Student loans, as any Economics 101 student (if they still teach that) would predict, drastically distort the market for higher education. Subsidize production and supply will increase. However, due to relatively inelastic demand, price (tuition) hasn’t gone down. Instead, universities capture most of the surplus. Tuition keeps skyrocketing—it doesn’t really affect the very poor (who are subsidized anyway) or the very rich (who can presumably pay anyway), but it hurts everyone in the middle. Taxpayers have been coerced into acting as effective co-signers for nearly every student loan in America, totaling $1T of outstanding liability according to a recent estimate by the New York Times.
Where does the money go? Partially to fund more financial aid—raising the income threshold below which students don’t have to pay anything—but also to bloated university bureaucracies, boondoggle construction projects, and social programs on campus.
What a great business model universities have. They get a steady flow of income from the government with a relatively inelastic demand for their product. No one on campus is really accountable for anything, while special interest groups feed at the trough for their share of the pie. There is nothing commercially-oriented about the way most campuses operate. Yet somehow most universities are feeling a financial pinch—for the same reason as government is, namely, runaway spending. Yet universities have absolutely no accountability if a student defaults on his loans.
It would be nice if universities evaluated applicants as credit risks (investments) like banks do in evaluating mortgage applicants. But they don’t, because they have no reason to. We agree with Alex J. Pollack on a relatively simple fix to reduce the distortions in the student loan market by giving universities a stake.