Capitalisn’t: How Do You Solve a Problem Like Student Debt?

Constantine Yannelis: There are alternatives to these blanket loan-forgiveness programs that are being considered now. Then we can target this forgiveness in a progressive way.

Bethany: I’m Bethany McLean.

Speaker 2: Did you ever have a moment of doubt about capitalism, and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Speaker 3: First of all, tell me, is there some society that doesn’t run on greed?

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should have killed the capitalist system in the process.

Bethany: Student-loan debt, it’s something many of us are familiar with.

Speaker 4: The amount of student-loan debt Americans hold is at a record high.

Bethany: Some 45 million borrowers have federal student loans for a total of over $1.6 trillion, according to a group called EducationData.org. So, the headlines about President-elect Joe Biden possibly canceling up to $50,000 of it per person have been, understandably, big news.

Joe Biden: This is holding people up, they’re in real trouble. They’re having to make choices between paying their student loan and paying their rent.

Bethany: Luigi, as an Italian, what do you think of the student-loan situation in the US? How screwed up is it?

Luigi: Actually, I have to admit, as a student in Italy, I was admiring the fact that in the United States you could get a loan to study. However, we seem to have taken a good idea and brought it to the worst possible outcome.

Bethany: Explain that. What do you mean?

Luigi: First of all, you’re told that education is priceless. If you don’t go to college, you’re going to be screwed up for life. And nobody really monitors whether you can repay in the future. All these loans are guaranteed by the government. So, the lenders have very little incentive or no incentive to check. And, I’m sorry to say, universities in general are at the party, pushing everybody to go to school because that’s increased their revenues. The other point, which I think got lost in the debate, but it’s pretty important, is why, in a world in which we are subsidizing demand—for mostly good reasons, but we’re subsidizing demand—supply is very inelastic. Why? Because, especially, not-for-profit colleges, by not being non-profit-maximizing, they’re not very fast in responding to increasing prices. If you have a very inelastic supply and you push the demand up with subsidies, there is one obvious answer, economics 101, prices go up.

Bethany: There really is an analogy between the student-loan market and the mortgage market in the run-up to the financial crisis. Homeowners, too, would-be homeowners were told, “You’re doing the right thing. This is what all good Americans do. You’re buying a home. This is mom, America, and apple pie.” And it’s very much the same thing with student loans. Kids who arguably are less capable of assessing whether or not this really does make sense than a would-be home buyer are told, “You’re doing the right thing. Get yourself an education. Don’t worry about going into debt.” And the job market isn’t going to be there to support it.

Luigi: Yeah. I completely agree. The thing that is particularly painful for me is that the role of predatory lenders, the Angelo Mozilos of the situation, are now us, the universities. As much as I would like to blame only for-profit colleges, I think all of us have benefited from this. Not enough of us have spoken aggressively against this, because in part it was benefiting us.

Bethany: I was going to say, you’re more the Wall Street of the situation. Horrors! You’re the ones figuring out how to make money from something that is going to cause a calamity, both to the economy and to millions of Americans.

Luigi: Yeah. And University of Phoenix is the Goldman Sachs of the situation. That is synthetically producing something that looks like a college degree, but has nothing of a college degree, but still costs like a college degree. And they profit from it.

Bethany: Let’s talk about this strange system that we have. I don’t think I really understood it until I started covering it. Actually, I wrote a piece on the old Sallie Mae back in the early 2000s in Fortune. Because I was so stunned by this idea that Sallie Mae was a private company and advertised itself as a private company with shareholders and a bottom line, and a stock price. And yet most of its business was actually guaranteed by the US government, because it made student loans that were guaranteed under this program passed in 1965, called the Higher Education Act, which created this Federal Family Education Loan program and basically reimburses student loans. And so, there’s that whole part of it. But then, also, we had this explosion in for-profit colleges, who also are able to get their loans, the loans they extend, guaranteed by the government. So, you have this very odd and quite pernicious mix of for-profit institutions with shareholders to please and government guarantees.

And that’s almost always a bad situation. I remember back in the early 2000s when I was starting to cover Sallie Mae, a lot of short sellers were sure that the for-profit colleges were ripping students off and were destined to failure. And it’s been a couple of decades of scandal after scandal involving the for-profit schools with overly aggressive marketing, et cetera, and terrible default rates. But the pushback from the people who are believers in these companies on Wall Street was always that the schools were offering an education to people who otherwise wouldn’t be able to get one, who otherwise were locked out of the system. And it was a fascinating debate, because it was hard to prove who was right for a lot of years. But I think now, given the default rates on loans made through for-profit colleges, I think the verdict is in. And, for whatever reason, for-profit colleges seem to be a problematic enterprise.

