Biden Threads the Needle on Student Loans

The President Adopts A Compromise Approach

President Joe Biden has taken a radical approach to tackling the student loan crisis, and that’s not a compliment. Biden will issue an executive order wiping out $10,000 to $20,000 of Federal loans for millions of borrowers, regardless of their ability to repay their obligations. As a result, some affluent borrowers will receive a windfall from the government, which could trigger a political backlash from blue-collar workers.

The President has many reasons for taking this drastic step, but political considerations loom large. Biden has been under massive pressure from progressives, and he is trying to shore up his party’s position going into the midterms.

In any event, the debt relief program could have been much worse. To his credit, Biden has adopted a middle course. He has rejected the extreme demands of progressives, who wanted to eliminate virtually all Federal student loans, even for highly paid professionals. Instead, borrowers will have to meet an income test to be eligible.

The President has also proposed changes to make repayment of loans easier in the future for all student loan borrowers. These revisions seem fair for the government, and they should provide badly needed breathing room for many young Americans struggling to pay off their education loans.

Pressure From Progressives And Minorities

Biden recognized during his presidential campaign that millions of borrowers have struggled to repay their student loans, and he promised to provide debt relief of up to $10,000.

After Biden was elected, progressive Democrats such as Senators Bernie Sanders, Elizabeth Warren and Chuck Schumer lobbied him relentlessly to eliminate most Federal student debt. They urged Biden to write off $50,000 per borrower, without any income test. Other progressives argued that the government should permanently reduce the interest rates on the education loans.

Black and Latino politicians have also pressured the President, citing statistics that indicate that Black and Latino borrowers have higher default rates on student loans. As he contemplated his options, Biden has been keenly aware that his approval ratings with young voters in general, and young Blacks and Latinos in particular, are in the basement.

A Compromise Approach

After months of debate within the White House, Biden has set forth a compromise approach. The government will forgive $10,000 of debt for most borrowers and $20,000 for recipients of Pell grants, who are by definition lower-income. However, borrowers will be eligible only if their income falls below a certain amount: $125,000 for an individual and $250,000 for a family.

Biden’s modifications should skew the benefits of the program more toward middle-class and working-class Americans, rather than the top tier of wage earners. One of the most significant elements is that the program will offer twice as much debt relief to the lower-income, Pell grant recipients.

Furthermore, students from more affluent families tend to have larger loan balances, since many of them attend graduate school. They probably would have benefited disproportionately from a $50,000 write-off. Students from less affluent families often have lower balances, so the $10,000 write-off will have a greater impact on them.

Although the income limits are fairly high, they should exclude the top 5% of US households. So the program is not likely to provide a bailout to highly paid, Ivy-League educated lawyers and financiers, despite Republican claims to the contrary.

Biden also announced that the present moratorium on loan repayments, which began during the Trump Administration, will end in January 2023. In effect, the President rejected progressives’ calls to reduce interest rates on the loans going forward, and he put borrowers on notice that the debt relief is a one-time event.

Relief For Millions Of Americans

We have to recognize that Biden’s executive order will address a huge problem in American society. Millions of young Americans have struggled financially for years because of their student loans, despite their best efforts to pay them off. Tuition has skyrocketed, but salaries for Millenials have stagnated in many sectors. Many student borrowers have not been able to start a family, buy a home or launch a business. For them, the American Dream has turned into a nightmare.

Biden’s approach should give many of these borrowers a new lease on life, through the one-time debt write-off.

Biden has also proposed two changes in the the Department of Education’s rules for “income-repayment plans”, which would help all Federal student loan borrowers in the future:

· Interest payments would be capped at 5% of discretionary income, rather than the current 10%

· The Government would forgive loans after 20 years of payments, for most borrowers, and 10 years of payments for public-sector workers

These proposed changes seem fair to both the borrowers and the government. A 5% cap will provide borrowers some leeway in their finances. There’s no risk of moral hazard if borrowers have faithfully made their payments for 20 years, or 10 years for public-sector workers. The 10-year time frame for public servants such as teachers, police and firemen recognizes that they generally earn less money than employees in the private sector.

These changes are especially important because under the current system, borrowers often pile up large amounts of accrued interest if they request grace periods on their payments. By taking advantage of the government’s “forbearance” program, borrowers get some breathing room…but the interest is only deferred, not eliminated, and it is added to their balances.

There are far too many sad stories of borrowers in their 50s or 60s who are still paying down their loans, because of the accumulated interest.

Flaws In The Program

Still, Biden’s solution for the student loan crisis has flaws, as we have noted in two previous articles: Cancelling Student Loans Could Be a Blunder for Biden and How Should Biden Tackle the Student Loan Crisis.

We favored a lower income limit of $75,000, so that less affluent Americans would be the main beneficiaries of the debt forgiveness program. We also proposed that student loan borrowers be allowed to wipe out their loans by declaring bankruptcy, which they cannot do under current law.

We would have preferred that the Administration target the debt relief to borrowers who clearly could not repay their loans, rather than write off loans across the board. In particular, we wanted the government to focus on loans related to for-profit colleges, which have a terrible track record for defaults.

Under Biden’s approach, borrowers who have not had any problem repaying their loans may nonetheless receive a $10,000 windfall from the government. This “handout” will undoubtedly anger borrowers who sacrificed to pay off their student loans in full. And blue-collar workers who are struggling to pay their mortgages may ask, “Why do the rich kids get a break?”

There is also considerable risk of moral hazard. Will new students be inclined to take on too much student debt, assuming that the government will bail them out again? Will unscrupulous college officials assume that they can continue to raise tuition, because the government will in effect foot the bill?

The Price Tag Is Large

Here’s another problem: the government’s finances will take a hit from Biden’s initiative. The Administration’s claim that the program will be “paid for”, because loan payments will resume in January 2023, does not stand up to scrutiny.

The suspension of loan payments has cost the government about $50 billion a year. If the government writes off the principal amount of student loans, it should recognize that loss right away. The Administration has estimated that 43 million borrowers could be eligible for debt relief, so the write-off will be a big number.

Nonetheless, the resumption of payments on loans that remain outstanding in 2023 might offset much of the interest lost from the forgiven loans, in subsequent years. But that is a separate issue from the write-off of the principal amount of loans.

At this stage, the estimates of the program’s costs are preliminary and vary widely, given all the moving parts. It won’t become clear for a while how many borrowers will qualify for debt relief and how many will actually apply. In any event, Wharton Economics has estimated that the cost to the government over the next 10 years could be at least $300 billion, mostly in the first year, and perhaps significantly more.

That is a lot of money, but we have to put it in context. Federal revenues run about $3.5 trillion a year, so a $300 billion hit would increase the annual deficit by about 8%…for one year.

The Inflation Bogeyman

Republicans, and some Democratic economists, have criticized the debt forgiveness plan as “inflationary”. Their theory is that after debt relief, student loan borrowers will have a lot more money to spend, which will drive up prices.

But that seems unlikely. After all, many borrowers will still have loans outstanding. The average amount of Federal student debt is about $27,000. For most borrowers, only $10,000 will be forgiven…if the debtor qualifies under the income test. Many will not be eligible.

Furthermore, as Biden pointed out, borrowers whose loans are not forgiven will have to start paying interest again in January 2023. Since many student borrowers have been truly strapped, barely making ends meet, they probably won’t go on a spending spree.

Still worried about inflation? Even Goldman Sachs doesn’t think the debt forgiveness program will add much fuel to the inflationary fire. The firm estimates that the impact on inflation would be modest.

Despite its drawbacks, Biden’s plan for debt relief should give millions of young Americans another shot at the American Dream.