Student loans should not be subsidized

By DAVID MOON, Moon Capital Management, LLC
October 23, 2011

Twenty-nine years ago today, an unranked University of Tennessee football team beat number-two ranked Alabama for the first time in 11 years. I celebrated until 8:00 the following morning. Last night I went to bed at 9:30. In-state undergraduate tuition at Tennessee was $633 a year in 1982, compared to $8,400 today.

Some things have changed in almost three decades.

A recent Wall Street Journal article detailing problems with the student loan industry described the plight of one college student overwhelmed with his student loans. The 38-year-old doctoral student receives some financial aid, but has had to take on a part-time job to cover his $3,000 a month house payment. He expects to have $25,000 in student loan debt when he graduates.

Poor child.

It is not a coincidence that college tuition and healthcare costs have increased several times the rate of inflation. Once society declares something a right, the price becomes irrelevant. By definition, a right must be guaranteed and protected at all costs.

Like healthcare, the education consumer doesn’t experience or see the true cost of his purchase at the time of the transaction. He personally bears only a fraction of the cost of his purchase. At the University of Tennessee, tuition covers only 16 percent of the cost of running the school. The rest is borne by donors and taxpayers.

Government has a well-earned reputation of being a less-than-frugal spender. If the government subsidized electronics purchases, an iPhone would likely cost $2,000, only about $200 of which the consumer would pay.

The total amount of college loans currently outstanding is almost one trillion dollars, which is more than the total amount of US consumer credit card debt. Unlike the credit cards, however, most of those student loans are guaranteed by the federal government.

FinAid.org estimates that 60 percent of all student loans outstanding are currently non-performing. That is, they are in default, deferment or forbearance.

Unlike a home mortgage or credit card loan, however, a student loan is non-dischargeable. Bankruptcy doesn’t absolve the borrower of the debt. And unlike a house loan, there is no asset on which to foreclose, other than a graduate’s future earnings.

Some students today are extending their loan terms as far out as 30 years. They will still be paying their college tuition when their own kids enter college.

Or the taxpayers will be paying it.

When a bank lends money for a house purchase, it assesses the value of the house to determine whether or not to make the loan and, if so, how much to lend. Student loans should work the same way.

The loan amount offered to a student should be capped based on the historic earnings of that school’s graduates in the student’s chosen field of study. Like currently occurs in the for-profit-school industry, universities whose students default at rates exceeding a certain percentage should be shut out of the government program.

That would provide needed incentives and discipline on both the schools and the students.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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