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The Student Loan Fiasco: Made in D.C.

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Tags EducationFree MarketsInterventionism

06/27/2007Robert P. Murphy

In response to mounting controversy over the student loan industry, the House recently passed the Student Loan Sunshine Act by a large margin (414 to 3). The Act would require lenders to disclose any financial relationships they have with educational institutions, and it would prohibit certain questionable activities, such as lenders giving "gifts" to the employees in a school's financial aid office.

Straightforward as this act seems, it will fail to address the true causes of corruption in higher education. Stronger proposals, such as to bypass the private lenders altogether and have all students get their loans directly from the federal government, would be disastrous. At root the problem is massive government subsidies and regulations, and more of the same will only make the situation worse.

To understand it all, we need to separate out the various allegations. On the one hand, Democrats are accusing the Bush Administration of very benign neglect of what has been dubbed "recycling and refunding," whereby lenders use artful manipulation of their portfolios to qualify for a 1980 provision (when interest rates were far higher than today) that guaranteed lenders a 9.5 percent return on their student loans. As reported in a critical Salon.com article: "While payments on 9.5 percent loans had held steady at below $200 million per year since 1990, according to a 2004 report by the Government Accountability Office, the amount of 9.5 percent payments rose from $209 million in 2001 to over $630 million in 2004."

If true, these allegations would be deplorable indeed; hundreds of millions of taxpayer dollars would be funneled into private hands in clear violation of the spirit of the original laws. However, the solution here would be to end the subsidies, not demonize the lenders who can't resist picking up millions of dollars lying on the table. For an analogy, there are currently plenty of landowners who get paid large sums by the federal government not to grow crops. (This dates back to a misguided New Deal–era program designed to prop up farm prices.) The solution here too is to stop making such payments, not to gnash our teeth about greedy landowners or (even worse) suggest the federal government nationalize all food production.

However, the real outrage in the past few months hasn't been over wasted taxpayer dollars. Instead, the controversy centers on the cozy relationships between private lenders and school officials, whereby colleges steer new students to preferred lenders who then reward the compliant staff with gifts and other compensation. For example, in 2005 JP Morgan apparently paid $70,000 for a harbor cruise in New York City for over 200 financial aid officers — and one gets the sense that this wasn't an altruistic effort by the investment bank to promote maritime appreciation. With seemingly outrageous behavior like this, surely the federal government needs to step in, right?

The problem with this knee-jerk reaction is that it is government involvement that has led to the corruption in the first place. For example, why don't we read daily newspaper articles about the problem of kickbacks in, say, the retailing industry? After all, the manager of the apparel section in a Wal-Mart could easily take bribes from a vendor in order to stock the shelves with a more expensive sweater.

But we don't need the federal government to police this possibility, because Wal-Mart executives themselves have every reason to stamp it out, since such self-seeking behavior by the individual manager hurts Wal-Mart's bottom line. Customers are always free to shop at a different chain that does a better job controlling its employees and thus holding down costs. (For those younger readers who might wonder whether my analysis is realistic, I merely refer them to the episode of Friends when Monica is fired from her prestigious job as a chef when she innocently accepts steaks from a vendor. This is serious stuff!)

These incentives for self-regulation are largely absent in higher education. For one thing, a large volume of student loans is processed through government-run schools in the first place. There, if the administrators keep a sharp eye out for corruption and thus hold down costs, this doesn't translate into higher profits for shareholders. But even in nominally private colleges and universities, government regulations and massive subsidies effectively blur the distinction between private and public. Very few schools in the United States today are "run like a business," and that's precisely why corruption is so manifest — unlike the vast majority of businesses.

The solution to the crisis in higher education is to take the government out of the equation. The "single payer" Pentagon certainly doesn't hold down costs, and the ranks of politicians are certainly not known for their upstanding morals. The idea that the federal government can be trusted to root out waste and corruption is absurd — those proposing such a "remedy" need to get educated.

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