It’s Time to Outlaw Student Loans

Now hold on. Before you think I’ve totally lost my mind, hear me out on this one.

More than two decades ago, when Hillary Clinton was busy working on her plan to nationalize our nation’s health care system (yes, that would be when she was First Lady), the idea of how to stop spiraling health care costs suddenly hit me: Outlaw health insurance.

The reasoning was basic economics: Sellers charge what the market will bear. Because consumers didn’t pay their health care costs out-of-pocket (that’s what health insurance is for), they had no incentive to “shop” for the best price. As a result, the market (i.e., those health care consumers) could bear almost any price. Given that, it was only natural prices skyrocketed. (Well, that and an unconstrained tort system that made medical malpractice one of the fastest growing industries in America.)

Now consider college costs. They’ve skyrocketed, too. Why? Because the financial “aid” system is predicated on student loans. Although students (actually, their parents) pay some out-of-pocket expenses, various financial lenders (government, banks, and, yes, sometimes even – again – parents) pay the bulk of the transaction through what we’ve come to call a “student” loan. In an era of low interest rates, these loans have been incredibly easy to come by. And since the consumers of college education (i.e., students) have no choice but to use loans to pay for their education, education providers (i.e., colleges) can charge whatever the market can bear.

The reality is much worse. Colleges use the high cost of tuition as a metric to determine how “elite” they are. Want to be perceived as an Ivy League school without the burden of actually joining the Ivy League? Simply up your tuition to the same level as Harvard, Yale, Princeton and the rest of their leafy ilk. It’s not a real price, it’s just a price tag. The real price is determined by financial aid. Do you absolutely positively want this particular accepted student to matriculate? Offer a financial aid package that an NFL team would give to its franchise player (i.e., an offer too good to refuse). Got someone you need to accept but don’t really want to encourage to matriculate? Offer less financial aid and let your competition “steal” the less than worthy student.

From the colleges’ perspectives, the real beauty of this deal is, for the most part, they don’t take any of the risk. Since the largest chunk of financial “aid” comes from student loans, it’s the state and federal governments as well as the banks that are left holding the bag if the student doesn’t live up to expectations.

In this sense, where’s the incentive for colleges to keep tuition fees low? Right, there is no incentive. This is why they are attracted to the idea of “free” tuition. As long as the government is paying, they may as well charge what the market can bear. And what politician has to guts to tell constituents their precious children can’t go to college?

From an economic standpoint, student loans are no different than “free” tuition. They provide an avenue for colleges to regularly overcharge for tuition without any repercussions. Now, if we outlaw student loans, we instantly dry up this steady stream of free cash to colleges. All the sudden prospective students will be a lot more demanding when it comes to asking colleges to justify their costs. Indeed, I wouldn’t be surprised if the basis for charging students becomes the major they choose to study. Engineers generally get the highest paying jobs, so they can bear the highest tuition; therefore, they would pay the highest tuition. Humanities majors generally get the lowest paying jobs, so they can’t bear a high tuition; therefore, their tuition is the lowest.

It gets better. Since engineering students pay the highest tuition, the school can afford to pay engineering professors more than, say, humanities professors. Even better, colleges will no doubt find the margins on higher tuition students are better than the margins on lower tuition students, so they will begin to recruit more higher margin students. Pretty soon, we’ll see the arts & sciences becoming less arts and more sciences.

OK, even I have to admit that might be going a bit too far. Maybe there’s a good compromise. Maybe we won’t outlaw student loans, we’ll just require colleges – not the government, the banks, or the parents – to co-sign student loans. That way we’ll know their incentives are properly aligned to the best interests of the student and not their faculty, administration, or board of trustees.