In the midst of the political debates, we are hearing proposals to forgive all student loan debt to eliminate the $1.5 trillion burden hanging around the necks of 45 million borrowers. The rationale being that all these borrowers would then use the funds that would have paid off their student loans to go purchase other things and boost the economy. A tax or charge on some form of wealth within the economy would fund this. Sounds great, right? Well, it would certainly be tremendous for the 45 million borrowers. But there are plenty of caveats.

The Root Cause

Problem solvers of the world will quickly point out that solutions that do not address the root cause of an issue will fail in solving the problem. In terms of student loan debt, the root cause, in our view, is that the cost of attending college has been growing faster than wages, financial aid, and just about everything else. Loans have become the bridge for the gap between college costs and financial resources available to families. Over the years, this has resulted in students and parents taking on a ton of student loan debt to cover this gap (see chart 1) Forgiving this accumulation of debt will not cure the core problem.

Chart 1

Debt Servicing Capacity And Accountability

Increased financial literacy and income

Meanwhile, news reports drawing attention to the burgeoning student loan debt has helped to vastly increase the financial literacy of students and parents today compared to just 10 years ago. There is information available at schools and lenders assisting borrowers to better understand the implications of borrowing for college costs (see chart 2). These efforts have been further supplemented by Higher Education Authorities to provide meaningful tools to support financial budgeting around college.

Chart 2

All of this education and intelligence is allowing people to make decisions that are more informed. There is now information available to help with the value proposition that takes into account the cost and more data regarding starting salaries for occupations that are associated with various types of college degrees (see chart 3). The focus on school costs has also created a push for more transparency on graduation rates and average incomes. Households have access to more information than ever before to assist in the financial decisions made to attend college.

Chart 3

Income share agreements, college repayment benefits, and the bankruptcy option

Another positive coming out of all this student loan debt is the energy around income share agreements, which allow for borrowers to make loan payments based on a percentage of their income after graduation for a certain amount of time. These financial arrangements have the potential to create a meaningful payment alternative. There are also many more employers offering college repayment benefits than ever before as competition for college graduates heats up and companies use recruitment tools to separate themselves from the competition. Income-based payment plans have also been introduced to provide more affordable payments. More work needs to be done on these fronts to create more sustainable success, but these are viable strategies.

The point here is that a large portion of the student loan borrowing universe is repaying its debts. Student loan refinance companies have targeted high-income graduates to offer lower interest rates and there are millions of applications funneling into these companies. Unfortunately, there is not enough financial interest to fund the demand in the private sector. However, refinancing student loan debt could be a great opportunity for the federal government to use its financial strength to offer borrowers reduced interest rates to save money while paying back their student loans. It seems rational that, to the extent they have the financial resources to do so, students should be responsible to foot the cost of the college that they chose to attend. After all, they are the direct beneficiaries of their educations. (See chart 4.)

Chart 4

For those who can't sustain their debt burdens, there is already a solution: bankruptcy. It is a well-established process that has been around a long time. To date, borrowers are generally not able to discharge student loan debt in bankruptcy. But enabling this may be a more viable option than having the government pay off the debt. From another perspective, forgiving all student loan debt would absolve nonpayers and erase important credit bureau data for student loan borrowers, which is currently informing lenders about creditworthiness. In the forgiveness scenario, student loan borrowers would receive preferential treatment compared to borrowers holding other forms of debt.

Warning Sign

There are already a large number of skeptics with any type of federal forgiveness plan given the recent reports on the public service loan forgiveness (PSLF) program distributed by the Department of Education (ED). This program established in 2007 permits Direct Loan borrowers making 120 monthly payments under a qualifying repayment plan, while working full-time for a qualifying employer, to have the remainder of their balance forgiven. The latest report on the PSLF shows that few applications have been approved, and news reports are highlighting a 99% rejection rate. Process issues, such as incomplete forms, appear to be the primary reason for the turndowns; therefore, these borrowers may just need to supply more information to qualify. However, stories are surfacing of extremely frustrated borrowers with the wrong federal loans that do not qualify. In many cases, these individuals have sacrificed higher income jobs for a loan forgiveness opportunity that they find they are not able to obtain.

Finding Another Way

Proponents of the loan forgiveness proposal have accounted for its affordability by using forecasts showing economic growth in the future. But other considerations of how to spend the $1.5 trillion seem entirely warranted. Many other areas of society could benefit from just a sliver of a $1.5 trillion fund (see chart 5). Higher education is extremely important, but it seems only fair that borrowers who directly benefited from the loans be held accountable for their decision to use federal student loans.

Chart 5

Student loan debt forgiveness for all would not be addressing the multi-decade problem of escalating college costs. It would not fix the funding challenges for higher education at the state level. In fact, freeing borrowers of their student loan debt would likely further unleash the exploding costs of higher education. In our view, it would be wise to explore alternative solutions.