Luigi: Yeah. But even more than the default rates. Because if you see just the high default rates, then you can try to blame the borrowers, not necessarily the schools. What I find even more damning, here I rely on some research by my colleague, Constantine Yannelis, who we’re going to bring on the podcast momentarily. But some of his research shows that the median student in this college, so that’s the 50 percent level of the students, doesn’t gain anything in wages by attending college. So, it’s not only that they default . . . It’s kind of surprising that they don’t default even more. Because if you don’t gain anything, and you take on more debt, you are bound to default. And, in fact, for-profit colleges represent only 10 percent of the borrowers, 20 percent of the debt, but 60 percent of the defaults. So, they’re not the only cause, but it’s a big, big part of it.

Bethany: Yeah. The numbers are pretty stunning. I think the reason why more students don’t default is because the cost of defaulting is so incredibly punitive. You can’t expunge your student loans in bankruptcy. And when I wrote about this for Fortune, I found a number of borrowers who still, in retirement, were having their Social Security income garnished for their student-loan debt. And, in a lot of cases now, what’s happened is you’ve had parents guaranteeing their children’s student-loan debt. And those parents will now be on the hook for it, and be on the hook for it going into their old age if their kids can’t pay. So, there’s an enormous incentive. And it’s an interesting back-and-forth on whether it’s too punitive or appropriate to have it be that way. What do you think?

Luigi: Having some ability to default under extreme circumstances is very important. But all this emphasis, and I know it’s probably the most popular and easy thing to do, but all this emphasis on loan forgiveness is only making the problem worse in the future. If you have a leaking faucet, you should not collect the water. The first thing you should do is prevent the faucet from leaking. Because, otherwise, every bit of water you collect, more water will come.

Bethany: Colleges will still continue to accelerate their tuition costs, because why not? Once the government steps in and wipes out the debt, then why shouldn’t the University of Chicago continue to encourage students to take out debt they can’t afford? And why shouldn’t for-profit colleges just continue their rampage through the population, because there’s no cost to them?

Luigi: Absolutely. Why shouldn’t students say, “This actually is free, because with some probability, in the next crisis, this is going to be forgiven. So, let’s borrow more and take the chance.” And also, because if I was prudent and I borrowed less money, and maybe I skipped lunches and dinners during my college years, and I don’t get my loan forgiven, why did I suffer for nothing? I should actually have a party.

Bethany: Let’s bring in an expert who has written a lot about this to help us think through these issues. Constantine Yannelis, a former Treasury Department official in the Obama administration, who is now a colleague of Luigi’s at the University of Chicago.

Constantine Yannelis: Great. Thanks for having me today. I’m very happy to talk about anything and everything related to student loans.

Luigi: Beware what you wish for. Let me start with a simple question, which is, how did we get here? Most people know that there are student loans, but probably most people are not aware of the magnitude of this market. How did we reach this level?

Constantine Yannelis: Absolutely. I think people are shocked by the numbers. We’ve seen a more than 600 percent growth in aggregate student-loan volumes. We haven’t seen that in any other loan market. According to the New York Fed, student loans have the highest delinquency rate of any form of consumer debt. That actually understates true nonrepayment, because a lot of people are not repaying through programs like income-driven repayment.

It’s actually a complicated question, whether they end up paying more or less under income-driven repayment. Because if they’re not paying, interest accrues and the balance of the loan ends up growing, so they could end up paying more. I’ve actually done some work on this, and it turns out that it is a net negative in terms of repayment. But that’ll end up meaning taxpayers will pick up some of the tab for these loans that aren’t repaid. There are reasonable forecasts of the present value of the loan programs. In order to make those forecasts, we have to make assumptions about income growth. If people are doing income-based repayment. We also have to make assumptions about what future policy will be. So, I think there’s a lot of uncertainty about how big losses will be. But we estimate the present value of the loan program to be around $800 billion.

Luigi: But so, if the loans are on the order of $1.4 trillion, then you’re talking about, what? $600 billion of losses?

Constantine Yannelis: Yeah. In that order of magnitude.

Luigi: OK. Just to get a sense, I’m sorry. I don’t want to hold you to one particular number, but I think it’s important. We’re not nickel-and-diming billions here. We’re trying to get an order of magnitude. The order of magnitude seems staggering.

Constantine Yannelis: It is very large.

