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How to Reduce Student Borrowing

It was a kind of mania. People got in too deep, way overleveraged. Why? The cost of being in the game kept going up – but so, it seemed, did the return on investment. You just had to get in, get out and find a nice landing spot, before the music stopped.

Yes, that description fits the financial crisis that sparked the Great Recession. But it also describes student loans, which at a total of $1.75 trillion surpass Americans’ aggregate credit-card debt and have some politicians talking about broad forgiveness.

Both cases highlight a special brand of moral hazard – the kind our government creates when it helps fuel a problem, and then proposes a solution that allows others to escape the consequences of their actions.

Moral hazard is often invoked to describe the effects of a given action. For example: “If we give amnesty to illegal immigrants, more people will immigrate here illegally.” That kind of moral hazard is worth heeding.

But another aspect is likely at play with student loans: Even talking about an action will prompt some people to behave as it will happen eventually. Returning to the immigration example: “Because high-ranking politicians say they want to grant amnesty to illegal immigrants, more people already have immigrated here illegally.”

The mere possibility of being let off the hook is enough for some desperate or just imprudent people to get themselves hooked in the first place – risking death or financial ruin.

Some actors in the financial crisis were probably (ahem) banking on a bailout if they got into trouble. There were plenty of examples within the memory of longtime executives: Penn Central Railroad, Lockheed, Franklin National Bank, Chrysler, Continental Illinois, various savings and loan institutions, even New York City – all between 1970 and 1990.

“Too big to fail” was almost 25 years old when it again became a common phrase in 2008. Too many lenders and investors had been spared the consequences of backing overly aggressive banks in the past.

Were those banks indeed “too big to fail”? Maybe. More to the point, the notion they might ever be allowed to fail came too late to prevent their bad behavior.

Back to student loans. No one believes for one second that a blanket forgiveness of student loans by the federal government – the lender in the vast majority of student loans – would be a one-time thing, any more than bank bailouts have been. If it is done once, it will become a permanent expectation.

But is it an expectation already?

Student debt certainly has increased in recent decades, by any measure. But short of thousands of borrowers admitting they took on debt thinking they’d get a bailout one day, it’s hard to prove they acted on the expectation of loan forgiveness.

That said, the numbers tilt in that direction. The average cost for tuition and fees at a public university was about 5.1 times higher in 2020 than four decades earlier; for private universities, it was about 3.3 times higher.

The amount of debt per student was about 7.7 times higher. What’s more, the share of enrolled students who took out loans also rose substantially.

Students’ willingness to take on debt is growing out of proportion, even to the soaring cost of higher education. This, despite the increasing clarity that salaries for college graduates aren’t keeping up with debt loads. (The debt-to-income ratio for college grads tripled between 1980 and 2020.)

Did politicians’ promises to wipe out student debt spur these trends? We can’t say for sure. But in a country divided 50-50 politically, with only two major parties, the eventual likelihood of leaders who favor loan forgiveness coming to power and finding a way to enact that policy surely is high enough for some people to believe their debts would be erased.

We’re now navigating the hazards of that kind of thinking. The best way to reduce student borrowing may be to stop telling students they won’t have to pay back their loans.