The Student Loan Debt Problem
Does higher education have a "value" problem?
In our last two posts we’ve described the connection between a college education and higher wages, and the extraordinary challenges facing workers who don’t go on to finish college, including: the decreased likelihood of having a job, or getting married or moving out of your parents’ basement; the increased likelihood of being disabled, or medically uninsured, or incarcerated; and the increased likelihood of living (much!) shorter lives. Despite all this, there are growing concerns about student loans and the rising debt burden they pose on large numbers of former college students. These concerns have led to multiple rounds of loan cancellations under the Biden administration (and court decisions reversing those cancellations).
If going to college is such a financial windfall, why has student loan debt risen so fast and with such calamitous consequences for so many families?
Some history behind the current student loan crisis
A recent article by Adam Looney and Constantine Yannelis, “What went wrong with federal student loans?” surveys the changing legal and economic landscape that gave rise to the current situation. We highly recommend it to our readers – here is a quick summary.
The total number of borrowers and total debt exploded over the last 25 years, largely as a result of changes in federal rules on borrowing.
This isn’t the first time that student loan debt and debt defaults have risen rapidly. In response to a previous student loan crisis, Congress passed a series of constraints on student loans in the late 1980s: prohibiting schools from accessing loans if their borrowers had systematically high default rates; limiting the share of revenue that for-profit schools could obtain from federal loans to 85 percent; and banning the use of federal student loans at institutions that enrolled more than 50 percent of their students in a distance-based or online platform. These rules caused a dramatic decline in student loan defaults (and many loan-dependent educational institutions to exit the market!).
But a decade later Congress changed its tune, repealing the exclusion of distance/online programs from student loans and increasing to 90 percent the share of revenue that could come from student loans plus Pell grants. Borrowers were allowed to defer or reduce payments during military service, while attending grad school, or if unemployed. While interest charges facing the borrower continue to mount during a payment deferment, these deferments do not count toward a poor-performing school’s default rates. (Which if you think about it, is crazy: the federal government says, “We’ll count non-payment against schools unless the education they offered was so bad that students couldn’t find any job and exited the workforce.”) Finally, after 2007, caps on borrowing for graduate programs were lifted, so that students could effectively take out unlimited loans for graduate school.
What effect did looser federal rules have on borrowing?
What happened? Well, just about what you would expect. Beginning shortly after these changes there was a sharp rise in both the number of undergraduate students enrolling and the share of these students who borrowed to pay for school. Combining the two, there were particularly sharp increases between 2000 and 2012 in the total number of borrowers among Black (+167%) and Hispanic (+172%) students, first-gen students (+113%), students who declared themselves independent from parents (+165%), and finally, students attending for-profit institutions (+250%) and community colleges (+290%).
Similar patterns held with graduate program enrollment, but there the biggest increases came not from the number of borrowers but the now-astronomical tuition prices that could be funded entirely through student loans. Again, for-profit institutions were responsible for the largest growth, an astonishing increase of 926% from 2000-2012. But there are plenty of examples of traditional universities charging high graduate tuition prices for programs that seem unlikely to generate commensurate returns for students.
There is good news and bad news in these data. The good news: increasing access for low income and traditionally unrepresented students can yield significant earnings increases and make the return on investment large and positive. But that only occurs if students graduate, and only if the institutions in questions provide students with an education that prepares them for higher paying jobs.
Graphic from Looney and Yannelis, “What went wrong with federal student loans?”
The bad news: during the 2000-2012 surge in borrowing, Looney and Yannelis show the largest increases in enrollment occurred in those institutions that had the worst student loan repayment rates. They single out for-profit institutions for particular criticism, citing a variety of studies linking them to higher debt, higher default, and lower earnings after enrollment.
The effect of non-completion and institutional quality on loan performance can also be seen by examining the amount originally borrowed by students to the amount now owed. (If you are not making loan payments, interest payments cause debt to grow beyond the initial loan amount.) An analysis by the HEA Group shows that the growing loan balance problem is primarily concentrated among non-completers, students who take out loans but do not finish degrees and thereby fail to earn the associated wage premium. An exception is student loans taken out for study at two-year institutions, certificate programs, and for-profit four-year programs. In these cases, even students who complete these programs now face, on average, greater loan balances than what they originally borrowed. In the case of for-profits, much greater!
