless the candidate can show that paying them off would cause “undue hardship” on the candidate, the candidate’s family and dependents.

So if bankruptcy isn’t the reason for this “free money,” what is? I almost shudder to think, but for now let’s assume it’s both noble and justified. First, allow me to explain why I call this “free money.”

Suppose a bright student applies and is accepted to a prestigious university in another state where the annual cost of tuition, room and board, fees, etc. is on the order of $35,000 per year. Let us further assume that the student is indeed able to graduate in precisely four years, paying a rough total of $140,000 for school. Let us then suppose that all of that was paid for by student loans.

Upon graduation (or a few months after), those loans begin to demand payments. Usually it is a small amount relative to the amount owed, in part because of the low interest rate. Under Obama’s proposal however, that amount would be capped at 10% of the student’s income per year, regardless of how high the interest might be or how large the debt.

Now suppose that student makes $50,000 per year (let’s use this as the average over the 10-20 years before the debt is forgiven). Further, let’s suppose the student never goes without a job or hits any hardship that would warrant deferment of payments.

Over the course of one year, the student would pay no more (but possibly less than) $5,000 toward this debt. That means in 10 years, should the student choose a career in public service, the student will have paid $50,000 of the $140,000 debt, roughly 36% (forget interest). If the student chooses some career not under the “public service” label the amount of $100,000 will have been paid, still less than 72%.

So, what’s the problem here? It sounds like a nice deal for the student. Simply go get a huge loan to go to a fancy expensive school and not have to pay all of it back, let alone the interest. That’s free money for every student out there who can get these loans!

The problem is where does that money come from? If it’s coming from the government and only these loans are subject to the 10% cap on payments and the 10-20 year forgiveness policy, it means we, the taxpayers, are subsidizing the education of every student that gets these loans. I actually don’t have a problem subsidizing education, but this isn’t the way to do it. Instead our government (state and federal) should be giving the money to schools directly, or to students as grants to help pay for the costs of education, not in phony loans that act as grants in the long term.

If however this policy applies to loans made in the private sector, we have a bigger problem. Instead of creating a boon for students who just need a chance to get an education so they can finally get a leg up on life, the policy will dry up the very business of student loans that’s already helping people do that. If investors see that for every $1 they invest in student loans they can only expect to get (at best) $0.75 back, that’s not an investment many people will be making. Loans will dry up and students won’t be getting them.

That is where the liberal policy of “Free Money” takes us every time. Either the tax payers subsidize an industry, practice, or “right” via round about means (again, I’m okay with the direct approach depending on what they want to subsidize), or we create some kind of bubble that eventually pops and creates a crisis (Sub-prime mortgage crisis anyone?).

So, let’s not adopt this new “Free Money” policy. Let’s instead invest in education the way we used to, by giving scholarships and grants to deserving students (can be defined as academic or sports capability, or just economic need), let’s fund our public universities and colleges sufficiently so average kids can afford to go to them, and let’s encourage universities and colleges to get their costs under control so they don’t grow at 2-3-30X the rate of inflation, by regulation if necessary. Finally, let’s dispel the notion that money ever was or can be “free.”

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