Why Federal Student Aid Programs are Dysfunctional and Among the Worst of Many Bad Federal Programs
Federal Student Aid and the Law of Unintended Consequences
Hillsdale College - Imprimis: The following is adapted from a speech delivered on May 10, 2012,
at Hillsdale College’s Allan P. Kirby, Jr. Center for Constitutional
Studies and Citizenship in Washington, D.C.
FEDERAL STUDENT financial assistance programs are costly,
inefficient, byzantine, and fail to serve their desired objectives. In a
word, they are dysfunctional, among the worst of many bad federal
These programs are commonly rationalized on three grounds: on the
grounds that assuring more young people a higher education has positive
spillover effects for the country; on the grounds that higher education
promotes equal economic opportunity (or, as the politicians say, that it
is “a ticket to achieving the American Dream”); or on the grounds that
too few students would go to college in the absence of federal loan
programs, since private markets for loans to college students are
All three of these arguments are dubious at best. The alleged
positive spillover effects of sending more and more Americans to college
are very difficult to measure. And as the late Milton Friedman
suggested to me shortly before his death, they may be more than offset
by negative spillover effects. Consider, for instance, the relationship
between spending by state governments on higher education and their rate
of economic growth. . . .
What about higher education being a vehicle for equal economic
opportunity or income equality? Over the last four decades, a period in
which the proportion of adults with four-year college degrees tripled,
income equality has declined. (As a side note, I do not know the
socially optimal level of economic inequality, and the tacit assumption
that more such equality is always desirable is suspect; my point here is
simply that, in reality, higher education today does not promote income
Finally, in regards to the argument that capital markets for student
loans are defective, if financial institutions can lend to college
students on credit cards and make car loans to college students in large
numbers—which they do—there is no reason why they can’t also make
student educational loans.
Despite the fact that the rationales for federal student financial
assistance programs are very weak, these programs are growing rapidly.
The Pell Grant program did much more than double in size between 2007
and 2010. Although it was designed to help poor people, it is now
becoming a middle class entitlement. Student loans have been growing
eight to ten percent a year for at least two decades, and, as is well
publicized, now aggregate to one trillion dollars of debt
outstanding—roughly $25,000 on average for the 40,000,000 holders of the
debt. Astoundingly, student loan debt now exceeds credit card debt.
Nor is it correct to assume that most of this debt is held by young
people in their twenties and early thirties. The median age of those
with loan obligations today is around 33, and approximately 40 percent
of the debt is held by people 40 years of age or older. So when
politicians talk about maintaining low interest loans to help kids in
college, more often than not the help is going to middle-aged
individuals long gone from the halls of academia.
With this as an introduction, let me outline eight problems with
federal student grant and loan programs. The list is not exclusive.
(1) Student loan interest rates are not set by the forces of supply
and demand, but by the political process. Normally, interest rates are a
price used to allocate scarce resources; but when that price is
manipulated by politicians, it leads to distortions in the use of
resources. Since student loan interest rates are always set at
below-market rates, too much money is borrowed for college. Currently
those interest rates are extremely low, with a key rate of 3.4
percent—which, after adjusting for inflation, is approximately zero.
Moreover, both the president and Governor Romney say they want to
continue that low interest rate after July 1, when it is supposed to
double. This aggravates an already bad situation, and provides a perfect
example of the fundamental problem facing our nation today: politicians
pushing programs whose benefits are visible and immediate (even if
illusory, as suggested above), while their extraordinarily high costs
are less visible and more distant in time.
(2) In the real world, interest rates vary with the prospects that
the borrower will repay the loan. In the surreal world of student loans,
the brilliant student completing an electrical engineering degree at
M.I.T. pays the same interest rate as the student majoring in ethnic
studies at a state university who has a GPA below 2.0. The former
student will almost certainly graduate and get a job paying $50,000 a
year or more, whereas the odds are high the latter student will fail to
graduate and will be lucky to make $30,000 a year. . . .
(3) Perhaps most importantly, federal student grant and loan programs
have contributed to the tuition price explosion. When third parties pay
a large part of the bill, at least temporarily, the customer’s demand
for the service rises and he is not as sensitive to price as he would be
if he were paying himself. Colleges and universities take advantage of
that and raise their prices to capture the funds that ostensibly are
designed to help students. This is what happened previously in health
care, and is what is currently happening in higher education.
