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Rep. Tom Petri (R-WI 6th District) has a plan to tackle student debt. It allows automatic withdrawals from a borrowers' paycheck. And? It will only exacerbate the student loan crisis. The bank-friendly 2005 bankruptcy laws that guarantee student loans will get paid back till (notwithstanding a few loophole miracles) death do you part need to be scrapped. The money spigot full on, banks and colleges are traipsing into the sunset with higher commissions and higher tuition. That needs to end, too. Funding public universities might help, as would something like the GCE-A that makes college affordable in the UK. More below the fold...

As Washington slides ever closer to the fiscal cliff, financial vortex, or whatever will be the next term du jour, and our national focus finally shifts to fixing that which has heretofore been deemed "unfixable," perhaps 2013 is the year we endeavor to fix our very broken student loan system.

In the first quarter of 1999, Americans owed $90 billion on student loans. It now exceeds $1 trillion. That's not a bubble, dear friends, that's a black hole.

The laissez-faire environment that fostered this extreme growth (1100 percent) has more in common with the repeal of the Glass Steagall Act or the zoning plan of the greater Houston area than it does with a properly functioning free market system.

Higher education has become a confidence game, with banks and slick marketing machines playing shill in a scam where the "mark" is the dream of American prosperity, parental aspirations and an army of kids conned into believing that an appreciation of Shakespeare will magically result in an appreciation of their net worth.

At the risk of sounding like Rick Santorum (which in my world is a fate far worse than death), just because there's plenty of dough (for purchase at a premium), doesn't mean everyone should go to college. Among those who are gifted in a college sort of way, the lack of financial literacy that prevails among prospective students is dangerous. Kids are not being prepared for the challenges of life -- including the acquisition of a job, housing and all the rest -- so much as they are being prepped for the rigors of witty banter at a cocktail party.

We face a moral hazard. Money is too easy to get. Kids aren't taught about the realities of the workplace. They get hard-to-market degrees, rack up a lot of debt and then can't find jobs that pay enough to justify the expenditure. It's deadly, too.  The government farms out delinquent student debt to collection agencies -- those boiler room guys who specialize in intimidation and relentlessness... The result: suffocating debt and an increase in suicide among jobless graduates.

Last week Congressman Tom Petri introduced a plan to tackle student debt. The Wisconsin Republican's solution will be quite familiar to people from Commonwealth countries, including the UK, New Zealand and Australia. It allows automatic withdrawals from a borrowers' paycheck (capped at 15 percent of a borrower's income) to be managed directly by the Education Department and the Internal Revenue Service. In fairly short order, this practice would ease the demand for the services of collection agencies, saving an estimated $1 billion in commission payments that would otherwise go to those dastardly denizens of the deep.

"This doesn't mean leaving taxpayers on the hook if a student borrows too much," Petri told Bloomberg News. "It does mean providing much stronger protections against the kind of financial ruin that is all too prevalent in our current system."

The problem here is that Rep. Petri's heart is in the right place, but he's missed the mark. The only thing that will prevent the financial ruin associated with the current system is to hobble the conditions that make it possible.

One of the fundamental problems is that since the law was amended in 2005, student debt cannot be discharged through bankruptcy.

That Bush-era modification of bankruptcy laws turned the basic precepts of debt upside-down. With most loans, a borrower with a low credit score pays a higher interest rate to compensate the lender for the increased risk of default. But there is almost no risk of default when it comes to a student loan, because bankruptcy very rarely results in the discharge of the debt. So, lenders can throw lots of money at mirror fogging degree-seekers, whether or not they are suited for their educational pursuits (or those pursuits will yield the return that justifies the expenditure), and the bank-friendly 2005 bankruptcy law guarantees they'll get paid anyway. (If you're thinking, "That's not a credit market. That's legalized theft," you'd be right.) Petri's proposal serves to further deepen that rut.

Colleges and universities charge higher and higher tuition each year because there is an endless flow of federal loans and federally insured private loans protected by bankruptcy laws that are so lender-favorable they'd make a Feudal baron blush. With these ironclad guarantees that loans will be repaid, institutions keep the money spigots open, which in turn gives schools zero incentive to cut costs while creating optimal conditions for tuitions to increase exponentially.

I agree with the Obama administration, it's time to start treating student loans like any other type of debt and allow them to be erased by bankruptcy. That said, the administration's recommendations, which came by way of the Education Department and the Consumer Financial Protection Bureau this July, only apply to 15 percent of the total outstanding debt -- about $150 million in private student loan debt held by private lenders like SLM Corp.'s Sallie Mae and Wells Fargo. Why shouldn't the other 85 percent be treated the same way?

If the federal government and private lenders choose to make student loans, they should also accept the risks inherent in lending. Maybe that means creating academic benchmarks that qualify would-be college students for vocation-specific educational loans. That's for them to determine. For sure it means stripping the immunity currently enjoyed by these institutions from borrower bankruptcies. The result of this simple change will re-introduce free market fundamentals, which will cause an adjustment to the cost of credit. Some students will pay higher interest rates on the money they borrow -- but they will also be more careful about what sort of credits they use it for. They will also be pickier about where they spend that money.  These factors should exert downward pressure on tuition.

Colleges have adopted a corporate model of competition, building condo-like dormitories and outrageous student centers, installing state-of-the-art technology and Nobel Prize-winning labs at schools where no Nobel-level faculty can be lured, even with teetering mountains of cash and prizes used to lure the next best thing. It's the academic version of an arms race, and it will continue making college an engine for financial ruin for millions of young Americans until we, as a nation, start insisting on a reality principle -- that there should be some relationship between expenditure and the return on investment for students.

