Where can an investor earn a 7.9 percent guaranteed annual rate of return? Not 30-year United States Treasury bonds, which pay about 3 percent; shorter-term bond rates are even lower. And certainly not other countries’ sovereign debt; some of the most economically fragile nations in the Euro zone sell 10-year bonds bearing interest rates of less than 6 percent—and those returns are surely not guaranteed.
Try your kids. The interest rate on subsidized federal student loans is currently 3.4 percent, but will jump to 6.8 percent on July 1—and that covers just a slice of the market anyway. For undergraduates who don’t qualify for the subsidy, it’s already 6.8 percent. For graduate students (including law students), the rate is 7.9 percent.
Big Returns, No Risk
The program is a moneymaker for the government. According to a February 2013 Congressional Budget Office report, the federal government makes about 36 cents in revenue for every student loan dollar it puts out. Graduate (and law) student loans are especially lucrative: 55 cents on the dollar.
These eye-popping returns are especially juicy because the loans have virtually no risk of nonrepayment. If a student defaults, the feds retain a collection agency to pursue the money (total cost of all federally retained debt collectors for the most recent fiscal year: more than $1 billion).
Eventually, they’ll get it because such loans are among those rare debts that survive a personal bankruptcy filing, along with alimony, child support, certain fines, and taxes. An exception for debtors who can demonstrate “undue hardship” rarely applies.
How did this happen? Good intentions went awry. In the 1960s, Congress followed economist Milton Friedman’s earlier recommendation that the government provide direct loans for higher education. The underlying principle still resonates: a society’s investment in human capital pays dividends in the long run. The corollary is that those who benefit personally should repay loans for the education that gives them a better life.
Unfortunately, while that better life has become more elusive for so many, the student loan program has converted struggling young people into profit centers for the government. In the trillion-dollar world of educational debt, students entering the professions—including law—are among the most unfortunate victims, in part because both their tuition and the interest rates on their loans are the highest.
The Special Plight of Young Lawyers
Lawyers generate little sympathy from the rest of the population. But 85 percent of today’s law graduates have educational loans exceeding $100,000. The grim job prospects confronting newly minted attorneys mean that only about half of them are finding full-time long-term employment requiring a law degree. Even fewer earn enough to pay off their staggering loans. (Before blaming these young people for their plights, take a close look at the behavior of many law school deans who misled them into the profession with deceptive information about postgraduate employment prospects. Meaningful transparency on that topic is a recent phenomenon.)
As the July 1 deadline for expiration of the current partial subsidy nears, proposals that seem to be gaining traction in Washington would preserve all above-market rates and the student loan program’s profitability. They also suggest that we’ve learned little from the subprime mortgage debacle. The House recently passed Representative John Kline’s (R-MN) bill that would reset the graduate student rate at 4.5 percent above the 10-year Treasury, subject to a 10.5 percent cap.
In the unlikely event that the House bill clears the Senate, President Barack Obama has threatened to veto it. At the same time he has expressed a willingness to have students borrow at a variable rate that’s still significantly higher than the 10-year Treasury, but with no cap. (Once the rate was set, the president’s plan would leave it in place for the life of the loan.) Combining the floating rate elements of Representative Kline’s proposal with the president’s plan could produce a truly disastrous compromise that would, at best, be a questionable improvement. The president also wants income-based repayment and debt forgiveness. Because Republicans with blocking power oppose those partial remedies on the grounds that they will encourage students to take on more debt, those proposals seem doomed.
Senator Elizabeth Warren (D-MA) recently offered her first bill since taking office. For a year, Warren would cut the student loan rate to 0.75 percent—the same rate that big banks get on their borrowing from the Fed. Unfortunately, a prospective one-year solution is no solution at all. U.S. Senator Kirsten Gillibrand (D-NY) has the best current plan: set a 4 percent rate for all student loans and allow graduates with existing debt to refinance at that rate. But that won’t happen, either.
As policymakers grapple with the growing educational debt bubble, they might consider two governing principles. First, those running institutions of higher education should be held accountable financially for their graduates’ poor employment outcomes. Otherwise, federal dollars will continue to worsen the situation as administrators focus myopically on filling classroom seats to maximize tuition revenues. Allowing the discharge of educational debt in bankruptcy and permitting the federal government to seek recourse from schools that impoverish their graduates with tuition loans might alter some schools’ worst behavior.
A second principle should be even easier to implement. No mechanism for funding higher education should convert our kids into profit centers.
Steven J. Harper is an adjunct professor at Northwestern University and author of The Lawyer Bubble: A Profession in Crisis (Basic Books, April 2013), and other books. He retired as a partner at Kirkland & Ellis in 2008, after 30 years in private practice. His blog about the legal profession, The Belly of the Beast, can be found at http://thebellyofthebeast.wordpress.com/. A version of the column above was first published on The Belly of the Beast.