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Forgive Student Debt?

Michael P. Tremoglie

NEW YORK (MainStreet)—The latest trend in Congress is to all for bailing out college students from their student loan debt. After all, the logic goes, if the American people can bail out the banks why not students? They are our greatest resource and they have a greater impact on the economy than inefficient, greedy and incompetent bankers.

For this purpose, two pieces of legislation have been introduced--one on March 21, in the House, by Rep. Karen Bass (D-CA) and the other, on May 8, in the Senate, by freshman Elizabeth Warren (D-MA).

Bass calls hers the Student Loan Fairness Act of 2013. Warren titled hers the Bank on Student Loan Fairness Act. They attempt different strategies, but in the end, the one common denominator is that the taxpayer will pay the debt of students who borrowed money to pay college tuition.

Not all students, mind you, will benefit from these plans. Certainly not the students who are working their way through college; certainly not those students whose parents mortgaged their homes to pay the tuition; certainly not the students whose parents are draining their IRA's and 401K's to pay for college.

Both Rep. Bass and Sen. Warren were contacted for comment about their legislation. Bass's office responded. Warren's office did not.

Bass's bill takes a multipronged approach to the student debt problem. It creates a repayment schedule for student loans in which an individual would be required to make ten years of payments at 10% of their discretionary income, defined as being a certain amount of income in excess of the poverty line. After such payments were made the remaining debt would be forgiven.

Also see: Can the Student Debt Crisis Outshine the Housing Bubble?

It also permanently caps the interest rate for all federal student loans at 3.4%. This eliminates the need for Congress to enact temporary measures every year to prevent rates from increasing as is being contemplated now.

But Bass's bill also allows "eligible" student debtors to convert their private loans into federal direct loans. According to Bass's office, "An eligible borrower is defined as a borrower who is not in default and is in a good payment status regarding their private loans."

She would also make provisions for the unemployed and rewards graduates entering into public service.

Also see: Obama's New Student Financial Tool--Does It Matter?

In a prepared statement when she introduced the bill, Rep. Bass said:

"I'm introducing this legislation to address the crippling issue of student loan debt and the debilitating impacts this debt is having on American's ability to contribute to the growth of the United States economy. In Washington we talk a lot about not passing debt onto the backs of our children and grandchildren – well, there is no more immediate or direct debt on the backs of future generations than the amounts taken from their paychecks to pay back increasingly expensive student loan debts. We have gotten to this place by not adequately addressing how we finance higher education and treating a college degree as though it isn't an investment for the collective public good of our country. Education is a ladder to economic opportunity but for far too many Americans the opportunity is coming at too great a cost."

Senator Warren's bill, which was announced May 8, is designed to prevent student loan interest rates from doubling. The rate is scheduled to increase dramatically, and it will increase soon, if Congress does not act. The interest rate on federally guaranteed Stafford loans will go from 3.4 % to 6.8 % on July 1. This is what Warren seeks to prevent.

She wants students to pay the same interest rate on their government loans as banks due when borrowing money from the Federal Reserve Bank. This is currently a rate of approximately 0.75%. This would only be for a year. By delaying the interest rate increase, according to Sen. Warren, Congress will have a chance to "find a fair, long term solution on student loan interest rates."

But how fair would Warren's bill be since her solution is more restrictive than Bass's bill? Warren only affects Stafford loans – i.e. loans guaranteed by the government?

Also see: Obama's Déjà Vu Moment on Student Loans

Bass, at least, makes a provision for those who did not qualify for government loans. According to Kevin R Harris, Rep. Bass's communications director and policy advisor, " [Bass's] legislation has a provision that would give them more favorable interest rates as well as allow them to participate in more manageable repayment programs. However, the bill has a cap of $45,000 so borrowers would only be able to take advantage of this legislation for debt totaling no more than that amount."

Warren's bill seems unfair, because it would ultimately make private borrowers and those who self-financed their college educations pay twice. They will not only pay – via their taxes – to subsidize those who benefit from Warren's scheme, but also will pay higher interest for their own loans.

Professor Richard Vedder, an economist at Ohio University who specializes in education issues, was critical of both bills. Regarding Bass's bill, Vedder wanted to know how she will pay for all of this. He also opined that the idea of only rewarding those who borrowed penalizes those parents who refinanced homes and those who are working their way through college.

"This is sort of a wishy-washy loan forgiveness program," said Vedder. "There are a lot of incentives not to pay back their loans. There is incentive to be unemployed. Another problem is that the whole idea of loan forgiveness for borrowers is disconcerting. It discriminates between those borrow and those who do not."

Regarding Warren's program, Vedder wanted to know why it is just limited to Stafford loans.

"Why just Stafford loans--Why not others?" he asked. "What about the people who pay off their loans? If going to college is a publicly desirable objective, why not treat all borrowers equally?

Another skeptic is Andrew Kelly, a resident scholar in education policy studies at the American Enterprise Institute in Washington D.C.

Also see: Will Student Loan Interest Rates Double?

"We need to be very careful about incentives for loan forgiveness. Why would people take a less expensive path to a degree when they know it will be forgiven in ten years?" he said. "Also what message does it send to institutions about keeping tuition prices low?"

There is one other problem with these loan forgiveness schemes. It provides incentives for people who did not take out tuition loans to do so – thereby adding to the outstanding debt.

It is often said that the road to hell is paved with good intentions. It is possible that both the Bass and Warren bills will provide the asphalt.

--Written by Michael P. Tremoglie for MainStreet

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