Why on Earth Do We Have a "Student Loan Crisis"?

By Leef, George C. | Freeman, November 2008 | Go to article overview

Why on Earth Do We Have a "Student Loan Crisis"?


Leef, George C., Freeman


Amid all our other crises, you may have missed the student loan crisis. It isn't nearly so lifethreatening as global warming, nor as financially alarming as the subprime-mortgage collapse, but it does have a lot of politicians clamoring that the country needs them to prevent serious harm. That's because - for reasons I'll get to soon - many of the firms that lend American college students money are struggling. Long-faced politicians are gravely concerned that unless they do something fast, some students won't be able to borrow for the academic year.

What is going on? Student loans for college are largely a creature of federal interven- tion. Decades ago, politicians decided that it would be good to have more people go to college, and they created a system of grants and subsidized loans to make that possible. As we have (or should have) learned from the great economist Ludwig von Mises, government intervention nearly always has unanticipated consequences that create the apparent need for still more intervention. That is exactly what we see when it comes to higher education and its financing.

Federal Intervention in Higher Education

Before World War II the federal government had virtually nothing to do with higher education. It had no regulations that colleges and universities had to obey and it paid for no one's college attendance. Occasionally, it commissioned some scientific research from professors, but otherwise it played no role. Only a small percentage of the population pursued college studies; most people didn't think it was worth the cost.

Things changed with the passage of the GI Bill in 1944, since that law provided, among other things, that returning soldiers would be eligible for federal grants if they enrolled in college. Many took advantage of that subsidy, and the government's interventionist course was set. Almost immediately, the heads of colleges realized that this new revenue source could be tapped endlessly. Expand the student body and rake in the dollars! What had been a quiet backwater of American society would become a sizzling growth industry.

During the "Great Society" presi- dency of Lyndon Johnson, government intervention took several giant steps into student finance. After all, if going to college was good for those who had served in the armed forces, why not help make this good generally avail- able? So Congress passed and LBJ signed the Higher Education Act of 1965, which established several grant and loan programs to make it easier for students to go to college. In particular, the Act created what is now called the Stafford Loan program. Stafford loans are made by private institutions. The government sets the interest rate at a level that is supposed to keep higher education "affordable"-currently 6.8 percent. And to make these fairly risky loans interesting to lenders, the government guarantees repayment. Until recently, lenders could recover 97 cents on the dollar on defaulted loans, but in 2007 Congress cut that to only 95 cents. (More on that later.)

With subsidies now flowing for a wide swath of the college-age population, expansion really took off. Before World War II, only 10 percent of high-school graduates enrolled in some sort of higher education. By the 1990s that figure was 70 percent. Americans were getting hooked on higher education and the idea that without a college degree a person would be hopelessly mired at the bottom of the labor market. It didn't particularly matter what one studied or how diligently. Simply having a college degree was assumed to guarantee at least a good middle-class job.

Credential Inflation

The college mania was also fed by employers. First, with an ever-growing pool of people with college degrees to choose from, many firms adopted personnel policies that made the possession of a college degree a requirement for applicants - even for jobs that could easily be learned by anyone with a decent high school education. …

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