Bethany: I want to back up a little bit to the structure of the overall market, because you’ve written about this as well. Some portion of the problem that we have is the growth in for-profit colleges, right? How did that become part of the educational landscape? And are we at a place now where we can say this has been a bad thing, or this has been a good thing, or there are pros and cons of it?

Constantine Yannelis: Yeah. I would say that the bulk of the problem is due to for-profit colleges. My numbers might be a little bit ballpark, but when I wrote one of my papers on this, for-profit colleges accounted for about 10 percent of all enrollment, about 20 percent of all student-loan borrowers, and approximately half of all student-loan defaults. And if you look at student-loan defaults over time, they very closely track the share of students attending for-profit colleges. And I don’t want to be overly negative on the idea of for-profit colleges. The problem is just the way that we’ve set up the incentive structure for profit-maximizing schools. Because, basically, if you’re a hyperrational school, you just want to make a profit. Because of these government loan programs, all you have to do is sign up students to get them to borrow and then pay tuition. If they end up defaulting on the loan, it’s a taxpayer’s problem. It’s not your problem. Potentially, we could design a better system, giving these for-profit colleges some skin in the game, making them on the hook for defaulted loans. Or, perhaps, by doing something more innovative, having income-share agreements, where, rather than paying tuition, students could pay a portion of their income to the school for a couple of years.

Luigi: Can you explain to us why the incentives are structured in such a stupid way? This is not something we discovered now. I’ve written about it 10 years ago. Bethany, believe it or not, wrote it about 20 years ago. So, this was completely foreseeable. Anybody with, I think, an undergrad in economics will understand that the incentives are screwed up, and particularly screwed up when you face somebody that is profit-motivated. One of the great things about a non-profit-motivated institution is that they’re not that fast to act, in the positive and in the negative domain. Why have we left this problem in this situation for many years? In fact, why have we doubled down on this? Because, as you said, this sector has increased tremendously in the last 10 years.

Constantine Yannelis: Yeah, absolutely. That’s a very good question. And I think there’s a combination of kind of nice goals and bad. There’s this view that we want to enroll more people in colleges. There was some view that any policy that increases college enrollment is a good thing, so let’s not worry about the returns or the value added. Then, of course, the more nefarious explanation is lobbying. A lot of these for-profits spend quite a lot of money lobbying the government. They’re very influential. Prominent politicians have been on the boards of various for-profit colleges.

Luigi: Can we go a little more into the details of this market? Because if everything is guaranteed by the federal government, why do so many of us pay such a large interest payment, interest rate, on our loans?

Constantine Yannelis: The interest rates are set by Congress. So, Congress just decides what student-loan interest rates are each year. Lately, they’ve been fixed. In the past, they’ve been variable, but they typically just track the federal funds rate plus the spread.

Bethany: And that spread is heavily dictated by lobbying, isn’t it?

Constantine Yannelis: Yeah. I’m not sure if it’s lobbying per se. Because, remember, it’s not really private companies that are making profit today, at least. I can only really speculate on how Congress is setting the interest rates. I mean, it’s a large institution with many members, and they might have very different views on why they’re setting interest rates one way or another. But if I had to speculate, I would just say that if student-loan interest rates are above or below market rates, either the government program is making a lot of money or losing a lot of money, and hence will come under pressure either to not make too much money on paper from students or to not subsidize them too much. My guess is that those are the political-economy forces, but I’m speculating. In the past, there may have been more lobbying pressure because of the guarantee program. And then, banks were making quite a bit of money.

Luigi: No, but sorry. You are saying that basically 20 percent of the loans are terrible. They cost a lot. And then you share some of that cost with the other part of the distribution. In a sense, what the government is doing is giving away loans without proper underwriting and charging the good guys for their own mistakes.

Constantine Yannelis: Yeah. That’s true to some extent.

Luigi: But isn’t that something that needs to be fixed? Because it’s crazy that you have an asset that is guaranteed by the government. And so, it should have an EIR that is close to government debt. And we know that government debt has interest rates approaching zero, at least for the short maturities. So, why do so many students have to pay such a large amount? They have to pay because the government has given away money indirectly to other people. That is really super inefficient and unfair.

Constantine Yannelis: Yeah, absolutely. No private loan market would have a uniform interest rate, for obvious reasons. You’ll also have different groups cross-subsidizing each other. For example, the default rate for women is much lower than the default rate for men. So, effectively, by having this uniform interest rate, you have women subsidizing men.

Luigi: But also, isn’t there an industry in the fintech world that is picking and choosing the best borrowers, and basically cream-skimming and dumping the rest on the government?

