Why Canceling Student Loans Has Devastating Effects

Public Choice | Financial Freedom

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About 46 million Americans have some student loan debt, totaling roughly $1.75 Trillion. These numbers keep increasing every year.

This led to some politicians supporting the idea of canceling government student loan debt. This wouldn’t include any private student loans someone may have taken out, but some in the past have advocated for the cancelation of all student loan debt public and private.

The claim is that return on investment of college is not as it was originally portrayed to be. You were supposed to take out a loan, go to college, get a good high-paying job with the knowledge gained from college, and pay off your student loans quickly. Instead, students have gotten themselves in a lot of debt and now struggle to find a job to be able to pay off their loans.

There has been even more of a push to cancel student loans after President Biden has increased the grace period of paying off student loans for the fourth time so far in his term. Many are saying the next step for the president is to cancel them altogether.

The Next Generation

Although this seems like a great idea since many have outstanding debt, it’s not as effective as one may think.

This may help the students who are currently in school, recently graduated or anyone with student loans. It’s only a temporary fix to the actual problem. It is a band-aid over a bullet hole.

If you cancel student loans what will happen in 10 years when a decade of new college graduates is also in significant debt? Cancel the loans again? Let them fend for themselves?

Free College

If you cancel the loans again what’s the purpose of giving out loans if you’re going to keep canceling the loans, they should just make college free. Since that’s essentially what canceling the loans is doing.

Some people and politicians support free college but that brings a slew of other logistically problems with it. For one, colleges are then incentivized to charge whatever they want because the government will pay for it. Thus significantly increasing government spending. Which brings us down the rabbit hole of do we print more money or charge more in taxes?

Fend for Themselves

If you don’t cancel the next generation’s loans and let them fend for themselves you will end up in the same or even worse problem you have now. So canceling the original loans did nothing to fix the problem.

Lack of Personal Responsibility

Another problem that comes with canceling student loans is that it teaches students that personal responsibility isn’t important.

Many students graduate from college with loans and work hard to pay off their debt quickly. Canceling the loans of the other students that are lackadaisically paying off incentivizes not being responsible for the loans you take out.

Debt-Free

People sacrifice a lot to become debt-free. Like being frugal with their money, not going out to eat, no vacations, and working more hours. It’s a big punishment to them if you cancel the loans of the other student who out of college traveled the world instead of paying off their debt.

If you still want to cancel student debt, one solution to this problem is to give the students who already paid off their college debt a check for how much student debt they were in when they graduated and send them a check for that amount. But that is a lot of money and would never happen.

Return on Investment

Canceling the loans also creates a bad habit of personal responsibility. It won’t just cancel the loans but the responsibility that you agreed to take on when you agreed to the loan. By signing up for the loan you agreed that they would pay for your college so you can get higher education and in return, you would pay off this loan once you graduate. Canceling the loans is disregarding half of the agreement.

Some people claim that they should be canceled because the job they got after college doesn’t pay them enough. To those people, I say they should have looked at the return on investment of the degree they graduated with before they took out a loan. Canceling the loans after these students made a poor investment decision is rewarding the poor decision. This will inevitably lead to more poor decisions in the future since they think there are no consequences for their decisions.

Bear Stearns

In 2008 an investment bank called Bear Stearns was deemed “too big to fail”. They were over-invested in mortgage-backed securities right before the Great Recession in 2008. They were holding junk bonds that no one wants. On the brink of bankruptcy, Bear Stearns was bought out by JPMorgan Chase backed by the New York Federal Reserve Bank. Read more about the story of Bear Stearns here!

The Fed and Chase, as well as many others, agreed that Bear Stearns was too big to fail. That if Bear declared bankruptcy that could have spread to other banks. So it was almost necessary for them to bail them out, they were putting out the fire.

The big problem that comes with bailing out a bank like Bear and claiming that they are too big to fail is the precedence that it sets. Now investment banks know that if they become big enough they can invest in riskier and riskier investments because they can’t lose if they are too big to fail. Either the risky investments pay off and they make a lot of money or the investments don’t pay off and the Government bails them out just like did with Bear Stearns.

Too Little to Fail

This same concept is applied to student loans. If the student who has outstanding student loan debt claim they need their loans canceled and the government obliges its sets a bad precedence. That you can make a bad investment and there aren’t any consequences, the government will just bail me out again like they did last time, because I’m too big to fail.

The problem is that they aren’t too big to fail, many students graduate every year, and they are too little that they can fail. If any, one student fails to pay off their loan or makes a bad investment nothing really happens in the grand scheme of things. You wouldn’t even notice it. It doesn’t matter.

All canceling student loans do is put a bandaid over a bullet hole and create bad precedence that the government will always bail you out when you make a bad decision.

Potential Solution

One potential solution to the student debt “crisis” is to cancel interest on loans. Yes, some students struggle to pay off their loans, this is inevitable. One way to help with this is to cancel all interest on student loans. That way your loan doesn’t grow to an amount that is inescapable but still has the responsibility to pay it back.

The only downside to this is who will hold on to the loan. The government contracts private companies to hold onto the loan and the interest on the loan is how the private company makes money for holding it. So to pay this private company the government needs to subsidize the work they would do for holding onto the loan.

This would allow for student debt relief, keeping the responsibility of the loan on the students, and the private company that holds the loans would still get their money.