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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Feb 27, 2013

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Student loans are big business — just ask the government.

According to Congressional Budget Office (CBO) figures, the government will make $106 billion in federal student loans to college students for the fiscal year ending Sept. 30. In this fiscal time period, the government will make an estimated $39 billion in interest off of federal student loans.

And there is no decrease predicted for the future. The CBO predicts that within a decade, nearly $145 billion in new federal student loans will be dispersed for fiscal year 2023.

But the U.S. government is losing an uphill battle. The trillion dollar student loan debt crisis continues to grow. Potential for added revenue could force the government into serious financial issues.

The government didn’t always have its hand in the business of higher education.

So was it worth the risk?

The Beginning of a Business Model

Before the Second World War, the government was practically disassociated with higher education. But after two world wars, things began to change.

The government’s passage of the GI Bill in 1944 allowed for returning WWII soldiers to apply for federal grants if they enrolled in college. Many soldiers took advantage of this benefit.

Dr. Nathaniel Cline, assistant professor of economics at the University of Redlands, said that it is commonly suggested that the GI Bill “created the image of higher education as a standard achievement of the middle class.”

Soon after, higher education became a large business both for the government and universities. In 1965, with the passage of the Higher Education Act of 1965, several grant and loan programs were established by the federal government to make higher education more accessible to potential students.

Cline said this federal lending created the student loan market.

The ACT itself created the Stafford loan program, one of the many types of federal student loans. Stafford loans, which are no longer available, are made by private institutions, but the interest rate is set by the government. This was created in order to set a more affordable rate for students. The lenders were willing to make loans with a low interest rate because the loans were guaranteed by the federal government, meaning that if the loans defaulted, the government would provide repayments to the lenders.

Cline told loans.org that the government has incredibly low borrowing cost and can offer student’s loans at low rates and he questions the government’s ability to make the CBO’s projected estimate of $39 billion in interest.

But regardless of the government’s ability to offer attractive rates for students, Cline said the federal government “should not be in the business of using student loans for revenue.”

Dr. Timothy Nash, vice president for strategic and corporate alliances at Northwood University, said the federal government entered into student lending for a short source of revenue. He said the government saw the amount of money going to the private lending sector and wanted to gain a portion of that revenue.

And it worked.

According to a Center for Education Statistics report, before the Second World War, only 1,494,203 students pursued higher education. Ten years later, this number jumped by almost 1 million to 2,444,900.

The next 60 years saw a spike unlike any other. For fall 2012, a record 21.6 million students were expected to attend Americans college and universities, according to the National Center for Education Statistics (NCES).

Even the number of higher education institutions has increased significantly. At the beginning of WW2, in 1939, there were 1,708 higher education institutions reported. In 2009, the U.S. Census found a total of 4,495 degree-granting postsecondary institutions.

Cline said that while opening up federal student loans did increase higher education access, the overall cost, as we see now, is “brutal.”

“We are witnessing what could only be described as debt peonage,” Cline said.

Education, Made in America

With each additional student pursuing college, the potential for profit increased for the government. But their desire to make a profit has created an influx in the higher education population.

The more students and funding pumped into the higher education system increased the chances for a problem to develop. Before it could be stopped, a crisis ensued.

“There is a true societal cost to this student loan default crisis,” Nash said.

Student loan debts have steadily grown to become a trillion dollar issue — one that is not shrinking or being solved.   

As seen with the auto industry, bailouts are a last ditch effort. But the government cannot afford a large-scale bailout of student debtors at this time.

The United States has a national debt that is 104 percent of the country’s Gross Domestic Product (GDP). It is problematic when the country owes more than the country itself has and is worth. It’s as if the country is underwater on their mortgage, or has a negative bank balance. But this is a debt that cannot be ignored or absolved.

Although the government, as previously mentioned, could stand to make an estimated $39 billion in interest off of federal student loans, it is simply not enough to financially prepare for the potential economic crisis that is continually building each day.

Part of the reasoning could be a misconception about the actual cost of higher education. Some students enter high education with the delusion that it is affordable.

The NCES reported that in 2010, the total annual cost to attend a public college or university for in-state tuition cost an average of $20,100. For private colleges and universities, the average year cost was $39,800.

Nash said that, statistically speaking, in 1940, around four percent on the total population had a college degree or masters. Today it reaches to 24 percent.

But Nash is not pleased with that number.

“We would be better off if a higher percentage of our population graduated from college,” he said. “It’s a system that gives a tremendous amount of people a chance.”

He stated that the U.S. education system is “robust” and “the envy of the world” but that there are always ways to improve.

“Can it get better, more efficient? Yes,” he answered.

Nash said he believes the United States has a valuable education system, but that students should research to find “the best possible value.”

Value, in this case, is being realistic about a given major and its market value.

“You can’t go to college and incur a lot of debt and then be surprised that you have a degree that the market doesn’t want to pay for,” Nash said. “Right now, parents and young people have to be smarter.”

Default Rates and Dire Consequences

According to the U.S. Department of Education, two years after leaving higher education, student borrowers default on their federal loans at a rate of 9.1 percent. This is an increase from 8.8 percent in the previous year’s count.

The federal student loan default rate climbs to 13.4 percent for the three-year marker.

But defaulting on student loans is different from other forms of loans.

Unlike failed mortgages, student loans lack collateral. Instead of turning over a home during foreclosure, lenders turn to the student and parent consumers themselves.

Nash said that the student loan crisis puts a “more dire consequence” on individuals than the mortgage crisis did due to the fact that the government targets multiple outlets for repayment.

The government, in its quest to retrieve federal student loan payments, can garnish future wages, seize tax refunds, social security payments, and even personal assets to reclaim funds from defaulted loans. Since so few federal student loans are absolved in bankruptcy, the threat of the government as a feared debt collector will follow students for years to come.

And wage garnishments not only elicit fear, they inhibit the economy’s growth.

Cline said student’s increased debt-to-income ratio allots for less disposable income. This income is what fuels the economy. He said it harms the economy because we currently have insufficient aggregate demand and it postpones student’s abilities to reach “major milestones of adulthood.”

Nash said student loan default rates could cause the next financial disaster for the U.S. economy. He said beyond federal and local government debt, the student loan crisis is his next pick for a large economic crisis.

Cline agrees. He said that student loan debt presents a major impediment for economic recovery.

“The massive inequality in the U.S. poses the largest threat, and the student loan debt crisis is, in part, a consequence of this,” he said.

Responsibility and Averting the Crisis

Although Nash believes there is a serious threat looming, he does not foresee a need for the government to step in.

“I’m not sure what the government can do to mediate the difficulties,” he said. “I don’t think it’s the role of the government to avert this crisis.”

Instead, Nash said a solution will take a differing mentality for consumers; a need for rational decisions is fundamental for change.

“It’s the role of the individuals,” he said. “People are going to have to sacrifice to pay off their student loans.”

Cline has little faith in bailouts as a solution.

Cline believes that taxpayers should not be responsible to bail out private lenders. He said lenders were bailed out in the current financial crisis, and lending did not resume as expected.

“One thing politicians have not learned from history is that these kind of financial recessions are never fixed until debtor’s balance sheets recover,” Cline said. “The federal government should work to bail out students the way it bailed out homeowners during the Great Depression.”

But Nash disagrees.

“This economy cannot afford to bailout the student loan problem,” Nash said.