Constantine Yannelis: Yes, absolutely. So, there are companies like SoFi and Common Bond, and that’s exactly what they’re doing. They’re taking these borrowers from elite institutions. SoFi, initially when they started, would only take borrowers from certain programs at certain schools. If you go to the Stanford or Chicago MBA, nobody ever defaults on a loan. If you can get them to borrow with you, they’re a safe credit risk. They were very small in the past, and that’s probably why they haven’t received a lot of attention from regulators.

They chose to actually expand in a very smart way. Because if they had gone down the distribution, because we would keep playing this game on and on, and on and go down and keep cream-skimming more borrowers, my guess is that eventually this would have led to some kind of response, because the federal loan program would have become, effectively, a bad bank. What SoFi did instead was they expanded, let’s call it horizontally, rather than vertically. They have this pool of very creditworthy student-loan borrowers, and they were their first creditors. They started offering other types of loans to this pool of borrowers, mortgage loans, vehicle loans, so on and so forth. That’s the way they expanded rather than going down. So, you’re absolutely right. There’s some cream-skimming going on. Right now, it’s fairly small, although that could change in the future.

Luigi: To make sure that everybody followed, because maybe we went a little bit too fast. These guys, what they’re doing, they are lending money to Harvard graduates at a lower rate than the government, because Harvard graduates are so good that they don’t default, but they are charged a rate that is above the rate that they should be charged.

Constantine Yannelis: Yeah, exactly. And, of course, that makes the average borrower worse in the federal loan program, because the federal loan program is losing these very creditworthy borrowers who don’t default.

Luigi: This, I think, is the essential problem of running a political goal inside a lending program, because you do two things. You want to cross-subsidize different categories in a way that is very unsustainable if you have an open market. So, either you shut down the open market, or you resort to doing the right thing, which is to subsidize through the fiscal instrument and let the market work. But I think that politicians want to hide some of the costs of these programs. And, by hiding it, they do this complicated system that ends up creating more leakages and more problems than the subsidy to begin with.

Constantine Yannelis: Yeah. That may be true. I don’t want to speculate on politicians’ motives, but that’s quite possible.

Bethany: If we do accept that we’re not going to blow up the US system, then are there things we can do, especially given the last, whatever, let’s call it two decades of experience with for-profit colleges, and experience with a student-loan program in a modern economy? Are there things we can do that can remove some of the efficiencies, and that can make the system work better for everybody from taxpayers to students?

Constantine Yannelis: Absolutely. One thing we can do is fix this misalignment of incentives. Brazil, recently, for example, they had a very similar problem with for-profit colleges. This is very new, so it’s hard to evaluate. But one thing they did was they made schools on the hook for a portion of defaulted dollars, and to pay if students are receiving government aid and they end up dropping out. It actually makes the school’s bottom line contingent on student outcomes. There’s also a more direct way to do it through income-share agreements. This is basically an equity-type contract where students pay a portion of their income, rather than a debt contract. Now, of course there are . . . I don’t want to come out strongly in favor of that in any way, because there are other concerns with an income-share agreement. Namely, it could function as a sort of tax and lead to a labor-supply disincentive.

Bethany: Sort of a modern-day serf system, right? In a way that the people who are least able to afford it end up owing a chunk of their income for the rest of their lives. I mean, it’s almost modern-day indentured servitude, or at least it could become that.

Constantine Yannelis: I mean, we have income-driven repayment. But I wouldn’t call it indentured servitude. We’re talking about a contract of 10 or 15 percent of somebody’s income for a set number of years. So, I think indentured servitude is a little bit strong. And people would be able to break the contract through the courts or the bankruptcy system. It’s very similar, though, to an income-contingent loan contract, which we already have. The only difference is it’s uncapped.

Luigi: I agree with you, Constantine. When I wrote my book, basically 10 years ago now, I had a chapter discussing exactly these issues. An income-sharing agreement is very appropriate in a world in which the returns to education are becoming more asymmetric. In the past, everybody benefited fairly homogeneously through education. Today, you see some particularly talented people who make an enormous return and many that make nothing. And so, adding some form of repayment based on income is a way to share that risk. I’m 100 percent with you on that dimension.

But I got pushback when I wrote about this. Many people said, “Oh, there have to be some limits.” The impression is really not very well tested. So, you can do a bit of that. But what is the limit? I agree with you, 10 percent does not seem too much. I don’t think there is a bright line that says, below 20 percent, you’re fine, but if you go to 21 percent, it becomes slavery. I think that it is an open issue.

