Reforms to Student Loans Create More Problems Than They Fix

August 4, 2016

The Department of Education’s (ED) proposed new regulation regarding student loans is getting a lot of attention.  It received almost 7,000 public comments on proposed changes to how it administers its Federal Direct Loan Program and its requirements for postsecondary schools whose students pay for tuition using federally funded student loans. Unfortunately, ED has not done its homework. Our comment on the proposed rule finds that is likely to create more problems than it solves. Not only could it disproportionately harm socioeconomically disadvantaged students, but the Department estimates it could end up costing taxpayers up to $4.23 billion per year.

As of April 2016, the total outstanding balance of student loans is estimated to be approximately $1.32 trillion. Throughout the recent period of economic crisis from the late 2000s until 2014, the student loan balance quadrupled and default rates among student borrowers reached their highest levels in 20 years.

Proposed Changes

The rule proposed by ED would make several amendments to the regulations governing its Federal Direct Loan Program. Among the most significant changes are 1) an expansion of the conditions wherein ED would forgive borrowers’ loan balances, 2) additional provisions that would broaden ED’s ability to recover losses directly from institutions, and 3) the addition of conditions that would automatically trigger additional reporting for postsecondary schools. Schools would be required to comply with these provisions if they want to continue being eligible to be paid by borrowers using federal funds appropriated under title IV of the Higher Education Act (HEA).

Regressive Effects on the Poor

Although this rule is likely to create several unintended consequences, the most troubling is that it could hurt for the most economically disadvantaged students—in theory, precisely the group that ED is most concerned about protecting. “Non-traditional” borrowers (predominantly those of low income, minority groups, or women) historically experience higher default rates on their loans than traditional borrowers. However, many of these defaults having nothing to do to schools providing poor quality education. Those members of society that have relatively fewer resources have the hardest time paying back debts—particularly during hard economic times, such as the recent U.S. recession.  Unfortunately, those are the very people who will be hurt if ED moves forward with the proposal.  The majority of the Department’s efforts only apply to the for-profit school sector—precisely the kinds of schools where non-traditional borrowers typically enroll.

The Department’s proposed rules would require schools to secure additional financing under several conditions. This would likely be particularly burdensome for many schools serving disadvantaged populations. Additionally, these schools would be held directly accountable for the performance of their graduates with regards to paying back their loans instead of merely being accountable for the quality of the education they provide. This may lead schools to raise their admissions standards in an effort to avoid admitting students that don’t “seem likely” to pay back their loans (e.g., the poor).

No Plan for Review

The only way to know if a regulation has had its intended effect is to measure its real-world results after they have been in place. Scholars and subject matter experts agree that the best way for regulatory agencies to do this is to write specific plans into their final rules detailing what they intend to measure and how they intend to measure it. ED did not include a plan in its proposed rule for measuring the outcomes of its new regulations. This is ill advised given that the Department’s current estimate for this rule’s cost spans a huge range – from $199 million to $4.23 billion annually.

Planning for retrospective review is particularly important in this case because it is will likely be quite difficult to estimate the effects of this rule even with ex post data. If borrower default rates go down is that proof that this rule had its intended effect? Given the rule’s potential to disproportionately hurt the most economically disadvantaged borrowers, lower default rates could very well be the result of reduced access to education for the very people the Department should be trying to help.

ED should reasonably demonstrate that its proposed changes to the federal direct loan program will likely create a net benefit for taxpayers and borrowers. As currently proposed, it is difficult to believe this is the case.