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The Student Loan Bubble   April 29th, 2012
We've seen this story before       


More observations...

The term "ownership society" was coined by President Bush in the early 2000's. This surrounded policy proposals intended to increase the number of citizens that were homeowners. Helping people achieve the dream of homeownership seemed like a good and noble cause.

In addition to the existing tax deduction for mortgage interest, the Federal Reserve was artificially pushing interest rates down. Though the general intent was to stimulate the post-9/11 economy, it also had the effect of lowering mortgage rates. This combined with the Carter and Clinton-era Community Reinvestment Act to encourage a lot of people that couldn't afford homes to think they could afford homes, and to imprudently buy those homes.

And, initially, it was looking pretty good. People that didn't think they could afford a home were buying homes. Those that couldn't afford homes were buying homes and, when the payments got difficult, they'd sell their home for a quick profit. Homebuilders were building homes and the construction industry was booming. Everyone was winning.

Then came the predictable sub-prime crisis, and then the general financial crisis of 2008. While there were multiple causes, the principal enabling causes were:
  1. Artificially low interest rates caused by the Federal Reserve. The low interest rates made home loans more affordable to people that normally couldn't afford a home.
  2. A government-induced push to loan money to low-income borrowers due to the CRA. While this was worrisome, the private sector warmed up to it since home prices were skyrocketing and even if a low-income borrower couldn't pay, they could just foreclose and make a profit anyway. There was apparently no risk.
  3. Freddie Mac and Fannie Mae encouraging the activities described in the previous point. With implied government guarantees and an apparently risk-free environment, this led to 0% down loans, interest-only loans, and over-use of adjustable rate mortgages by unsophisticated borrowers.
  4. Due to the increasing demand of under-qualified borrowers, homebuilders built an astonishing number of homes to meet that demand.

Of course we know what happened then. Interest rates went up and those that had purchased adjustable rate mortgages started losing their homes when they were unable to pay the higher interest rate. Higher mortgage rates also made homes less affordable which decreased demand. And with such an oversupply of homes and a relatively quick reduction in demand, simple market forces started putting downward pressure on home prices. As prices decreased, homeowners found themselves 'underwater' where their home was worth less than the loan value. This led many to decide to simply walk away from their home resulting in an even larger number of homes available on the market.

The Ownership Society and even the Community Reinvestment Act were almost certainly both launched with the best of intentions. However, the ultimate outcome was entirely predictable. And a number of people did predict the subprime crisis and subsequent financial crisis. They were in the minority view, of course, but it can't be said our economic crisis was a surprise. The economics were easily understood and the warnings were out there.

The government got involved in the housing market, demand for houses went up, prices went up, the market crashed, and the government is going bankrupt.

A similar pattern can be observed when it comes to health care. Total healthcare spending in the U.S. was approximately 5% of GDP in 1960. After five decades of increasing government intervention in the form of Medicare, Medicaid, Obamacare, and increased regulation, we now spend over 15% of GDP. The government got involved, prices went up, and the government is going bankrupt.

And, not surprisingly, the same thing has happened in higher education.

As the government has become increasingly involved, tuition rates at colleges and universities have skyrocketed. It has been deemed that 'investing in our children' and graduating as many students as possible from universities is in the national interest. Yet despite the seemingly good intentions, this increased government intervention has driven up the price of getting a college education which makes it more difficult, causes more students to depend on the government, and is costing our government money it doesn't have. And when a student graduates from a university, most of them can't find a job due to Obama's self-destructing government debt-based economy.

Since 2007, the federal government has been increasingly subsidizing student loans such that, today, a new subsidized student loan will have an interest rate of 3.4%. Under 2007 legislation, this rate expires on July 1st and will go back to 6.8%. It should be noted that those that have existing 3.4% loans will not see their rate change. Rather, the 6.8% will apply to new loans .

Both Democrats and Republicans apparently think we should continue subsidizing these interest rates to the tune of nearly $6 billion per year. The debate isn't over whether we should subsidize interest rates but how we should pay for it. Obama and the Democrats just want to extend it whereas Republicans are trying to extract the money from an Obamacare slush fund. But everyone is shouting as loudly as they can, 'We all agree we should continue subsidizing interest rates.'

But we've seen this story before. Whether it's home ownership or health care, everything the government gets involved in becomes more expensive and eventually crashes. And, in the process, the government goes further in debt. Sure, helping students afford college sounds like a noble cause-- but so does helping people afford houses or trying to provide universal health care. But we must focus on the outcomes, not the good intentions. And when the government tries to manipulate the free market, we've seen time and time again that it makes matters worse.

The government should not be subsidizing interest rates, period. Just as we had a housing bubble caused largely by the policies of the federal government and the manipulation of interest rates, there's already talk of a 'tuition bubble.'

Republicans in Congress--and the presumed GOP presidential nominee--have ceded the most important argument on subsidized student loans to the Democrats. The question shouldn't be how to pay for subsidized interest rates, but rather whether the government should be doing it at all.

The answer is NO, it shouldn't.

Regardless of whether Republicans win in their attempt to 'pay' for subsidized interest rates from an Obamacare slush fund, we still will have lost because congressional Republicans will have fought the wrong battle. They will have accepted the premise of the Democrats that the government should be in the business of subsidizing interest rates and manipulating the market as long as we pay for it with the right money borrowed from taxpayers and China.

So while Republicans and Democrats in Congress argue over who should 'pay' for interest on student loans, maybe we should instead be asking: How about the people that borrowed the money pay the interest on their loans?

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