Constantine Yannelis: Yeah. I agree with that. And like any consumer loan market, this would need to be regulated. There are some experiments, for example, in Indiana. And also, a couple of small companies are offering income-share agreement now. To my knowledge, they aren’t facing legal difficulties. But this is on a very small scale. And some other companies, Lumni in Latin America, have pioneered this in Colombia and Peru. So, there is some precedent.

Now, it’s questionable whether a private market would work for income-share agreements due to adverse selection. If there’s both an equity and a debt market, one student knows that they’re going to earn a lot, and the other student knows that they’re not going to earn a lot, obviously the student who will earn quite a bit in the future would want to select the debt contract, and the student who won’t earn very much will want to select the equity contract and basically walk away.

Luigi: But don’t you think that we are already in a system like this, but softly? A lot of private colleges, if you make a lot of money, they come after you and they ask, or “demand,” a big donation from you. And, to be fair, a lot of very successful alumni have done that. So, we are in a form of income-based repayment in which 99.9 percent repays close to nothing. And then 0.1 percent repays a huge amount.

Bethany: But the 0.1 percent isn’t doing it. The 0.1 percent isn’t “repaying.” They’re only acceding to the college’s demands because they want to get their progeny into that school. So, it’s not as if it’s a demand that you’re forced to make. You do it to continue to perpetuate the inequality in our system that exists anyway, right?

Constantine Yannelis: I agree. I mean, there are some concerns with this donation-based model, in that there is this incentive to donate to get children in. And, of course, colleges have an incentive to keep this model going, because they have a lot of money. It might solve this problem to have a direct income-based system. And I also want to point out that this is only the model at very elite institutions at the top. And this is functioning very well, right? The student-loan default rates at places like the University of Chicago, or Harvard or Stanford, are close to zero. Almost nobody defaults at these institutions. And, actually, most elite institutions now have no-loans policies, so that students can pay without going for loans. So, this is really a problem not at the top end of the distribution.

One thing that I think is really important to mention, a lot of the current policy debate is focusing on loan forgiveness. And one thing that’s missed is that we already have a very progressive loan-forgiveness program. It’s called income-driven repayment. The way these income-driven repayment plans work is that borrowers pay, depending on the plan, 10 percent or 15 percent of their income above 150 percent of the poverty line. Then, again depending on the plan, after 20 or 25 years, remaining loan balances are completely forgiven. If somebody earns less than 150 percent of the poverty line consistently, they’re very poor, they end up paying nothing on their student loans. So, we already have some loan forgiveness built in. When we’re talking about loan forgiveness, we’re really talking about loan forgiveness for those borrowers who are earning more and wouldn’t qualify under the minimum threshold for income-driven repayment.

And one thing that I think is important and often missed in the public-policy debate is, one alternative way of expanding loan forgiveness, and making those benefits only accrue to low-income borrowers, is raising this threshold for income-driven repayment. For example, rather than having it be 150 percent, you can have it be 200, 300 or 400 percent. And then you would avoid this problem of people with a lot of debt who earn a lot of money, like MDs, JDs, and MBAs, benefiting from this loan forgiveness. Because, actually, I have a new paper out on this universal loan forgiveness, and it is an extremely regressive policy.

More than $100 billion would go to the top decile of the income distribution, and less than $20 billion would go to the bottom decile of the income distribution. That’s for the simple reason that people in the bottom of the income distribution often don’t go to college. And, if they did, they drop out or they’ve gone to community college. So, there are alternatives to these blanket loan-forgiveness programs that are being considered now.

Bethany: So, to summarize, even if we are going to take the shortcut, as we so often seem to do in this country, and just do loan forgiveness rather than tackle the underlying problems in the student-loan market, there are ways we can be a lot smarter about it, at least than what’s being currently discussed in the headlines. Is that a fair summary?

Constantine Yannelis: Exactly. And we can target this forgiveness in a progressive way.

Luigi: But Constantine, if President-elect Biden were to appoint you czar of education, of the student loans, besides that, what would you do? How would you restructure this very complicated market?

Constantine Yannelis: I would have a system that looks much more like the Australian system. I would put all borrowers into income-driven repayment, and make that, if not mandatory, the default loan-repayment option. And simplify the program, eliminate a lot of paperwork, so borrowers aren’t getting kicked off. This would provide insurance to borrowers.

