The Student Loan Crisis has been picking up interest in the media lately.  Especially with Senator Elizabeth Warren attempting to fix the problem in a well intentioned bill that would make the problem even worse.  In order to understand the problem in student loans, you have to understand why artificial bubbles form in the economy; if we look at the housing bubble, we can see how the same factors are in play.

The Housing Bubble has its roots in decisions made by government policy makers in the 1990s.  The first problem was the Clinton Administration forcing banks to lower lending standards in the mistaken belief that minorities were being discriminated against as they applied for loans (you can read more about why this was wrong, HERE).  Second, then Federal Reserve Chairman Alan Greenspan lowered interest rates in a bid to “spur” the economy following the Dotcom bust.  Third, the Administration of George W. Bush actively promoted the goal of “home ownership” and used the quasi government enterprises of Fannie Mae and Freddie Mac to help bring about this goal artificially (Good books on this can be found HERE and HERE).

Remember that nothing in economics is done without reason, saying that “greed” and “deregulation” caused the Housing Bubble is like being surprised that kindergartners left alone with pixie sticks and finger paint would make a big mess, and then punishing them for what they did.  What people on the left are doing is refusing to see how the stage was set in the first place.  Home mortgages were one of the most stable loan enterprises in American industry for 75 years,  it all unraveled within a few short years, and no one seems to ask “why”.  

What we have here are three factors which brought about a “perfect storm” in the housing market:  1)  Government forcing lenders to make riskier loans  2)  The Fed supplying nearly unlimited money to make loans to lenders  3)  A quasi government enterprise heavily involved in the mortgage market, guaranteeing nearly 90% of home mortgages implying to lenders that their loans were “risk free” because they were backed by the government.

What happened?  Banks, feeling regulatory pressure from the Clinton and Bush administrations to make more home loans, begin to do so.  They find out that an easy way to do this is to offer “teaser” rate home loans to people who otherwise wouldn’t be able to afford the mortgage.  But this isn’t a problem to the people buying the home, because home values are artificially rising because so many people are getting into the market that otherwise wouldn’t be.  Simple supply and demand says that when supply goes down and demand goes up, prices go up.  During the housing boom, they went up astronomically, and so home loan borrowers knew they could pay back the money by selling the house, and banks knew that if the borrower couldn’t afford the mortgage, that they would make money in foreclosure anyways.  All parties involved had every reason to get involved in the market.  

There was no risk, the media trumpeted constantly rising home values as proof that we were all wealthier than ever before.  It all worked until enough people couldn’t pay back their mortgages at once, and once that happened, the house of cards fell.  Too many homes were put up for sale at once, leading to an increase in supply and zero demand, which caused home prices to plummet.  Banks foreclosed on homes and lost huge money selling them for pennies on the dollar (whatever they could get).  In short, the market never failed, the market just showed what it could do drunk with artificial money and regulatory laws.  (Side note: the media is seeing the bubble re-inflating and mislabeling it as “recovery” which would be equal to me saying that a heroin addict is doing better now that he has re-injected himself).

Okay, now how does this relate to student loans?  There are government programs designed to help “make college affordable” (AKA: free money for students).  The Federal Reserve under Ben Bernanke has brought interest rates nearly down to zero, which means banks are flush with cash for lending.  This means that banks have every incentive to make loans, and because of government “backing” they have nothing to lose when they make student loans.  

Example: a kid can borrow 200k to get a BA in Religious Studies (my major so don’t judge lol) without having to care how the student will ever find a job well paying enough to pay off the loans.  Because the banks don’t care what students are spending huge amounts of money on as they earn their degrees, students have access to borrow nearly unlimited amounts of money.  When students have access to unlimited amounts of money, colleges have NO REASON TO LOWER TUITION.  Colleges can RAISE prices, and the students can ALWAYS get the loan money to pay whatever that semester costs.  Look: College tuition is rising at an even higher rate than houses during the Housing Boom.

Why is it that in the Great Recession, the price for college education is going up, even as the quality of education is going down?  Because of artificial government policies distorting the market and creating incentives that would never exist in a free market.  Can you imagine playing Roller Coaster Tycoon and your patrons having unlimited money?  You could charge ANYTHING on for your rides, even going to the bathroom, and your guests wouldn’t care, if they wanted they would pay it.  That is what is going on in colleges right now!  All parties involved have every reason to get involved in the market.

That is why you are looking at a huge student loan bill.  The solution to this problem is the exact opposite of what Sen. Warren suggests (let’s make even more money available to kids).  The solution is to get government out of distorting the student loan market.  If you understand the disease rather than the symptoms, it is easy to see what is wrong.  We as a country are refusing to properly diagnose the disease, and it is why we are stuck in this economic quagmire.