The Real Problem With Rising Student Debt

David Leonhardt of the New York Times has made the surprising case that, despite what you've probably heard, enormous student loan burdens are not so common. Here he is citing a new report from the Brookings Institution:

Only 7 percent of young-adult households with education debt have $50,000 or more of it. By contrast, 58 percent of such households have less than $10,000 in debt, and an additional 18 percent have between $10,000 and $20,000.

This story set off a storm of argument and counterargument. Peter Coy at Bloomberg Businessweek has good run-down of the debate about the data here if you want more on what the fuss is about.

But let's forget about the absolute size of student debt. One thing that's absolutely clear, as the Awl's Choire Sicha says, is that the amount of it has grown very quickly.

...people with college debt saw their debt double, and also the number of those households with debt more than doubled. That is not exactly undermining this supposedly fake narrative of the increase of student debt!

More than a third of households headed by someone under 40 carry student debt now, up from just 14% in 1989. And that may be a big deal even if most debts are relatively small. Why? Because for many people student loan debt is risky.

Let's be clear. Borrowing to go to college can be an incredibly smart investment: The lifetime return, in terms of extra earnings, from a bachelor's degree may be as high as 15% year. But that's an average. Not everyone who borrows to go to college actually gets a plum job, not least because not everyone makes it to a B.A. Leonhardt says this is the real lesson of the Brookings study.

...the Brookings paper does contain a true cause for concern: “Among households with some college but no bachelor’s degree, the incidence of debt increased from 11 to 41 percent.” The average amount of debt among this group also more than doubled over the last two decades. Some members of the group are thriving community-college graduates, but more are college dropouts.

Leonhardt suggests fixing this is mostly about looking at the schools. Far too many colleges are drop-out factories. But I think this also points to a basic structural problem with debt as tool to finance the cost of a college education.

Imagine, instead of a student, that it's a company that wants to make an investment in its future growth. One way to fund this is to find equity investors (that is, issue stock.) Equity can be an attractive way to get money because the investors bear a lot of the risk—if the company fails to meet its earnings projections, it never has to pay stockholders a dividend. Investors have no recourse but to grumble and hope things get better. The other way to get money is to borrow, by going to the bank or by issuing bonds. That can be a riskier move. Whether earnings come in high or low, the lenders must be paid the agreed upon rate of interest.

Although this is beginning to change, for the most part, students who need extra funding for their college education have only the riskier debt option. If their earnings aren't what they expect, they still have to carry that loan. In fact, unlike other kinds of debt, student loans so hard if not impossible to restructure in bankruptcy.

Economists Atif Mian and Amir Sufi, whose book on the mortgage crisis, House of Debt, I recently wrote about, say that households need more equity-like ways to finance essential investments. For mortgages, they'd like to see a new kind of loan that indexed payments to local housing prices, so that in the event of a real estate crash the lender shared some of the downside. Mian and Sufi make a similar proposal for student debt. They'd link the principal value of the loan to the unemployment rate for college grads, so that if unemployment goes up the debt burden goes down.

The economists prefer this to the better known idea of basing loan repayments on income. The Obama administration has recently expanded one such program for people with federal student loans. Mian and Sufi worry that linking payments to individual income can create a perverse incentive to earn less. But income based repayment may help address the risk faced by people who start college but don't graduate, since they may struggle financially even when college grads as a group are doing well. In any case, both ideas are steps toward making college financing more equity-like.

Of course, America actually has a long experience of making an equity investment in college educations. State universities' subsidized tuitions are taxpayers' bet on students' future earnings. The ones who don't graduate, or don't land a high-paying job, or who decide to do something socially useful but poorly paid, aren't stuck with the huge bills their private-school peers may have. But the ones who do well end up paying the state back part of their upside—in taxes. In recent years, though, states have been spending less per student on colleges, and rising public college tuitions have contributed to the spread of debt. For today's students, that's been a step into a riskier world.