I would also try to align the incentives of schools and the borrowers by making schools on the hook for dropouts that were financed by federal dollars. I would also eliminate uniform interest-rate pricing, and have at least some risk-based pricing, so we don’t have different groups cross-subsidizing each other. And so, we don’t encourage students to borrow to do degrees that don’t have very high returns. It’s a little bit crazy that, under the current system, we have the same interest rate and the same cap for somebody doing a JD at Harvard, and for somebody doing an English master’s at the University of Phoenix. Of course, default rates are very different, and returns are very different, for these programs.

Luigi: We hope that President Biden will call you.

Bethany: For sure.

Constantine Yannelis: Well, I’m not involved in any political campaigns.

Bethany: Thank you so much for joining us, Constantine. This was really educational. No pun intended.

Constantine Yannelis: Oh, thank you.

Bethany: Or pun intended.

Luigi: This was fantastic, Constantine. Thanks a lot.

Constantine Yannelis: It’s really a pleasure to be here, and hopefully see you soon, once this pandemic is over.

Luigi: I hope so.

There is another aspect that I had not fully understood until we discussed it with Constantine. And I find it fascinating. The way the college loan program is designed is that everybody gets the same rate regardless of the level of intrinsic risk. But then they try to break even in making loans. In so doing, there is a pretty significant redistribution between one group and another, so much so that now there’s a pretty big industry of companies, mostly fintech companies, that are cherry-picking the best borrowers, taking them away from the pool of government-subsidized loans. Because government loans are at a rate which is much higher than what they should offer, let alone much higher than what everybody else is paying these days, with the Fed having a very accommodative monetary policy. Given that the government is on the hook, no matter what, in this business, if we want to subsidize marginal borrowers, it’s right to do it. But if you do it, you do it out of general funds, not out of the other participants in the program.

Bethany: It’s interesting, because it’s yet another analogy to the housing market because of the presence of Fannie and Freddie on a nationwide basis. In the housing market, you have very much the same dynamic, where a well-off borrower, who arguably could get a lower rate, is paying the same rate as a not-so-well-off borrower in a risky place. And that’s actually been one of the most complicated facets of getting Fannie and Freddie out of conservatorship and restructuring the housing market is, what do you do with this cross-subsidization that nobody likes to talk about, but is actually true in the mortgage market as well? And I was thinking when you talked about that with the private fintech companies coming and pulling the borrowers out of this market, the taxpayers . . . I was going to say the government, but of course it’s not the government. It’s taxpayers really are getting screwed six ways till Sunday, right? Because then the borrowers who help make the default rate lower and who helped taxpayers’ money get paid back are going to leave the program.

I guess the only way you can do that is coming up with a way that subsidies for the other borrowers work. Because the last thing you want, I think, is risk-based lending in the student-loan market, where the very borrowers who lack the privilege to go to a Harvard and get a degree in economics are then also forced to pay many times a higher rate on their student loans than the other kind of borrowers. Then you’re just exacerbating inequality in our system, right? The very inequality that an education is meant to help address. So, I don’t know. It can’t be as simple an answer as risk-based lending.

Luigi: You’re absolutely right. But one simple answer is, you have colleges take a first cut of the losses on the students. Then colleges would be more leery to admit students who are unlikely to benefit from the school. When it comes to mortgages and when it comes to students, and that’s the analogy between the two, we know that these are massive markets in which the average consumer, the average borrower, is not that sophisticated. And so, you want to put the burden of risk on the lender, because the lender is a sophisticated party and is the one that should decide whether you are worth investing in or not worth investing in. We should do that in education by having those colleges take the first 10 percent or 20 percent of the losses on all these mortgages.

Bethany: I want to agree with you. I do agree with you, theoretically. I don’t agree with you practically, because I fear that, practically speaking, what that would result in would be colleges clamping down and refusing to admit students who might be riskier propositions, thereby denying those students of their chance at an education. I think there has to be some kind of better system, so that, again, whatever fix we end up with doesn’t end up exacerbating inequality in America, thereby deepening the very wounds and divides that education was meant to help fix. And it seems to me that if colleges are going to bear a part of the cost, they’re just going to get very, very conservative about who it is that they admit. And that’s going to make matters worse already.

I found an interesting statistic from the Consumer Financial Protection Bureau that some 90 percent of Black students and some 72 percent of Latino students take out loans for college, versus just 66 percent of white students. So, you already have a divide here. And I worry that putting the burden on colleges to . . . putting the responsibility maybe on colleges to decide who gets loans and who doesn’t, the solution is going to be worse than the problem itself.

Luigi: I agree with you. And part of the solution, of course, is to make public colleges better and more affordable. What I always admired about the US system was the variety. You have the private leading universities, you have the community colleges, you have the very good state schools in the middle. That variety, I think, has shrunk over time, and the state schools have lost some of their reputation and some of their funding. I think that that’s a part that should be definitely be boosted.

