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Dive brief:

  • U.S. households carry nearly $ 1.6 trillion in outstanding student loan debt, making it the second-largest source of debt behind mortgages and creating a massive surplus on the economy.
  • Critics say efforts to fix the problem by forgiving all or part of the debt will only create new problems down the road, as it creates moral hazard.
  • Moral hazard is the idea that people behave riskier than they otherwise would because they are removed from the consequences of their actions.

Dive overview:

Outstanding student loans rose by almost 500 billion dollars in 2006 at nearly $ 1.6 trillion today, stimulating a number of legislative proposals in Congress to reduce debt before it becomes difficult for people to buy a house or a car or make the kind of large purchases they need to participate in the economy.

“The student debt crisis is real and is crushing millions of families,” said 2020 presidential candidate Senator Elizabeth Warren (D-Mass.), said in a press release On June 13, she announced that she was tabling a bill to cancel up to 95% of outstanding student debt.

Under Warren’s bill, up to $ 50,000 in student loan debt would be forgiven for anyone whose household income is less than $ 100,000. Lower amounts would be remitted for households with incomes between $ 100,000 and $ 250,000. Warren estimates that the bill would write off about 95% of the outstanding debt, at a cost of 640 billion dollars, for which she proposed to impose a tax on the richest households in the country.

Warren is not the only proposition. Wayne Messam, mayor of Miramar, Florida, and also presidential candidate, called for remission of all debts within 60 days of a new administration in Washington.

“I don’t think it’s fair that the student and the parent have to bear all this risk when it benefits the economy as a whole” said Messam.

Getting lost in the discussion of these and other forgiveness proposals is a long-term distortion of people’s borrowing decisions, says Neal McCluskey, director of the Center for Educational Freedom at the Cato Institute in Washington. “It should be a huge concern if people say, ‘Of course we should incur debt because we know it’s going to be forgiven,’” McCluskey told Banking Dive.

He pointed to a survey conducted by LendEDU two years ago of 500 university students, which found that just under half of students expected some of their debt to be forgiven after graduation. of their diploma.

The survey question asked, “Do you think federal student loan exemption programs will help you after you graduate?” ”To which 49.8% answered yes.

Since forgiveness already determines people’s borrowing decisions, “there’s no way to avoid the moral hazard problem, ”says McCluskey.

It was with this concern in mind that the editorial board of one of the nation’s largest newspapers, the Orange County Register, criticized Warren’s plan in an op-ed earlier this year.

“If taxpayers pay the debts of all those with delinquent student loans, how will that affect the decisions made by current students who are considering their higher education funding choices?” ” the board said April 28. ” What is the message ? Borrow as much as possible and wait for debt cancellation during the next presidential primary?

McCluskey and other reviews, including the editors of Forbes magazine, say the proper solution is to use existing programs to solve the problem.

In the longer term, the solution is to pull the federal government out of the student loan guarantees business because that is what drives up the cost of tuition and makes the loans difficult to repay needed in the first place. “You have to turn off the tap,” Heritage Foundation analyst Mary Clare Amselem told Banking Dive. “Private loans will lower tuition fees and lead to smaller loan amounts. “

Editor’s Note: Amselem’s quote was added after publication as an update.

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