Unintended side effects – student loans

One of the main reasons I have such a strong libertarian bent is because I’ve seen so many unintended side-effects from various government programs. It’s almost impossible to create a policy, tax break, or program that doesn’t affect the behavior of the free market.

The point of this list isn’t to say that these programs are bad or harmful. In fact, I agree with the stated goals of most of the programs that I’ll be examining. Unfortunately, as we’ll see, these programs always have unintended side effects that sometimes completely overshadow the effect of the program.

This is part 2 of a series on unintended consequences. In Part 1 of this series we looked at the mortgage interest tax deduction.

Student loans


The stated goals

Enable more people to go to college by making loans available to help pay for tuition and other educational expenses. A person’s level of education is predictive of a wide range of factors that affect quality of life including salary, net worth, divorce rate, and overall happiness.

In theory, providing loans to students will lead to an increase in the overall welfare of a society.

Explanation of program

These loans are typically available based on income level and financial need.

Some loans are offered by the federal government (and administered by the schools) and some are offered by the schools themselves. Loans offered directly by the university are called private loans.

Federal student loans are available to students who are enrolled at least half-time in participating schools. The federal loan program comes in 2 flavors – subsidized and unsubsidized. In a subsidized loan the federal government pay for the interest while the student is in school and during a “grace period’ of 6 months after graduation. Unsubsidized loans start accruing interest as soon as they are issued. The interest rate is generally low. As of August 2017, student loans for undergraduates are being issued at 4.45% interest.

Loans (including federal) are usually administered by each school. The school determines what a student’s financial need is – a student can borrow up to this amount of money. The amount of money that can be borrowed varies based on the student’s academic year and whether or not the student is “dependent” or “independent”. This ranges from $5,500 during a dependent student’s freshman year to $12,500 during an independent student’s senior year. The total loan limit is $31,000 for undergraduates and $57,500 for independent students.

Eligibility for and the size of private loans vary widely. It’s not uncommon for a student to graduate with private loans that exceed the size of their federal loans.


Unintended side effects

Loans drive up the cost of education

This is simple supply and demand. Loan make more money available to pay for college. More money available to pay for college means fewer people are unable to go to college for financial reasons. More people go to college, demand increases, prices increase.

It’s actually a brilliant business model for schools. Every year they can increase tuition at a rate that far exceeds inflation, then just provide even larger loans to enable students to pay the higher cost of education.

Universities aren’t the first industry to realize the value of providing financing to customers. Car manufacturers have been doing this for years. All major car companies have created financing divisions to provide loans to enable people to buy their cars. By offering low-interest loans the car manufacturers can increase the demand for their cars. This leads to more sales and higher prices.

If there were suddenly no loans available for higher education we’d see attendance drop overnight. Universities would be forced to find ways to reduce the cost of university to allow more people to attend. The availability of loans means there’s no incentive for universities to innovate to reduce costs.


It increases the proportion of students in low-paying majors

The only requirement for receiving a federal student loan is need. There is no credit check. There’s no analysis of future ability to pay. Can you think of another type of loan that is provided without factoring in a borrower’s ability to pay?

I’ll help you out – there isn’t one.

Let’s discuss a few hard truths here. First – different majors have different average salaries, and these average salaries vary widely. If you check out that link you’ll see that the average petroleum engineer makes $96,700 early in his career and $172,000 by the middle of his career.  Now look at the bottom of the list – the average early childhood education major starts at $30,700 and makes $37,500 by the middle of his career.

Doesn’t it seem insane to provide the same loans, for the same amount of money, and at the same interest rate, to petroleum engineers and early childhood education majors? The student majoring in petroleum engineering will initially make about 3.15x as much money as the early childhood education major, and that will widen to 4.59x as much by the middle of their careers.

More damning – if both students took out the maximum federal loan amount ($31k for 4 years), the petroleum engineer would graduate with debt that is 32% of his average initial salary while an early education major would graduate with debt that EXCEEDS his average initial salary. Frankly, it’s not fair for students in low-paying majors to graduate with that much debt. There’s just no way they can pay it.

Do you know what it would be called in other industries if mortgages were made available to people who the lender knew couldn’t repay them?

Predatory lending.

Student loans issued to students in low-paying fields are predatory loans.