Bethany: Once again, I’m going to reference the housing market. Because I remember being really surprised, when I was doing the research for my last book on the financial crisis, that the consumer advocates, in the run-up to the financial crisis, starting as early as the late ‘90s were saying, “No, no, no. Don’t give people access to credit. Because giving people access to credit, that’s going to kill them, it’s worse than no credit at all.” And it was actually the consumer advocates who were not saying, “Please, please, more mortgages.” They were saying, “No, no, no. Don’t give people mortgages they can’t pay back.” And it just gets to, once again, the fundamental issue here is that education in too many cases no longer delivers the payback that it’s supposed to. If you’re going to pay for it, it should give you a value on the other hand, in exchange. And, somehow, we’ve managed to decouple the cost of an education from the value that people get out of it. And we have to figure out a way to link those again.

Luigi: Maybe it is possible. And say, what should be done is to reduce the burden of the debt for people who went to schools that are not adding any value for them. But then not to make it as rewarding for people who went to the wrong schools is to eliminate those schools from the list of schools you can borrow against. So, let’s say that if you went to an online private college that charged you a lot, and doesn’t add a lot of value, you can get at least partial forgiveness of that loan. But in exchange, that school will not be on the list of authorized schools to get federal subsidies.

Bethany: We already have some version of what you’re talking about in the student-loan market. At least we’re supposed to. The schools that have too high a default rate, they’re supposed to be excluded from access to the federally guaranteed loan program. The problem is that the default rate can be manipulated by allowing students to defer their loans. And there’s also an income-based repayment program, which allows borrowers to pay only 10 percent of their discretionary income toward their loans. And an Education Department analysis just found that borrowers in that program will probably only repay about half of their debt.

Luigi: But then this program is feasible, because if you are basically doing systematic studies of incoming students and exiting students, you force every school to report this. And then you are going to forgive the loans of the ones who went to the worst schools, in terms of this ratio. But then you treat that forgiveness as default. So, automatically, because of the existing law, they will be excluded from future loans. That can help the situation.

Bethany: Yeah, it could, actually. And that might be one way around the way in which schools manipulate default rates. And that’s one of the things I’ve always found the trickiest at looking at the student-loan market is that, because colleges can sort of “manage” their default rates by pushing students to enroll in forbearance, which temporarily relieves borrowers of the obligation to pay their loans, the numbers are really misleading. It’s really hard to tell from looking at official default rates exactly how bad it is. And, since default status is measured three years after a student enters repayment, a borrower who goes through a forbearance and then defaults may not even get counted in the official statistics. The whole thing is so subject to gaming. I’m sure there’s somebody inside the for-profit education business who figures out how to manipulate the default rates in order to make them look better, so that the schools can keep access to federal funds.

Luigi: I’m sure there is. And I’m sure he’s paid pretty well for those services. There is an additional problem, in my view, which is that as inequality increases, even among college graduates, the average or the median is not really a relevant statistic. Particularly the average. Because the average is made up of a guy who makes bazillions and a guy who makes less than what he made four years ago. But also, in the richer institutions, you have a form of redistribution from the super-rich to the rest. You have one Bill Gates who drops out of Harvard but donates a lot of money. That helps pay for some of the education of the others. In lower-level colleges, you don’t have these billionaires that do redistribution. Something that will get me fired from the University of Chicago, but I will say anyway, is maybe what we should do is tax some of those donations and redistribute them a bit across colleges.

If you donate $150 million, like Bloomberg donated to Johns Hopkins, or Ken Griffin donated to Harvard, that donation is tax-deductible for the donor. And the endowment accumulates tax-free for the institution. There’s a lot of tax advantage going on in the process. Maybe a little bit less of this tax advantage will help struggling colleges to help with their tuition. We also have increasing inequality among colleges. The top 20 or 30 have become super-rich, both because they had an endowment to begin with and a phenomenal return on their endowment in the last 20 years, and because they got more and more donations from their successful students. And then, short of that, they became much poorer. And so, the question is, to help the median student pay for his or her college, maybe you need some redistribution not only within a college, but also across colleges.

Bethany: I like that idea. It’s interesting, because, of course, in many cases, the billionaire who is donating to his or her college is doing so not just out of the goodness of his or her heart, but also to get their children into that college. It’s actually a system that perpetuates a monarchy of sorts, or an aristocracy of sorts in the US. Because the billionaires who donate are kind of cost-insensitive. They’re giving that money so their progeny can get into Harvard. And so, they may be willing to pony up the taxes as well, and have that money dispersed across the system, as long as it doesn’t change their progeny’s ability to get into their school of choice.