One way to do that is to bring price competition back to the higher education marketplace by investing more in public universities. States are slashing funding for higher education, forcing schools to plug the holes by boosting tuition. Re-funding public universities will make them less dependent on tuition for operating and capital costs -- and with that more able to hold the line on tuition hikes; creating a more competitive environment.

The most effective way to tame student debt is a simple supply and demand approach. We need to slow the flow of money. Low interest rates fueled the mortgage boom. Cheap student loans are "funding" the indentured scholarship of lifelong student loan debt. Let schools use other sources of money, including endowments and alumni donations, to compete for market share by building lavish swimming pools or expanding into new disciplines.

Rep. Petri should be commended for advancing an idea that has already proven to be effective in the UK and elsewhere. The Commonwealth has another practice that would help our public universities reset the floor on college prices: national benchmarks that qualify students for a publicly-funded college education. In the absence of that sort of paradigm shift, we should at least consider going to the root of the problem. It's not about debt collectors and new creative ways to keep debt-saddled graduates from committing suicide. It's about addressing the conditions that made debt collectors and all the rest a reality.

Pretending the laws of supply and demand don't apply to college education is a recipe for disaster. The marketplace is wiser than the boardroom (and makes Washington look positively brain dead). It's time to return student loans to the discipline of the free market. Only then can tomorrow's graduates enjoy the futures they've been promised.

This column originally appeared on the Credit.com blog.

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Comment Preferences

  •  "We face a moral hazard." (3+ / 0-)
    Recommended by:
    ScottDog, codairem, simnyc

    You do realize that you're not using that term in its traditional sense, yes?

    Namely: moral hazard is the idea that someone who is insulated from loss is more likely to act in ways that will lead to that loss.

    A good example of moral hazard was AIG et al. shortly before the Wall St. meltdown: they knew that they were so big that the government would have to come in and help them—thus they didn't have to worry about what might happen if they f***ed up big time.

    If there is moral hazard here, it is not on the part of everyday Americans.

    We don't want our country back, we want our country FORWARD. --Eclectablog

    by Samer on Thu Dec 13, 2012 at 08:44:57 AM PST

    •  er, is *not* (0+ / 0-)

      Stupid italics. . . .

      We don't want our country back, we want our country FORWARD. --Eclectablog

      by Samer on Thu Dec 13, 2012 at 08:45:26 AM PST

      [ Parent ]

    •  i think we're on the same page (2+ / 0-)
      Recommended by:
      ScottDog, simnyc

      The moral hazard here is that legislation protects banks from bad loans by making the debt undischargeable. Further this allows tuition to increase because there is a free flow of bank money. But I think you're right that I did bend the term here a bit. Also: I think that everyday Americans need an education system that teaches financial literacy, so they see the pitfalls created by wild west lending practices, unregulated banking practices and bank-friendly legislation.

      •  Hell, I'm a conservative Republican (0+ / 0-)

        with no college debt and I completely agree with this. There's no reason that banks should be insulated from the consequences of getting college students to borrow money they could never hope to pay back. Let it be discharged in bankruptcy like every other kind of debt.

  •  Great idea! The economy doesn't need people to (0+ / 0-)

    buy things. (Snark) Let's start deducting money from his paycheck for every stupid idea he expouses. The twit would be bankrupt in a month.

    Hope has a hole in it when Republicans come, bringing shackles and sorrow; branding their greed on the backs of the poor. - Wendy Connors

    by Wendys Wink on Thu Dec 13, 2012 at 08:47:44 AM PST

  •  asdf (0+ / 0-)
    The Commonwealth has another practice that would help our public universities reset the floor on college prices: national benchmarks that qualify students for a publicly-funded college education.
    This doesn't address the student loan problem any more than scholarships do.  It would simplify and unify the process of  very smart people getting a full ride to college, but a lot of the student loan burden falls on people who don't qualify for scholarships, or even for admission to public/private universities.  

    In particular, we have an epidemic of massive student loan burdens among kids at for-profit scam schools.  We can do a lot by shutting that down, while an A-level free ride to college won't do much about it.

    Taking jokes seriously is the exact mirror activity of laughing if someone says they have cancer. --jbou

    by Caj on Thu Dec 13, 2012 at 10:04:33 AM PST

    •  Tho I should qualify (0+ / 0-)

      I'm totally in favor of some kind of A-level free-ride guarantee.  I think a lot of smart kids qualify for scholarships but aren't the competitive scholarship-pursuing type.  

      I also think a nationwide system of this type would help in an indirect way, by reinforcing a scholastic standard for higher education in the public mind.  Right now everyone is trying to go to college or send their kids to college, because it is perceived as "the" way to make it in today's world.  Periodically I see arguments for sending everyone to college---all ignoring the fact that college is supposed to be hard, and requires a minimum scholastic aptitude.  If academic standards are enforced, most of the population will flunk out of a 4-year degree program.  Thus it should not be seen as a universal economic remedy.

      Taking jokes seriously is the exact mirror activity of laughing if someone says they have cancer. --jbou

      by Caj on Thu Dec 13, 2012 at 10:11:21 AM PST

      [ Parent ]

  •  With low default rates (2+ / 0-)
    Recommended by:
    simnyc, Adam Levin

    why is my student loan set at 6.8% interest? The government should force the banks to lower interest rates to 2% or 3%.
    It is crazy that I pay 3.25% on my car loan that I can file bankruptcy on, but pay 6.8% on student loans that I can not file bankruptcy!

  •  We faced the moral hazard when the banksters (0+ / 0-)

    were bailed out. We lost and moral hazard won.

    To hell with the creditors of student loan debt. The entire $1T should be erased. Let the rich creditors take a haircut from the neck up.

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