(An analysis that we haven’t seen, but would like to: what is the student default rate for two-year public community colleges? The data above lump them in with a wide variety of professional, technical, and vocational programs - many for-profit. The return on this investment, and the associated default rate, seems particularly relevant in light of a recent push to provide entirely free access to community college education.)
That’s the past. What’s the current situation?
It is important to note that many of the changes highlighted here reversed themselves after 2012. Data from the College Board shows that the percentage of students who borrow for college rose steadily from 2000 (25%) to 2012 (38%), but declined each year since, returning to 2000 levels by 2023. That is, in the most recent year 75% of students didn’t take out any loans at all !
Looney and Yannelis show that, of the minority of undergraduates who do take out loans, they borrow small amounts — on average only $6500 a year. This results in a remarkably low finishing loan balance for the typical undergraduate student: only $27,400 for a graduate from a four-year public institution ($29,400 if we include public and private four-years.)
For comparison $27,400 is just over half the price of the average new car purchased in the US, and about *one year* of earnings premium for the median college grad compared to the median high school grad.
Yes, there are many stories in the press featuring students laboring under unsustainable debt burdens. But it is important to keep in mind how unusual these cases are. Very large debt balances (greater than $50,000) are concentrated among grad students, and undergraduates who attended for-profit universities. As the remarkable chart below shows, only 10 percent of borrowers hold 47% of total loan debt, and 57% of all loan debt is held by those with graduate degrees.
Graphic taken from College Board “Trends in College Pricing and Student Aid, 2023”
These subtleties are entirely lost on the reader of a typical scare story highlighting the student debt crisis, with higher education as a whole being found guilty by association. Given the reversals of many of these trends, why is student loan debt still such a hot button issue? There are four reasons.
First, the excesses of the 2000-2012 era are still with us, resulting in an accumulation of debt that peaked at $1.75 trillion before starting to decline. Student loans often come with a ten-year repayment plan, but deferments and missed payments can extend this time period for many decades. Students who made poor decisions during this period are laboring under an unrecoverable debt load.
Second, there are still bad actors – institutions who encourage students to rack up huge loans without generating sufficient value for their students to repay these loans. Many of these are for-profit institutions, others are traditional universities operating primarily in the over-priced graduate degree space. We’d recommend a new report out by the Georgetown University Center of Education and the Workforce. We’ll follow up on this in a later post, with some proposed solutions.
Third, non-completion of degrees is a critical issue. Nationwide, completion rates at four-year universities have *risen* to 67% (78% for four-year private schools, but only 46% at four year for-profit schools, and 43% at public two year schools). And to be clear, the completion rates at “four-year” schools are actually measured six years after matriculation, with far too many of these graduates paying five or six years of tuition and other expenses, not four. Sadly, after decades of improvement, one in three matriculants at traditional universities still do not finish their degrees. We’ll have more on this later as well.
Fourth, the cost of college varies widely across institutions and the returns to degree vary significantly across majors. Leaving aside the contribution of financial aid (more on this later) an excellent in-state institution charges as little as $20,000 a year for tuition, room and board, while some private institutions charge almost five times this amount.
If one were to attend, say, Duke or Columbia University and pay $370,000 dollars for an undergraduate degree in performing arts to earn a $2000 a year wage premium over a high school degree, the financial return on that college investment isn’t positive. In fact, at current rates, the opportunity cost of those investment dollars is about 10 times their return!
But if one were to attend a flagship public university in-state and earn an engineering or computer science degree, one would earn back the entire cost of tuition, room and board from the associated wage premium in as little as two years.
Put another way, we believe that much of this problem comes down to a fundamental failure of financial literacy connected to college choices, including the complexity of college pricing and financial aid. In our experience, students have a very weak understanding of how their choice of institutions (and the true cost of those institutions) and majors maps into expected earnings, with a host of consequences for careers and debt. We’ll take those issues on in future posts as well.
Next up: the underemployment problem. Why do so many college grads work in jobs they say do not require college degrees?
“Finding Equilibrium” is coauthored by Jay Akridge, Professor of Agricultural Economics, Trustee Chair in Teaching and Learning, and Provost Emeritus at Purdue University and David Hummels, Distinguished Professor of Economics and Dean Emeritus at the Daniels School of Business at Purdue.