Where can an investor earn a 7.9 per cent guaranteed annual rate of return? Not 30-year United States Treasury bonds; they pay around 3 per cent. Not other countries’ sovereign debt; some of the most economically fragile nations in the Euro zone sell 10-year bonds bearing interest rates of less than 6 per cent—and it’s certainly not guaranteed.
Try your kids. The interest rate on subsidized federal student loans is currently 3.4 per cent, but it will jump to 6.8 per cent on July 1 and covers just a slice of the market anyway. For undergraduates who don’t qualify for the subsidy, it’s already 6.8 per cent. For graduate students (including law students), the rate is 7.9 per cent.
Big returns with no risk
The program is a moneymaker for the government. According to a February 2013 Congressional Budget Office report, the federal government makes about 36 cents in revenue for every student loan dollar it puts out. Graduate (and law) student loans are especially lucrative — 55 cents on the dollar.
These eye-popping returns are especially juicy because the loans have virtually no risk of non-repayment. If a student defaults, the feds retain a collection agency to pursue the money (total cost of all federally retained debt collectors last year: more than $1 billion). Eventually, they’ll get it because such loans are in that small category of debts that survive a personal bankruptcy filing, along with alimony, child support, certain fines, and taxes. An exception for debtors who can demonstrate “undue hardship” rarely applies.
How did this happen? Good intentions went awry. In the 1960s, Congress followed economist Milton Friedman’s earlier recommendation that the government provide direct loans for higher education. The underlying principle still resonates: a society’s investment in human capital pays long run dividends. The corollary is that those who benefit personally should repay loans for the education that gives them a better life.
Unfortunately, as that better life has become more elusive for so many, the student loan program has converted struggling young people into profit centres for the government. In the trillion-dollar world of educational debt, students entering the professions — including law — are among the most unfortunate victims, in part because both their tuition and their loan interest rates are the highest.
The special plight of young lawyers
Lawyers generate little sympathy from the rest of the population. But 85 per cent of today’s law graduates have educational loans exceeding $100,000. The grim market for new attorneys means that only about half of them are finding full-time long-term employment requiring a legal degree. Even fewer earn enough to repay their staggering loans. (Before blaming these young people for their plights, take a close look at the behaviour of many law school deans who misled them into the profession with deceptive information about post-graduate employment prospects. Meaningful transparency on that topic is a recent phenomenon.)
As the July 1 deadline nears, proposals that seem to be gaining traction in Washington would preserve all above-market rates and the student loan program’s profitability. They also suggest that we’ve learned little from the subprime mortgage debacle. The House recently passed Rep. John Kline’s (R-MN) bill, resetting the graduate student rate at 4.5 per cent above the 10-year Treasury, subject to a 10.5 per cent cap.
In the unlikely event that the House bill gets past the Senate, President Obama has threatened to veto it. However, he is willing to have students borrow at a lower variable rate that’s still significantly higher than the 10-year Treasury, but with no cap (although once set, the rate would remain for the life of the loan). Combining the floating rate elements of the House proposal with the president’s plan could produce a truly disastrous compromise. The president also wants income-based repayment and debt forgiveness. Because Republicans with blocking power oppose those partial remedies on the grounds that it will encourage students to take on bigger debt, those proposals seem doomed.
Recently, Sen. Elizabeth Warren (D-MA) offered her first bill. For a year, it would cut the student loan rate to 0.75 per cent—the same rate that big banks get on their borrowing from the Fed. Unfortunately, a prospective one-year solution is no solution at all. Sen. Kirsten Gillibrand has the best current plan: set a 4 per cent rate for all student loans and allow graduates with existing debt to refinance at that rate. But that won’t happen, either.
As policymakers grapple with the growing educational debt bubble, they might consider two governing principles.
First, those running institutions of higher education should be held accountable financially for their graduates’ poor employment outcomes. Otherwise, federal dollars will continue to worsen the situation as administrators focus myopically on filling classroom seats to maximise tuition revenues. Allowing the discharge of educational debt in bankruptcy and permitting the federal government to seek recourse from schools that impoverish their graduates with tuition loans might alter some schools’ worst behaviour.
A second principle should be even easier to implement. No mechanism for funding higher education should convert our kids into profit centres.
Steven J. Harper, a former partner at the law firm Kirkland & Ellis LLP and an adjunct professor at Northwestern University, is the author, most recently, of “THE LAWYER BUBBLE – A Profession in Crisis.” A version of this column was first published on Steven J. Harper’s blog at thebellyofthebeast.wordpress.com and on The American Lawyer’s Am Law Daily, http://www.americanlawyer.com/amlaw_daily.jsp
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