Luigi: I would like to bring in another topic we have ignored so far, which is, in all those calls to forgive the student loans now, there are two arguments that I find particularly problematic. The first one is, you do it because this stimulates the economy. And the second is, you do it because that’s the only thing you can do via executive order without consulting Congress, and so, Biden should do it. I find both these arguments extremely disturbing. The second one because it’s really antidemocratic. You’re saying, “Let’s find the trick to do something that can be done without going through Congress.” This is basically at the same level as Trump finding tricks to finance the wall without passing through Congress. To me, it’s bad in both cases.

The second is, of course, having the economy grow is important. But I don’t think it’s the only criteria of economic policy. And, in particular, you want to think about what are the long-term consequences of your decision, and not just do the quick fix immediately and move on. An intervention, not justified within a reform, but just an ad hoc intervention to forgive without any sort of a fundamental reason, will create more of that down the line. And it would create uncertainty about what loans are repaid, what loans are not repaid. And incentives to take more loans, because you hope that eventually it will be repaid by the government, and so on and so forth. So, I think the argument cannot be limited only to the impact on aggregate demand, which is a factor. But it’s not the only factor.

Bethany: Yeah. I think Constantine’s argument that a policy of blanket student-loan forgiveness is actually quite a regressive policy is a really interesting one. It’s funny, because you have progressives advocating for this idea, and, I think, not thinking it through and not realizing necessarily that it actually is quite a regressive policy, or maybe they do realize it.

Luigi: Actually, I’m more cynical. I think that they do realize it very well. Because, today, the progressives are the educated. The big divide is on colleges. The non-college-educated are Republican, and the college-educated are mostly Democrat. And so, it’s exactly like when the Republicans decided to eliminate the tax deduction of state taxes, they knew that this would favor their states and their constituencies against the Democrats. Because most Democrats live in states that have higher state taxes. In the same way, the Democrats are doing the opposite. They’re creating a policy that redistributes money from the non-college-educated, who are the real losers of the 21st century. They are the ones that are left behind by globalization and by technology. Basically, screw them and subsidize the successful ones who got to college. And now they get it for free.

Bethany: You are more cynical than I am, Luigi. But I think that actually could be right, dare I say it. I think we’ve come out pretty firmly on the side of this blanket loan forgiveness being fairly stupid. Is that too blunt a word?

Luigi: I think it’s, let’s say, not justified. What can be justified is a targeted program to forgive part, or to reduce interest rates on others. And, most importantly, make sure that this doesn’t happen again. I think that we should do all these things together, and trying to find a shortcut of an executive order, I think, is a terrible idea.

Bethany: And when you said that we should find ways to make this better, I couldn’t help starting to laugh. Because here we are, 12 years now after the financial crisis, and the whole silver lining of the financial crisis was that we would figure out ways to make the mortgage market make more sense. And here we are, 12 years after the financial crisis, and Fannie and Freddie are still in conservatorship, which was supposed to be temporary, because our government cannot get it together enough to figure out what to do with them and how to restructure this. And so, I worry that actually making the student-loan market make sense, and figuring out how to make education work for everybody, which actually is one of the most important things the government could do, I worry that that’s actually beyond us. At least if the mortgage market is as a leading example, then you’d say it is beyond us to do anything remotely intelligent.

Luigi: But part of the problem is that we separated fixing the damage of the crisis with fixing the housing market. Once the urgency of fixing the damages was gone, the usual vested interests prevailed, and there was no reform. So, what we should do with the student-loan market is to say, we are going to have some relief, conditional on fixing the problem now. And so, the political benefits of the relief should come with the cost of doing the hard work of fixing the problem. If we do the relief, in fact, that’s an extra reason not to do the relief in this way, because that will only guarantee that the problem will get worse in the future, because the political will to make a change will disappear.

Bethany: So, do universities, as the Wall Street of this crisis, have the lobbying power in Washington, DC, that the big financial firms did to prevent that real work from being done? Are we going to see detachments from the University of Chicago heading to Wall Street in order to lobby their favorite senators?

Luigi: I actually think that universities are a pretty powerful lobbying organization. In the period in which there were still the pork-barrel special items attached to bills at the last moment, the universities pioneered this technique. So, don’t underestimate the power of lobbying of universities, because they come with this gigantic positive aura around them. And so, they are more effective in pushing their line.

Bethany: Yep.