Bad News: Defaulted Student Loans Don't Cost the Government

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College studentsNew data from the federal government confirms what founder Alan Collinge has been saying for years: Defaulted federal student loans don't cost the government.

The Wall Street Journal reports that (subscription required) "After paying the companies that actually collect the loans and other costs, the U.S. Department of Education expects to recover 85% of defaulted federal loan dollars based on current value. The recovery figures are quite generous when compared with other corners of consumer debt. Banks, for example, often retrieve less than 10 cents on the dollar from overdue credit cards."

That sounds like good news. It isn't. Here's why: When lenders don't end up suffering losses on loans that are excessive, they lack any particular incentive to lend responsibly. Why worry about a student borrowing too much for a bachelor's degree when the debt can't be discharged in bankruptcy -- and you can garnish the borrower's wages for the rest of his life while tacking on interest and fees? The result is tragic stories like this one.

Only the Borrowers Pay

Collinge tells DailyFinance that "It's like the Wild West, only it's government-sanctioned." He also takes issue with the 85% figure and says his calculations show that the government is actually making money on defaulted loans. Mark Kantrowitz of notes that the gross recovery amounts are 122.1% for the recently discontinued FFELP federal loan program and 110.6% for the federal direct program -- but that collection costs bring the net recovery rate down to 85%.

He calls the collections costs "very high" and notes that "Collection agencies for student loan debt are all quite profitable, and the government has no real incentive to rein in those costs as they are paid by the borrower, not the government."

Whether it's an 85% recovery rate or north of 100%, the fundamental issues are basically the same. Student lending has developed into a system where no one other than the borrower really loses when people are saddled with excessive debt. Colleges don't care because easily available borrowing smashes the natural ceiling on college affordability -- and allows colleges to continue raising prices at breakneck speed.

How to Lower Tuition

The only way to stop this is to change the bankruptcy laws so that all student loans -- private loans and, more important (because it's a bigger market), federally guaranteed loans -- can be discharged in bankruptcy. Let the banks and the taxpayers take some enormous losses -- and perhaps then reconsider the banks' aggressive underwriting policies. This isn't an ideal solution, but it's the only one that will restore sanity.

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What would happen then? Would no one be able to go to college? Would college lecture halls and recently constructed $200,000 per bed dormitories sit vacant? Please. There's no immutable law that says college costs must rise two to three times faster than inflation. Stop the flow of easy credit, and tuition prices will come down. If you don't believe me, Google "housing bubble."

The relationship between increased funding for higher education and increased affordability is not as linear as many would like to think. Economist Richard Vedder recently explained in The New York Times that "exploding student loan programs have contributed to higher tuition charges" and notes that a larger percentage of college students came from low-income backgrounds in 1970 than today -- in spite of the enormous increases in federal student aid.

But until someone other than borrowers suffers from the consequences of excessive student loan debt, this vicious cycle will not stop.

Zac Bissonnette'
s Debt-Free U: How I Paid For An Outstanding College Education Without Loans, Scholarships, Or Mooching Off My Parents was called the "best and most troubling book ever about the college admissions process" by The Washington Post.
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