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How Cheap Federal Loans May Harm Students

Rick Newman

Washington politicians are congratulating themselves for another giveaway to taxpayers: the looming deal to extend the 3.4 percent interest rate on subsidized student loans, instead of letting the rate return to its prior level of 6.8 percent.

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This appears to be a rare bipartisan moment, with a significant number of Congressional Republicans supporting a move President Obama has been advocating for months. Yet while both parties are clearly seeking to curry favor with young voters in an election year, the move to keep interest rates low may ultimately harm those they're trying to help.

Obama will no doubt repeatedly remind voters that extending the lower rate will save a typical student borrower about $1,000 over a decade. What Obama won't mention is that cheap, widely available loans are probably one of the factors pushing tuition to unaffordable levels, which in turn is leaving many graduates with overwhelming debt loads.

The cost of a college education has been rising by about 9 percent per year over the last decade, more than three times the overall rate of inflation. One year at a public university now costs more than $15,000; a private school costs about $33,000. For many families, education inflation is more onerous than the skyrocketing cost of healthcare, since you can't buy insurance that pays for college.

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Several factors are pushing tuition costs up, including cutbacks in state funding and an increasing number of students competing for university spots. But another pernicious cause may be a sharp increase in financial aid available to students, especially federally subsidized grants and loans.

Over the last decade, for example, the total amount of grants, loans, tax credits and other types of financial aid funded by Washington has risen by 164 percent, after accounting for inflation, according to the latest data from the College Board. The typical student benefits from more than $10,000 in federal aid each year.

That's a huge commitment to college education, and a seemingly smart way for Washington to prioritize spending. Yet many experts say that all that aid artificially increases demand for a college education and the money available to pay for it, which pushes prices up. There was a disturbing parallel in the housing market a few years ago, when interest rates kept artificially low by the Federal Reserve, along with lax lending standards, generated a flood of money available for mortgages. That helped push home values far above healthy levels, creating the housing bubble that began to burst in 2006, triggering a brutal recession.

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Employment at colleges and universities, meanwhile, has increased consistently over the last decade, in sharp contrast to the cutbacks that have occurred throughout the private sector and in state and local government. That suggests that there's little cost pressure forcing universities to become more efficient, as many companies have been forced to do. Many university administrators, meanwhile, complain of lavish spending on dorms, gymnasiums, student centers and other things that push up college costs without directly improving education.

Student debt has now drifted up to about $22,000 per borrower for graduates of public universities, and $28,000 for grads of private schools. The uptick per student has been modest in recent years, but student debt has become an acute problem because of the shortage of jobs available to new grads. Some economists worry that a wave of defaults could be coming as millions of young workers fail to earn enough income to pay off their loans

Keeping interest rates low will push monthly loan repayments down by a few bucks per student. Those savings could be negated, however, by even modest increases in tuition. The real way to promote education would be to incentivize schools to cut costs, and pass the savings on to students. But apparently they don't teach that in college.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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