Easy access to student loans for people who have little prospect of repayment helped feed the Higher Ed bubble, much as easy access to mortgages for people who had little prospect of repayment helped feed the housing bubble.  It made good politics but really bad economics.

Easy student loans have allowed higher education institutions to raise tuition at a far greater pace than any other sector of the economy:

Federal enablement of easy money goes straight into the pockets of universities, but the students have to repay the loans.  It’s a system which could work only in a strong employment economy for students, but that is a thing of the past as almost half of recent graduates are unemployed or underemployed.

There is no incentive for price competition, because students easily can take out more loans.

Paying back the loans is a different matter. The art major who graduates $150,000 in debt starts off in a hole which will be hard to get out of regardless of interest rate. So too the law school graduate who never will practice law because there are few high-paying law jobs for students graduating from lower-tiered law schools, and even from some highly ranked law schools.

The system is broken.

We have a choice, continue to grow the bubble with easy money, or try to wean the nation off the easy money tuition subsidies.  Certainly it can’t be done overnight, but we need to move away from growing the bubble even more.

Elizabeth Warren wants to grow the bubble more by making it easier for students to borrow more money by dropping the interest rate to that charged banks by the Federal Reserve, in what amounts to a giant class warfare non-sequitur.  Trying to stimulate the economy through bank lending has nothing to do with subsidizing tuition increases via student loans.

As usual, Warren portrays the plan in terms of victimization:

The new Democratic senator from Massachusetts introduced her first bill Wednesday, the Bank on Students Loan Fairness Act, offering students temporary relief from the burden of high interest rates on loans.

“If the Federal Reserve can float trillions of dollars to large financial institutions at low interest rates to grow the economy, surely they can float the Department of Education the money to fund our students, keep us competitive, and grow our middle class,” Warren said during a speech on the Senate floor, her second one so far.

Under the plan–and for only one year–eligible students would be able to borrow at the same interest rates on their federally subsidized Stafford loans as large banking institutions do with the Federal Reserve.

Big banks can currently lock down a rate of 0.75 percent, Warren made sure to note. College kids, however, pay much more than that. And it’s only going to get worse for them as of July 1, when the rate is scheduled to double from 3.4 percent to 6.8 percent.

“In other words, the federal government is going to charge students interest rates that are nine times higher than the rates for the biggest banks—the same banks that destroyed millions of jobs and nearly broke this economy,” she said. “That isn’t right.”

It’s classic Warren, playing on emotions but losing sight of the actual problem.  It’s similar to her campaign theme that we needed to fund infrastructure at the same rate as China, which has an infrastructure bubble.

Lowering interest rates to 0.75% from the current 3.4% doesn’t address the problem. It’s worse than rearranging the deck chairs on the Titanic, because it creates the illusion that there is no cost to money.

But the principal still needs to be paid back, so unless student loan forgiveness is the next step (probably), enabling students to borrow more money cheaply in order to subsidize tuition increases makes the bubble worse.

Not surprisingly, Warren had no co-sponsors when she introduced the bill yesterday, but she does have a big fan:

Feeding the tuition beast is not the answer. Except to Elizabeth Warren.

Update 5-10-2013:  New post, More on the bad economics of Elizabeth Warren’s student loan proposal

 
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