Tuesday, October 22, 2013

The Brookings Institution Makes A Proposal for Student Loan Reform: Let's Turn College Graduates Into Sharecroppers

The Hamilton Project, a public policy initiative sponsored by the Brookings Institution, issued a report this month that offers some promising ideas for reforming the federal student loan program. At the same time, not all of the ideas are good.

The Hamilton Project Proposal in a Nutshell

In a nutshell, the Hamilton Project proposes a simple income-based repayment plan for student borrowers that will replace the hodgepodge of repayment options now in place. Students will make loan payments based on a percentage of their income for a maximum of 25 years. Any unpaid balance owing at the end of this 25 year period will be forgiven with no tax consequences for the debtor.

Loan payments would be paid through a payroll deduction similar to Social Security deductions and debtors would be free to make larger loan payments than the minimum if they want to pay off their loans early. The proposal calls for the government to manage the repayment program instead of contracting out this work to private loan servicers.

In addition, the Hamilton Project recommends the elimination of interest subsidies for low-income borrowers while they are in school. The authors point out that these subsidies do nothing to increase the number of low-income students who enroll for college since the subsidy doesn't really benefit them until they enter the loan-repayment phase.  In the authors' opinion, money spent on subsidizing interest rates should be directed toward grants.


Long-Term Student-Loan Repayment Plans Will Create a New Class of Sharecroppers
Sharecropper cabin, 1936
Photo by Carl Mydans


Finally, the Hamilton Project proposes important reforms for the private student-loan industry.  Most significantly, the Project recommends the repeal of a 2005 Bankruptcy Code provision that makes it almost impossible for borrowers to discharge private student loans in bankruptcy.  The Project recommends that private student loans be treated like any other unsecured debt in bankruptcy.

The Hamilton Project's Proposal Contains Some Good Ideas

I like some of the Hamilton Project's proposals.  First of all, I heartily endorse the Hamilton Project's proposal for providing better bankruptcy protection for people who took out private loans from the banks. Congress made a mistake when it amended the Bankruptcy Code in 2005 to make it almost impossible for debtors to discharge their private student loans in bankruptcy. As I have said before, repealing the 2005 provision would probably have the salutary effect of driving the banks out of the private student- loan business.

I also like the Hamilton Project's proposal for simplifying the process for student debtors to participate in an income-based repayment plan and for having the government handle loan repayments through payroll deductions rather than having private student-loan servicers manage the repayment process.  Some of the private loan servicers are harassing delinquent student-loan debtors, and I would like to see their operations shut down.

Flaws in the Hamilton Project's Proposal

But  the Hamilton Project's proposal has some flaws.  First and most importantly, the plan calls for student-loan repayment obligations to stretch out for as long as a quarter of a century. In essence then, student-loan debtors will become sharecroppers for the government, paying a portion of their wages over most of their working lives in return for the privilege of going to college. I am opposed to lengthy income-based repayment plans as a matter of principle.

And, as I have said before, income-based repayment plans reduce students' incentives to borrow as little as possible and they reduce the colleges' incentives to keep their costs down.

The Hamilton Proposal is Based on a False Assumption

The Hamilton Proposal is based on the premise that most students don't borrow that much money, and thus they should have no trouble paying off their loans under an income-based repayment plan in just a few years. It points out that almost 70 percent of student-loan debtors borrow less than $10,000.

But as the Hamilton Project acknowledged in footnote 7 of its report, by the time people go into default, they owe considerably more than they borrowed due to penalties and accruing interest. If interest rates accrue for low-income borrowers while they are in school or if low-income borrowers' income-based payments are too low to cover accruing interest, then the amount of their debt will become larger--probably much larger--than they originally borrowed.

Conclusion: Some of the Hamilton Project's Proposals Have Promise, But We Should Avoid Putting Student Loan Debtors in Long-Term Repayment Plans

Some of he Hamilton Project's proposals have promise.  Restoring bankruptcy protection for private student-loan borrowers and eliminating the private student-loan repayment servicers are good ideas.

But the people who have been hurt the most by the federal student loan program are young people who attended for-profit colleges. As the Hamilton Project pointed out, people under 21 years of age have the highest loan default rates of any age group, and we know from many sources that people who attended for-profit colleges have the highest student-loan default rates.

The Hamilton Project's proposal is likely to put a lot of young, low-income people into long-term repayment plans they will never pay off.  And many of these long-term debtors--perhaps most of them-will be people who attended expensive for-profit colleges.

We simply must shut down the for-profit colleges.  Otherwise, the Hamilton Project's proposal for putting student-loan debtors in 25-year repayment plans will likely created a 21st century version of indentured servants--people who attended for-profit colleges that were too expensive and who will spend the majority of their working lives paying for college experiences that did not enable them to earn a salary large enough to quickly pay off their student loans.

References

Susan Dynarski and Daniel Kreisman. Loans for Equal Opportunity: Making Borrowing Work for Today's Students. Hamilton Project, Brookings Institution, October 2013. Accessible at: http://www.brookings.edu/~/media/research/files/papers/2013/10/21%20student%20loans%20dynarski/thp_dynarskidiscpaper_final.pdf

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