- American households are carrying almost $1.6 trillion in outstanding student loan debt, making it the second largest source of debt behind mortgage loans and creating a massive overhang on the economy.
- Critics say efforts to address the problem by forgiving all or a portion of the debt will only create new problems down the road because it creates moral hazard.
- Moral hazard is the idea that people behave in riskier ways than they otherwise would because they’re removed from the consequences of their actions.
Student loan debt outstanding has risen from almost $500 billion in 2006 to almost $1.6 trillion today, spurring a number of legislative proposals in Congress to curb the debt before it makes it hard for people to buy a house or a car or otherwise make the kind of major purchases they need to participate in the economy.
“The student debt crisis is real and it’s crushing millions of families,” Sen. Elizabeth Warren (D-Mass.), a 2020 presidential contender, said in a statement June 13 when she announced she was introducing a bill to forgive up to 95% of student loan debt outstanding.
Under Warren’s bill, up to $50,000 in student loan debt would be forgiven for anyone with household income below $100,000. Smaller amounts would be forgiven for households with incomes between $100,000 and $250,000. Warren estimates the bill would forgive about 95% of outstanding debt, at a cost of $640 billion, which she has proposed imposing a tax on the country’s wealthiest households to pay for.
Warren’s isn’t the only proposal. Wayne Messam, mayor of Miramar, Florida, and also a presidential contender, has called for forgiveness of all debt within 60 days of a new administration in Washington.
“I don’t think it’s fair that the student and the parent has to bear all of this risk when it’s benefiting the entire economy,” says Messam.
Getting lost in the discussion of these and other forgiveness proposals is long-term distortion of people’s borrowing decisions, says Neal McCluskey, director of the Center for Educational Freedom at the Cato Institute in Washington. “It should be a huge concern if people say, ‘Of course we should take on debt because we know it will be forgiven,'” McCluskey told Banking Dive.
He pointed to a survey of 500 college students conducted two years ago by LendEDU that found just under half of students expected a portion of their debt to be forgiven after they graduate.
The survey question asked, “Do you believe that you will be helped by federal student loan forgiveness programs after graduation?” to which 49.8% answered yes.
Since forgiveness is already driving people’s borrowing decisions, “there’s no way way to avoid the moral hazard problem,” McCluskey says.
It was with this concern in mind that the editorial board at one of the country’s largest newspapers, the Orange County Register, criticized Warren’s plan in an op-ed earlier this year.
“If the taxpayers pay the debts of everyone with outstanding student loans, how will that affect the decisions made by current students thinking about their choices for financing higher education?” the board said April 28. “What’s the message? Borrow as much as you can and wait for the debt to be canceled during the next presidential primary campaign?”
McCluskey and other critics, including writers in Forbes magazine, say the appropriate solution is to use existing programs to address the problem.
Longer term, the solution is to get the federal government out of the student loan guarantee business, because that's what's driving up the cost of college tuition and making hard-to-pay loans necessary in the first place. "You have to turn off the spigot," Mary Clare Amselem, an analyst at the Heritage Foundation, told Banking Dive. "Private lending will lower the cost of tuition and lead to more modest loan amounts."
Editor's note: Amselem's quote was added after publication as an update.