Subsidized Student Loans: 6.8 Day is Here!

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Washington hasn’t passed a new law to avert it, so today’s the day that all of higher education has, it seems, been dreading: The day that interest rates on subsidized federal student loans double, going from 3.4 percent to 6.8 percent.

Hooray?

In the long term, it might actually be good if these rates – which will only affect some federal borrowers – go up. (Congress could still lower them retroactively.) Why? Because federal aid has fueled decades of rampant price inflation, giving basically anyone whom a college would accept – and many colleges will accept anyone – the money necessary to pay sky-high prices. Perhaps the rates rising will dissuade some people from going to college who should be doing something else, or some people going to college who should be there from choosing a more expensive school that offers no better academics but lots of superfluous frills.

That said, the uptick in rates is likely to have little major effect on what people are willing to pay. And to some extent that is as it should be. The average college graduate will earn enough additional money as a result of having a degree that the additional debt is worth taking on. However, roughly half of people who enter college won’t complete their studies, and half of those will earn below the average for whatever piece of paper – some sort of certification or degree – they complete.

Perhaps the most discouraging aspect of all this isn’t the financial impact of the doubling, but that Congress couldn’t get a deal done. If you are going to have federal student loans, it makes sense to peg them to interest rates such as those of the 10-year Treasury Bond rather than having Congress fix a number for several years. At least then they will fluctuate with the overall time value of money. Indeed, that concept was sufficiently agreeable that President Obama proposed such an idea, and the Republican-controlled House passed roughly similar legislation. But, in a surprise move, President Obama threatened to veto the legislation without, it seems, any effort to negotiate with House leaders first, and Democratic Senate leaders called mainly for freezing rates at 3.4 percent until they could reauthorize the Higher Education Act. There was even a bipartisan effort in the Senate to push through a bill similar to the House measure and the president’s, but it went nowhere. 

Why the breakdown? It’s hard to know exactly, but easy to see a suspect: politicians, especially Senate Democrats and to a lesser extent the president, didn’t want to do anything that didn’t appear to give students the cheapest loans possible. That’s bad news for any future compromise, but much more importantly, a clear and troubling sign of why, barring loud public outcry, we won’t get the long-term solution we need: phasing out federal student aid to force students and colleges to demand and furnish efficient, effective higher education.

[Editor’s note: See this Cato essay for more on higher education subsidies.]