If you believe that the $1.6 trillion in student loan debt is a looming crisis that promises to only get worse, there is a simple change that would not only radically improve the student loan system but would also place a much-needed market discipline on the entire education industry.
Schools and universities should be held liable for students who default on their student loans.
Schools currently have little-to-no skin in the game. Colleges with consistently low graduation rates or high loan default rates can eventually have their access to federal aid dollars reduced after years of repeated failures. By then, however, those schools have already collected years of student loan proceeds, grants, interest rate subsidies and tax benefits – while their former students are left obligated for thousands of dollars in debt.
Incentives are powerful things. The current financing system imposes no price or quality of education discipline on colleges or trade schools. This partially explains why the cost of college has increased at twice the rate of inflation over the past 30 years. I am not suggesting that schools are indifferent to the plight of their former students, but the current system imposes little-to-no risk on schools.
This type of accountability would strengthen well-run schools offering valuable instruction at an attractive cost/benefit ratio. For proof, we have the mobile home industry as an example. During the home mortgage meltdown of 2007-08, the default rate on loans originated by Clayton Homes was less than that on the mortgages originated by First Horizon (parent company of First Tennessee Bank.) The difference was that the employees at a Clayton Homes dealer are paid – and penalized – based on the performance of the loans they originate. They are incentivized to sell you a home you can afford and penalized for selling you more.
In the same way that financial institutions transfer lending risk to shareholders, universities transfer risk the federal government.
My suggestion would apply to any school that accepts federal benefits – from Harvard (with its $41 billion endowment) to the local cosmetology school. Schools needn’t fund loans from their own resources; the federal government could continue to do that. The only “cost” to a school would be if its students don’t repay their loans.
This type of accountability wouldn’t likely affect most public schools with high numbers of in-state students. The three-year default for University of Tennessee-Knoxville federal loan program borrowers is 4.7%, less than half the 9.3% national average. The average UTK monthly payment of $207 is less than half of the monthly payment for a $22,000 automobile. The most affected would-be for-profit colleges, many of which could not exist without taxpayer money.
David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.