The U.S. Department of Education is sending e-mails to selected student-loan borrowers, urging them to consider signing up for income-based repayment plans (IBRs) to pay off their student loans. Currently, about 1.6 million student-loan borrowers participate in IBR plans, but DOE wants to sign up 3.6 million additional participants within the next six weeks. If DOE is successful, more than 5 million people will soon be making student-loan payments based on a percentage of their income over a long period of time--20 to 25 years.
A lot of the major players in higher education like IBRs--"pay as you earn" plans as some people call them. In a co-authored essay in Chronicle of Higher Education, Sandy Baum of the College Board lauded the President's plan for notifying students about IBRs and said IBRs should be the "default option" for student-loan repayment. In other words, unless student borrowers affirmatively opt out, they would automatically be enrolled in a student-loan repayment plan that would stretch their payments out over 20 or 25 years. Wow, what a super idea!
And how will income-based loan repayments be collected? The details aren't clear yet, but I imagine the feds will do what the Brookings Institution recommends. Student-loan borrowers will have their loan payments deducted from their payroll checks. The IRS will become the national debt collector, and a student-loan borrower's monthly loan payments will go up or down based on the borrower's current income, like income-tax withholding payments.
Thus, the day may be coming when former college students will see their monthly student-loan payment appear as just another deduction on their paychecks--like Social Security, mandatory retirement contributions, and federal and state taxes. And for most borrowers, those deductions will last about a quarter of a century.
President Obama probably thinks he is doing college-loan debtors a favor by encouraging them to sign up for long-term repayment plans. He reminds me of Colonel Nicholson in Bridge on the River Kwai. Colonel Nicholson (played by Alec Guinness) is so obsessed with building a bridge for the Japanese army that he loses sight of the fact that he is hurting his country's cause, not helping it.. Not until the end of the movie does the Colonel realize that he has betrayed his country and the soldiers he commands. The last lines of the movie are: "Madness, Madness!"
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| Col. Nicholson in Bridge on the River Kwai "Madness! Madness!" |
Why are all the insiders lining up in favor of IBRs? Two reasons:
IBR plans will hide the student-loan default crisis. First and most importantly, IBRs are a cosmetic fix for the soaring student-loan default rate. As I've explained before, the true student-loan default rate is probably twice as high as the anemic three-year default rate DOE reports every year. In the for-profit sector, the overall default rate is at least 40 percent. Over the long run, such a default rate is economically and politically unsustainable.
For years now, the for-profits have hid their institutional default rates by encouraging their students to sign up for economic hardship deferments so they won't be counted as defaulters. Millions of people have these deferments, but this shell game can't last forever. Eventually, the government will have to admit that a lot of people on economic-hardship deferments (probably most of them) are really defaulters who will never pay back their loans.
Putting people in IBRs is unlikely to increase the number of people who pay off their loans, but it will obscure the true student-loan default rate for several years. How? If people are automatically enrolled in IBRs, their loan payments will be lowered perhaps as low as zero for people who are unemployed or are in low-paying jobs. These people won't be paying off their loan balances because interest will continue to accrue. But they won't be counted as defaulters.
IBRs will take the heat off colleges and universities to keep their costs down. Second, IBRs benefit the colleges and universities. If students pay for their college experiences based on a percentage of their income instead of the amount they borrow, they will have little incentive to shop for a college based on price. And governmental agencies will have less incentive to try to keep college costs down. Colleges and universities can perpetuate the status quo indefinitely, raising their tuition rates every year without being pressured to keep their costs down.
The for-profits will be the big winners if IBR plans become the default option for student borrowers because their student-loan default rates will drop to zero in spite of the fact that too many students who attend for-profit colleges are paying exorbitant tuition and getting substandard educational experiences.
For most students and for American Society, IBRs will be a disaster. Income-based repayments may make sense for a small percentage of student-loan debtors, but if IBRs become the default option for college-student borrowers, the consequences will be disastrous.
First of all, as I just said, IBRs reduce students' incentive to borrow as little money as possible to attend college. In fact, many students will conclude that it makes economic sense to borrow to the max. Thus, if IBRs become popular, the total amount of money students borrow every year to attend college will continue going up--perhaps at a faster rate than in the past.
In addition, mass adoption of IBRs will hurt the American economy. If young people are locked into making student-loan payments for 20 or 25 years, their take-home pay will be smaller and they will have less money to purchase homes, have children, and save for retirement.
But this is the most chilling fact about IBRs: They have the potential for creating a large class of people who are in essence share croppers for the federal government They will be forced to contribute a percentage of their earnings to Uncle Sam for the majority of their working lives. No one can say with certainty what the psychological impact of this arrangement will be on American college graduates, but it could reduce their faith in the American dream and lead to mass cynicism about the American political process.
And IBRs will not increase the number of people who pay off their student loans. I predict that a majority of students who select IBR plans as their student-loan repayment option will be students who pay too much to attend for-profit colleges and don't make enough money after they complete their studies to pay back their loans. A lot of these people will be unemployed or working in low-wage jobs that entitle them to pay nothing on their loans or to pay so little that their payments won't cover accruing interest.
These poor people will see their federal loan debt grow, not shrink, over the years, even if they make all their loan payments on time. For example, the New York Times ran a story about a veterinarian who borrowed $300,000 to attend a for-profit veterinary school outside the United States. Even though this individual found a job as a veterinarian and is making regular student-loan payments under an IBR, her current job does not pay enough to enable her to make loan payments that are large enough to cover the accruing interest on her debt. A financial analyst estimated that when this veterinarian completes her 25 year repayment period, the amount of her debt will not have been paid off. In fact, it will have doubled--from the $300,000 she originally borrowed to more than $600,000!
In short--and I say this emphatically--wholesale adoption of income-based repayment plans is madness and its long term effect will be drive millions of people out of the middle class and into a new class of Americans--sharecroppers for the federal government.
References
Sandy Baum & Michael McPherson. Obama's Aid Proposals Could Use a Reality Check. Chronicle of Higher Education, August 26, 2013. Accessible at: http://chronicle.com/article/Obamas-Aid-Proposals-Could/141265/
David Segal. High debt and falling demand Traps New Vets. New York Times, February 23, 2013. Accessible at: http://www.nytimes.com/2013/02/24/business/high-debt-and-falling-demand-trap-new-veterinarians.html?pagewanted=1&_r=0
Michael Stratford. You've Got Mail. Inside Higher Education, November 4, 2013. Accessible at: http://www.insidehighered.com/news/2013/11/04/education-dept-will-email-35-million-student-loan-borrowers-about-income-based
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