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ANYTHING PEACEFUL

The Seen and Unseen of Federal Student Loans

MAY 13, 2013 by RICHARD LORENC

An Internet meme featuring U.S. Senator Elizabeth Warren is currently circulating to boost support for her very first bill, the "Bank on Student Loan Fairness Act,” introduced on Wednesday.

Everyone should be skeptical of legislation with the word “fairness” in its title, especially the people it is allegedly designed to assist.

Senator Warren’s legislation would lower the interest rate on federal student loans (called Stafford loans) to be more in line with the rate banks pay to borrow money from the Federal Reserve. The difference between the rate banks pay (0.75 percent) and average interest rate on Stafford loans (3.4 percent) is substantial, and Warren and other supporters of low student loan rates are acting now before rates double to 6.8 percent in July.

The discrepancy between these two interest rates is noteworthy, and should be of concern to anyone seeking to address government favoritism and cronyism.

But what would lower student loan interest rates actually mean for students?

To answer that, we should consider the words of Frédéric Bastiat, from his essay, “What Is Seen and What Is Not Seen.”

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

On the surface, doubling the interest rate on student loans would cause students to incur $12,000 in additional interest payments over the life of a four-year college loan, according to an analysis by the Institute for College Access and Success.

But look a bit deeper and you will see that Senator Warren’s well-meaning legislation will only put more upward pressure on college tuitions, making college more expensive for the next generation of students.

Aside from predictable praise from college students, faculty, staff, construction companies, and consumer advocates, here is what is likely to happen if Senator Warren’s bill becomes law:

  • Incoming college students will be able to borrow money at a lower interest rate than today’s students.
  • Lower interest rates will lower students’ upfront borrowing costs.
  • Lower borrowing costs will increase demand for spots at colleges and universities.
  • Increased student demand will cause tuition to increase faster than inflation, as it has for decades.
  • Higher tuitions will increase salaries for college faculty and staff and spark new building contracts on-campus.
  • Higher tuitions will also cause borrowers to spend beyond the maximum amount of their federal loans (now $20,500 annually).
  • Higher-education special interests will lobby for a higher maximum loan amount.
  • Increased borrowing will cause student loan interest rates to rise to meet higher demand.
  • Student loan debt will increase.
  • Higher-education special interests will lobby to lower student loan interest rates.

Rinse and repeat until the federal government can no longer borrow enough money to subsidize the higher-education industry.

As Bastiat wrote, “There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”

Instead of calling for lower interest rates on student loans, those who see the world through the economic lens should prefer interest rates to increase so that colleges and universities get the message that their services are too expensive and so that tuitions, for once in a long while, decrease.

Deflating the higher-education bubble in this way is the only sustainable way to make college more affordable for all who desire to attend.

ABOUT

RICHARD LORENC

Richard Lorenc is the director of programs at FEE.

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