(4) The federal government now has a monopoly in providing student
loans. Until recently, at least it farmed out the servicing of loans to a
variety of private financial service firms, adding an element of
competition in terms of quality of service, if not price. But the Obama
administration, with its strong hostility to private enterprise, moved
to establish a complete monopoly. One would think the example of the
U.S. Postal Service today, losing taxpayer money hand over fist and
incapable of making even the most obviously needed reforms, would be
enough proof against the prudence of such a move. . . .
(5) Those applying for student loans or Pell Grants are compelled to
complete the FAFSA form, which is extremely complex, involves more than
100 questions, and is used by colleges to administer scholarships (or,
more accurately, tuition discounts). Thus colleges are given all sorts
of highly personal and private information on incomes, wealth, debts,
child support, and so forth. A car dealer who demanded such information
so that he could see how badly he could gouge you would either be out of
business or in jail within days or weeks. But it is commonplace in
higher education because of federal student financial assistance
(6) As federal programs have increased the number of students who
enroll in college, the number of new college graduates now far exceeds
the number of new managerial, technical and professional jobs—positions
that college graduates have traditionally taken. A survey by
Northeastern University estimates that 54 percent of recent college
graduates are underemployed or unemployed. . . .
Connected to this is the fact that more and more kids are going to
college who lack the cognitive skills, the discipline, the academic
preparation, or the ambition to succeed academically. They simply cannot
or do not master well much of the rather complex materials that college
students are expected to learn. As a result, many students either do
not graduate or fail to graduate on time. I have estimated that only 40
percent or less of Pell Grant recipients get degrees within six years—an
extremely high dropout or failure rate. No one has seriously questioned
that statistic—a number, by the way, that the federal government does
not publish, no doubt because it is embarrassingly low.
Also related is the fact that, in an attempt to minimize this
problem, colleges have lowered standards, expecting students to read and
write less while giving higher grades for lesser amounts of work.
Surveys show that students spend on average less than 30 hours per week
on academic work—less than they spend on recreation. As Richard Arum
and Josipa Roksa show in their book Academically Adrift: Limited Learning on College Campuses, critical thinking skills among college seniors on average are little more than among freshmen.
(7) As suggested to me a couple of days ago by a North Carolina
judge, based on a case in his courtroom, with so many funds so readily
available there is a temptation and opportunity for persons to acquire
low interest student loans with the intention of dropping out of school
quickly to use the proceeds for other purposes. (In the North Carolina
student loan fraud case, it was to start up a t-shirt business.)
(8) Lazy or mediocre students can get greater subsidies than
hard-working and industrious ones. Take Pell Grants. A student who works
extra hard and graduates with top grades after three years will receive
only half as much money as a student who flunks several courses and
takes six years to finish or doesn’t obtain a degree at all. In other
words, for recipients of federal aid there are disincentives to excel.
* * *
If the Law of Unintended Consequences ever applied, it is in federal
student financial assistance. Programs created with the noblest of
intentions have failed to serve either their customers or the nation
well. In the 1950s and 1960s, before these programs were large, American
higher education enjoyed a Golden Age. Enrollments were rising,
lower-income student access was growing, and American leadership in
higher education was becoming well established. In other words, the
system flourished without these programs. Subsequently, massive growth
in federal spending and involvement in higher education has proved
With the ratio of debt to GDP rising nationally, and the federal
government continuing to spend more and more taxpayer money on higher
education at an unsustainable long-term pace, a re-thinking of federal
student financial aid policies is a good place to start in meeting
America’s economic crisis.
Read the entire article here: http://www.hillsdale.edu/news/imprimis/archive/issue.asp?year=2012&month;=05
RICHARD VEDDER is the Edwin and Ruth Kennedy Distinguished Professor
of Economics at Ohio University and director of the Center for College
Affordability and Productivity. He received his B.A. from Northwestern
University and his M.A. and Ph.D. in economics from the University of
Illinois. He has written for the Wall Street Journal, National Review, and Investor’s Business Daily, and is the author of several books, including The American Economy in Historical Perspective and Going Broke by Degree: Why College Costs Too Much.
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