Showing posts with label moral hazard. Show all posts
Showing posts with label moral hazard. Show all posts

Wednesday, August 24, 2022

Biden Administration Extends Pause on Student-Loan Payments Until End of This Year: Has The Government Created A Moral Hazard?

 Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. 

 The Economic Times

Christmas came early this year for student-loan debtors. First, the Biden administration is extending the pause on student-loan payments until the end of 2022, which means that college borrowers are getting a two-and-half-year holiday from making monthly loan payments. 

That's not all. President Biden will give every borrower under an income cap of $125,000 (or $250,000 for married couples) $10,000 in student-debt relief.

Borrowers who received Pell Grants in college will get $20,000 in debt relief.

That's big news--especially for borrowers who got Pell Grants while in school. If we add the Pell Grant money these student-borrowers obtained while in college, plus the $20,000 loan write-off, many of these people will have gotten a free education.

And there's more. The Biden administration will launch a more generous income-based repayment (IBR) plan that will lower income-based payments for undergraduate loans from 10 percent of discretionary income to just five percent. The Department of Education also intends to raise the amount of income considered nondiscretionary, meaning that undergraduate borrowers will pay less than five percent of their income on their student loans.

Still, Santa's sack of gifts is not empty. Under DOE's proposed rule, the government will cover the unpaid monthly interest for people in IBRs, meaning student debtors on income-based repayment plans won't see their loan balances go up due to negative amortization.

Party poopers like Larry Summers say that all this federal generosity will fuel more inflation, but who cares? Certainly not the student-loan debtors. In fact, rising inflation will be a bonanza for them because they will be paying back student loans with deflated dollars.

Grumps also argue that the Biden student-loan forgiveness scheme acts as a moral hazard, and I think this is true. If students know they will make loan payments based on their income, not the amount they borrowed, they have every incentive to borrow extravagantly.  

And Biden's munificent changes in income-based repayment plans will likely act as a moral hazard for the colleges as well. University leaders have no incentive to keep their costs in line when they know that students will cheerfully absorb tuition hikes because their loan-repayment plans are so generous that it won't matter whether their tuition bills get larger.

In defense of Biden's sweeping student-loan reforms,  I think everyone agrees that many students took out loans to get a college education that wasn't worth much and was too expensive. 

Millions of students were scammed by for-profit colleges or private nonprofit universities that cranked out overpriced, worthless graduate degrees. Surely the victims of the higher education racket deserve some relief. 

Nevertheless, the federal government is headed for catastrophe if it rolls out student-loan repayment plans that are overly generous while doing nothing to rein in the higher-education racket.

Unfortunately, the feds are doing nothing to stop students from being scammed. Instead, federal money is propping up the colleges--both profit and nonprofit, which allows them to raise tuition prices yearly. 

At the same time, the hucksters who run the colleges offer students educational experiences that don't help them get jobs after they graduate. As a consolation, I suppose, the government is making it very easy for ripped-off students to manage their college debt.

The cold war Russian economy, it was said, ran on the principle that the government pretended to pay the workers and the workers pretended to work.

Something like that is going on in American higher education. The colleges are pretending to educate their students, and the students are pretending to pay for it.

This will end badly for everyone--students, colleges, and taxpayers.  

Merry Christmas!



Friday, June 22, 2018

Researchers say Income-Driven Repayment Plans create moral hazard: Yuh think?

More and more student borrowers are being forced into income-driven repayment plans (IDRPs) because they can't pay back their college loans under a standard 10-year repayment schedule. According to an article in Educational Researcher, the proportion of student borrowers in IDRPs increased from 5 percent in 2012 to 20 percent in 2016.

Three researchers affiliated with a North Carolina research institute analyzed data on IDRPs, and their findings are not surprising. They found people entering IDRPs borrowed more than people who did not enter these plans. IDRP participants also had lower-income backgrounds than people who did not sign up for IDRPs.

They also found that IDRPs create a "moral hazard" because monthly loan payments under these plans are not coupled to the amount of money students borrow. "As IDR plans become more generous," the authors wrote, "students have less incentive to limit their borrowing and less incentive to seek high-paying jobs because upon leaving school their monthly loan payments depend only on discretionary income, not loan amounts." And, as students become more willing to borrow, colleges and universities "face lower incentives to curb tuition increases."

Put another way, if borrowers know their loan payments will stay the same regardless of whether they borrow $50,000 or $100,000, then why not borrow $100,000? And from a university's perspective, if students are willing to borrow enormous amounts of money to pursue their studies, then why not jack up tuition rates?

The researchers also pointed out that a lot of IDRP participants are making payments so low that their loan balances are growing due to accrued interest. In other words, their loans are negatively amortizing. Thus at the end of a 20- or 25-year IDRP, many borrowers will owe more than they borrowed.  People who complete IDRPs will see their remaining loan balances forgiven, but the forgiven amount is considered taxable income by the IRS.

Income-driven repayment plans were touted by the Obama administration as a good way for student borrowers to manage growing levels of debt. But the article in Educational Researcher adds to a growing body of evidence pointing to this stark reality: millions of people in IDRPs have student-debt loads they will never pay off.

So why did the U.S. Department of Education expand its income-driven repayment options? After all, even a child could foresee the moral hazard built into these programs.  These plans are being peddled for one reason and one reason only: They help obscure the fact that millions of Americans--probably 20 million--are not paying off their student loans.



References

Lacy, T. Austin, Conzelmann, Johnathan G.,  & Smith, Nicole D. (2018). Federal Income-Driven Repayment Plans and Short-Term Student Loan Outcomes. Educational Researcher, 47, 255-258.