What student loans, college financing, and Duff Beer have in - AEIdeas

The New York Fed:

Outstanding student loan debt now stands at $956 billion, an increase of $42 billion since last quarter.? However, of the $42 billion, $23 billion is new debt while the remaining $19 billion is attributed to previously defaulted student loans that have been updated on credit reports this quarter.¹?As a result, the percent of student loan balances 90+ days delinquent increased to 11 percent this quarter.

And as I blogger earlier, some sort of student loan bailout might be getting more likely.

All of this is an example of what I call the Duff Beer Phenomenon, named after Homer Simpson?s beverage of choice, which he once called ??the?cause of and solution to all of life?s problems.?

In the case of financing college, government is Duff Beer.?Since 2000, tuition at public four-year colleges has risen by an inflation-adjusted 72%, or nearly 6% a year. At the same time, the real average earnings for workers aged 25 to 34 with only a Bachelor?s degree have declined nearly 15%, according to Citigroup.

This raises two questions: First, are taxpayers getting value for the $65 billion a year in annual student aid and $100 billion in government subsidized loans? Second, could it be that student aid itself has a role the rise in tuition? Maybe, says a new Citigroup report:

Back in 1987, former Secretary of Education William Bennett suggested that ?increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase. ? Federal student aid policies do not cause college price inflation, but there?s little doubt that they help make it possible.??This has since become known as the so-called ?Bennett Hypothesis.?

Indeed, analysis from Stephanie Riegg Cellini of George Washington University and Claudia Goldin of Harvard finds a 75% difference in tuition between federal aid-eligible and ineligible for-profit colleges,?notes AEI?s Andrew Biggs.?That?s an amount comparable to average per-student federal assistance. Riegg and Goldin also find that that aid-eligible institutions ?charge much higher tuition ? across all states, samples, and specifications? which suggests ?institutions may indeed raise tuition to capture the maximum grant aid available.?

Some colleges may also take advantage of federal aid by reducing their own assistance. One study found that roughly four-fifths of the benefit students receive from tuition tax credits is lost through reduced student aid provided by colleges. Another found that ?institutions capture 16 percent of all Pell Grant aid? with selective private colleges clawing back 79%, Biggs writes.

There?s already plenty of incentive to attend college. The average student loan balance is $25,000, while the average Bachelor?s degree holder will earn $1 million more over his lifetime than a high school-only graduate Given how easily colleges can capture student aid from students who would go to college anyway, maybe it?s better to focus student aid on the truly poor.

Another option is using the venture capital model for student financing. ?Milton Friedman was in favor of ?human capital contracts.? As I wrote for U.S.News & World Report back in 2006:

A?student in need of college financial aid would go to a venture capital market and obtain investors in his education. In return for that equity-like financing, the student would pledge a specific percentage of his future income?as opposed to a loan?s fixed interest rate?over a specified period of time to be paid to the investor.

Eventually, human capital contracts could be combined into investment pools so the default risk could be spread over a large number of students. And as economist Gary Wolfram explains in?a study, ?As the market for these contracts developed further, shares in the funds would be traded in the same way that individuals purchase shares in such things as real estate investment trusts. This would create an economically efficient way to finance higher education that would allow students to graduate without having to fear that their future earnings would not be sufficient to pay their student loans.?

A radical idea? Only by the narrow standards of Washington policymaking.

Source: http://www.aei-ideas.org/2012/11/what-student-loans-college-financing-and-duff-beer-have-in-common/

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