If, instead, loans were issued to students based on their projected ability to pay, we’d see more money available for majors in the STEM fields (Science, Technology, Engineering, and Math) and less money available for majors in lower paying fields. This would lead to higher levels of enrollment in STEM fields and lower enrollment in other fields.

Note that I’m not making a value judgement here. I’m not saying STEM majors are better than non-STEM majors. Clearly we need people to study early childhood education and other lower paying fields. But providing loans in excess of students’ ability to repay the loan does not help anybody.


It leads to non-STEM fields being underpaid

This is related to the previous side-effect. By allowing anybody, regardless of prospective ability to pay, to receive a student loan, students have less incentive to consider future income. This leads to lower enrollment in higher-paying majors and higher enrollment in lower-paying majors than would be the case if loans considered projected salary.

And simple supply and demand tells us that more students in a given major should lead to lower salaries in that major. Conversely, fewer students in a given major would lead to higher incomes.

By making it a bit more difficult to major in, for example, early childhood education, fewer people would pursue that major and the salaries of early childhood education specialists would rise. And as the father of 2 young very young children, that’s something I’d like to see. It’s criminal how poorly paid teachers and other child-related professions are paid. I firmly believe that there are lots of great teachers that are forced out of teaching due to the low salaries.


Encourages people to attend college who shouldn’t be in college

Here’s another hard truth – not everybody should go to college. Not everybody needs to go to college. Not everybody WANTS to go to college.

Even if everybody in the world had a Ph.D. the world would still need plumbers, electricians, janitors, and  truck drivers. None of these professions need a college degree. Now you could argue that everybody benefits from a college education, in that there’s inherent value in knowledge. There IS some truth to that, and that’s why we provide a basic and general education to everybody through 12th grade. You learn about geometry and the Louisiana purchase and sedimentary rocks, even though very few of us use any of this information in our day-to-day lives (much less our jobs).

It’s hard to draw a bright line and say that education through high school is valuable for everybody but education at the college level and beyond is not. However, there is one big differentiator – students pay for college but not high school. And when you consider not only the actual financial cost of attending college but factor in the opportunity cost forgoing 4 years of a salary, it’s seems clear that the decision to attend (and pay for) college should not be make lightly. (Another factor – labor laws prevent kids under 16 from working, so there’s really no alternative to education at 15 or younger).

By making loans widely available you’re encouraging people who don’t want or need a college education to go to college. This increases the demand for college, which increases the price of college.

And the worst case scenario is that a student takes out loans to attend college for 2-3 years, decides they don’t enjoy and/or want to continue to go to college, and drops out. The student is then left with significant college debt and no college degree. Unfortunately, this is a common occurrence. According to the National Center for Education statistics, 59% of college students graduate within 6 years from the college where they started. Perhaps a few additional students transfer and graduate somewhere else, but we’re looking at 30-40% of students who pay for at least some college and never graduate. It’s likely that at least some of these students were enticed to start college because the availability of loans made it the path of least resistance.


The low-interest rates on federal loans come at a huge cost

There are two reasons federal student loans are available at lower interest rates than private loans:

  • The federal government presumably isn’t trying to make a profit on the loan programs. The government just needs to charge enough interest to cover inflation + the costs of running the programs.
  • There is virtually no risk of default because student loans can’t be discharged with other debt as part of a bankruptcy. This puts federal student loans in a category that includes child support payments, alimony, and debt owed to the IRS.

It’s this second point that I find troubling. These loans are made available to anybody regardless of credit, income, or projected ability to pay. Once the loan is made there’s no way to escape them because they survive bankruptcy. There IS a program to help student who are suffering “undue hardship” as a result of their loans, but this program is very hard to qualify for and usually results in a restructuring of the loan rather than loan forgiveness.



Possible fixes

Scale loan size to projected ability to pay

As discussed above, different majors have very different starting and mid-career salaries, which means different majors have dramatically different abilities to repay loans.

Of course, there are a number of counter-arguments. Many people don’t believe that higher education should be vocational. Students are often told to follow their passion and study something they love, with the promise that the money will follow.

Personally, I think that’s terrible advice. College is expensive. It makes no sense to spend $100,000+ over 4 years for tuition and not consider your availability to pay. If you love 18th century French literature you can study it on your own (or minor in it). But majoring in a subject with limited job prospects isn’t a great idea. Taking out loans and going into debt to major in a subject with limited job prospects is a terrible idea.

