Student Loans & Government Subsidies: One more Government “Benefit” Creates Economic Chaos

The federal takeover of student loans is a subsidy because it sells below their market value the interest rate, the financing standards, and the repayment conditions of this specific type of loan.

The origins of the federal student loan system are well documented and stick to similar trajectory to most  government subsidy programs in American  history.

Each earlier government subsidy program has had a history of mismanagement, inefficiency, backwards incentives, and inflationary pressure via creation and distribution of new dollars in exchange for goods and services at prices below their market value.

The federal takeover of student loans is a subsidy because it sells below market value the interest rate, the financing standards, and the repayment conditions of this specific type of loan. These categories were exacerbated during the emergency response to the particular pandemic beginning in early 2020:   interest rates on federal student loans were reduced in order to 0 percent, required obligations were temporarily suspended, and now there is confusion about whenever, if ever, interest payments can resume or whether the federal government will write off these  debts altogether.

The change in the transaction terms has also created immediate incentives for borrowers to prevent payments on their student loan financial obligations even if they have the means to pay. With debts at negative real interest rates (and the hope that it may be forgiven in the future) and the option to hold wealth in savings accounts or utilize it in other more profitable uses, borrowers have little reason to pay off their financial obligations.

The Biden administration’s actions to date have got contributed to inflation and backwards incentives for debtors. If this administration is to correct the ship, they will have to speak clearly on the upcoming of federal student loan financial obligations. They should warn the debtors that payments will continue on August 31, 2022, and that the zero interest period will not continue, but instead the original interest rate will prevail.

They should explicitly state that there will be no additional suspensions of payments. When the Biden administration proceeds down the path of confusion for that borrower  and allows the taxpayer to bear the  expenses of this subsidy, there will only be one option for Our elected representatives. Congress will have to declare that they will pass legislation to remove the particular authority of the federal government in order to lend money to college students for college education. This process would not  punish the citizen who may be seeking to get reduced borrowing expenses, rather it would be  the only logical step to clear up  confusion about whether loans will be required to be compensated in the future. Once the precedent  is placed that the government is ready to bail out borrowers, they  will begin to expect similar activities in the future.

The federal government has a long history of unintended consequences and the student loan plan is no exception. One of these implications is the concept of moral hazard. Moral hazard occurs for the entity creates a safety net (such as  insurance) but inadvertently and simultaneously reduces the expense of risky behavior. When the authorities created the FDIC (Federal Deposit Insurance Corporation) in the wake of the Great Depression, it opened the door for banks to engage in riskier actions, knowing that most of their debris are insured by the federal government.   Thomas Hoenig, vice chairman of the FDIC said in a speech within 2017 :

The threat of failure serves to ensure that banks remain more sensitive to risk, and it inhibits the from trending toward too much risks. Without the discipline provided by depositors and other creditors likely to withdraw their funds when they suspect a financial institution of being unsafe, banks come with an incentive to take on such exposures.

Within the wake of the financial crisis of 2007– 08 the government sensed compelled to react by bailing out many finance institutions and companies. In response, the particular special inspector general for that US  Treasury’s Troubled Asset Relief Program (TARP),   Neil Barofsky, had written in  a quarterly report last year : “ Absent significant regulatory reform, TARP operates the risk of merely reanimating marketplaces that had collapsed underneath the weight of reckless habits. ”

Government intervention encourages moral risk by  excessively risky conduct from disconnecting financial penalties. Right now the Biden management is considering whether to remove yet more of the economic price of decisions made by the forty-three million individuals with student loans totaling $1. 606 trillion dollars, averaging $37, 000 for each borrower. If all or a portion of these loans are pardoned, then the precedent  will be fixed for this safety net to appear again for future student loan debtors.

The borrowers risk calculus changes once the taxpayer may pick up the particular tab. There will be an increase in borrowers and an increase in the balance of the loans when paying cash today costs more  than paying interest  for a few years before your debts are likely forgiven.   Since the first quarter of 2022 , 78 percent of such borrowers owe less than $40, 000, and 56 % owe less than $20, 500. If debt forgiveness will become expected, future borrowers will be incentivized to take on more education loan debt  and hold it for longer terms.

Forgiving some value of student education loans today will immediately replace the spending habits of those that have the money earmarked in cost savings accounts for repayment of their debt  or  who have made programs to pay debt with long term earnings. This will stimulate these borrowers to make  alternate plans for that money, plans that will no doubt artificially boost demand for goods and services within the coming years.

Current student loan borrowers do not need additional confusion on the payment terms of their loans, long term student loan borrowers do not need to undervalue the cost of their payment responsibilities, monetary policy does not need additional inflow of dollars to the economy, and taxpayers do not need additional burdens while moving wealth to student loan debtors. President Biden should be very clear that debt payments will certainly resume on August 31, and borrowers should start preparing  to repay their loans according to their original terms. If the president fails to make this very clear, or forgives any amount of student loan debt, then Congress must remove the authority from the federal government to issue brand new student loans.


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