It might also make sense to scale loan sizes according to the quality of the college being attended. In 2017 the most selective college was Stanford (5% acceptance rate). The least selective college was Gainesville College (99% acceptance rate). The average SAT score for a student accepted to Stanford is 1520 (out of 1600). The average for Gainesville is 1045. I’m going to go out on a limb and say the average Stanford student is likely to make a lot more money than the average Gainesville student.

I’m going to make another crazy prediction – the average petroleum engineering student at Stanford will likely make a lot more money than the average early childhood education major at Gainesville. Perhaps we should be scaling loan sizes/availability appropriately.


Make college free (or a lot cheaper)

I can’t decide if this is a great idea or a terrible idea.

On one hand, I’m a big believer in making college available to everybody who will benefit from it. By making college tuition free you enable anybody to attend. Nobody would need to worry about how to pay for college. This isn’t as radical an idea as it sounds. State schools used to provide inexpensive quality education. In fact, when the University of California system was created in 1868 the charter mandated that tuition and fees would be free to all California residents. In 1921 a “fee” of $25 was introduced for California residents, and tuition has risen ever since. Now the cost of attending even a state school is out of reach of most lower and middle class families.

On the other hand, people tend to value something according to its cost. By lowering the cost of tuition (or making it free) you’re enabling more students to attend who don’t really want to be there. Since they don’t have any skin in the game, students are more likely to think of college as a place to spend a few years before they figure out what they want to do with their lives.

One solution to the latter problem would be to have only a few state schools that provide free tuition, and make they reasonably selective. This means only average to good students would benefit from free tuition. Students who had poor grades in high school could go to community college for 2 years and if their grades were good enough they could then apply to a state university with free tuition.

One side benefit to making state tuition free is that it would put pressure on private universities. Harvard will have a harder time justifying its cost if it’s 10x more expensive than a state school. This would almost certainly slow the rate of increase of tuition at private schools.


Embrace the “gap year”

Part of the problem with the current system in the US is that everybody is brainwashed into thinking that the “right” timeline is to go to college immediately after graduation from high school. Most 18-year-old kids have no idea what they want to do with their lives, much less what they want to study in college. Unfortunately in the current system there’s so much pressure to “stay on schedule” that most high school kids feel like they have to go right into college.

When I was in school I found that older students were more dedicated and took school more seriously than my average classmate. They were usually paying for school themselves (rather than having their parents pay for it) and so they put a lot more value on their education.

I think there would be huge value in encouraging high school graduates to go out and get some real world experience before they head to college. Encouraging kids to go travel or work for a few years before starting college might help give them perspective and a sense of purpose.

One way to actually implement this would be to make college acceptance good for something like 3 years. If you were accepted to UCLA or UT Austin you could actually start anytime in the next 3 years (perhaps you’d have to give the school notice of your intent to enroll before they make their admissions decisions for any given year).



I know that much of the analysis above sounds elitist. It’s not politically correct to point out that not everybody should go to college. It’s almost downright unAmerican to suggest that not all students should be treated equally.

But the reality is that a college education is an investment in a student. The current system of throwing loans at students to enable them to go to college is clearly not sustainable. Students aren’t incentivized to consider future salary when selecting their major and tuition costs are pushed up for all students.

Of course, not everything is about money. And it’s unfortunate but true that the lower-paying majors (and careers) tend to be in education, social work, and other areas that provide huge value to society. Most people who enter these fields do so because they love the work, want to help others, and want to make a difference. I think the best solution would be to find ways to make those jobs pay higher salaries. Unfortunately, those jobs are usually government-funded, and given the state of government finances, I don’t think raising these salaries is a feasible solution.


What are your thoughts on student loans? Have you (or somebody you know) been burdened by crushing student loan debt? Do you think the current system puts downward pressure on salaries?


2 thoughts on “Unintended side effects – student loans

  1. Many countries in Europe have a much cheaper cost of higher education, although it seems like much of the cost becomes distributed among everyone through taxes. Which is better? I’m not sure.

    Many of the wealthy in Europe actually come to the U.S. or U.K. for their education. It is arguably better? Again, this is up for debate.

  2. I’m in favor of finding ways to decrease the cost of education. If the cost of college had risen at the rate of inflation I don’t think I’d have a problem with loans. The thing that I think is really unfair is that we keep increasing the cost of tuition but fool ourselves into thinking that college is still affordable because loans are available to pay the cost of tuition.

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