Student Loans: A Slippery Lifeline
Student Loans: A Slippery Lifeline
By: Burton Bollag
Date: December 7, 2001
Source: Chronicle of Higher Education. (December 7, 2001): A34.
About the Author: Burton Bollag is a journalist who works as an international correspondent for the Chronicle of Higher Education.
For many college students, particularly those studying in the United States of America, the process of taking out loans is as much a part of the academic experience as is registering for classes or purchasing textbooks. The cost of a post secondary education has risen steadily and has significantly outpaced the ability of most American (and, increasingly, worldwide) families to save or prepare for the expenses involved in the support of their children's educations.
The history of financial aid for college students, particularly that of the academic loan process, began in the state of Indiana in the mid—1930s. In 1935, there was legislation passed in that state that enabled college-level students who performed above a specific range on competitive standardized testing to receive awards that resulted in having a portion of their tuition reduced. Essentially, this was a program involving the creation and implementation of merit-based grants and scholarships. Several years later, in the 1940s, Indiana University opened its first Financial Aid Office, specifically created for the administration of diverse types of financing for college students. The protocol was both efficient and effective and was used as a model for other academic institutions.
After the end of World War II in 1945, the United States was in an enormous state of economic and technological growth—industry and technology were growing rapidly, and it was necessary to develop a cadre of professional and technologically-savvy personnel to enhance and evolve the new programs. At the same time, there was an enormous number of young people, particularly young men, returning from the War who had limited ability to compete in a progressively more complex job market. The National Defense Education Act (NDEA) was designed as a means of incentivizing colleges and universities to expand and modernize their programming as well as to create means of making post-high school education affordable and appealing to young adult learners.
In the late 1950s, the NDEA was vastly expanded, as the United States engaged not only in the Cold War but actively competed with other countries, particularly with the United Soviet Socialist Republic (Russia, or the USSR), in the development of space technology. The Russian's successful deployment of the Sputnik satellite was another enormous catalyst for the advancement of the technological professions in America. It became critical for the United States to find a way to make higher educational opportunities more universally available to students. College and university education was extremely expensive, relative to the median salaries of most families, so a creative means of funding academic studies had to be found. The NDEA evolved into what is currently known as the Perkins Loan program, and it offers post-secondary students who demonstrate significant financial need low-interest loans that can be paid back over a period of a decade or more, after the completion of the educational process.
The initial paradigm in most countries other than the United States was that post-secondary education should be made available and affordable to all qualified students. That paradigm has shifted with changing world economies, and many other countries have begun to adopt the American model of student-loan financed education. As has been the case in the United States, the system has had a number of problems, not the least of which have been the imbalance between students' debt burden at graduation and their ability to earn sufficient incomes as to be able to repay the loans, and the frequency with which students (this is a global phenomenon, as is the debt imbalance) default on their loans (cease or fail to make the agreed upon payments).
As more countries institute tuition, borrowing has become crucial and more fraught with problems
With tuition costs going up worldwide, a growing number of countries are throwing young people a new financial lifeline: student loans. But those lifelines are proving to be slippery. A rapid increase in enrollments in recent years has put huge strains on the budgets of countries that traditionally have had free or low-cost public higher education. More and more countries are requiring students and their families to share education costs by paying tuition. Loans are supposed to prevent higher education from becoming an exclusive privilege for the children of the affluent.
But student-loan programs, difficult to get right even in the United States where they have been around since 1958, are proving even more prone to failure elsewhere. Three of the world's most populous countries—China, Russia, and India—have tried to start loan programs in the past two years, but the only one that could be called operational, in China, is plagued by problems. In some countries, programs have been run so inefficiently that administrative costs have eaten up as much as a quarter of the money available for loans. Elsewhere, little of the money lent out was recovered, because few graduates bothered to repay their loans, or governments charged students such low interest rates that the loans ended up functioning largely as grants. Loan programs exist today in some 60 countries, but in many nations they reach only a small share of the young people who need them.
Finding the Right Balance
"The trick is to find a balance between providing subsidies to needy students, and making loan programs financially sustainable," says Jamil Salmi, deputy director for educational policy at the World Bank, which is currently helping about a dozen countries establish or strengthen loan systems. Loans may be intended to reduce the pain of rising fees, but that doesn't mean students are always happy about them. "Loans put people in a trap," says Jacob Henricson, chairman of the National Unions of Students in Europe, known as ESIB. "If you don't have a very large salary, you're going to have problems repaying."
In Europe, with the exception of Britain, public higher education systems are still free or very cheap, and many governments provide students with stipends for living expenses and study materials. But as enrollments continue to climb, the stipends are beginning to come as loans, instead of grants. Henricson, a political science student at the University of Stockholm, says that with Scandinavia's high living costs and expensive imported textbooks, it is not uncommon for Swedish students to graduate $25,000 in debt.
Pressure from students and their families to make borrowing for college cheap leads to one of the thorniest problems policymakers face—how much to subsidize interest rates of loans. A high subsidy, with students charged low or zero interest, means that, due to inflation, students end up paying back only part of the value of the money they borrow. Nicholas Barr, a professor of economics at the London School of Economics and Political Science, says that when subsidies exist they unfairly benefit the middle class. Students usually come from the middle or upper middle classes and can afford to pay back loans at close to commercial rates, he argues. Without subsidies, loan programs are cheaper for the taxpayers, and more money can be made available to more students. Special assistance can then be provided to students from poor backgrounds, or graduates who go into low-paying but socially beneficial professions. But the middle class has considerably more political clout than the poor, Barr says, and policymakers often give in to their demands for cheaper loans for all.
That has been the case in Britain for the last decade. Interest on student loans has been kept so low—generally equal to the inflation rate—that the government has gotten back only about half of the value of the money it has lent out. Now there are strong demands to reduce the interest rate subsidy and give more help to those in greatest need.
Sharing the Burden
One method for spreading out students' debt burden that has attracted international attention is Australia's national loan system, the Higher Education Contribution Scheme. Repayment is pegged to a graduate's income; repayment starts when he or she is earning at least $12,000 per year, and is set at 3 to 6 percent of his or her income above that. So low earners pay back smaller amounts, but for a longer time. Another feature of the program is that administrative costs are kept down by piggybacking on the income-tax system. Payments are billed as a surcharge to income taxes and are generally deducted by employers.
Yale University tried another approach to promoting social equity in the 1970s. Some view the program as having been an embarrassing flop, others as a noble but flawed experiment. The World Bank's Salmi says it "illustrates how the implementation of a theoretically sensible and generous concept turned into a nightmarish adventure." Under Yale's Tuition Postponement Option, graduates had to repay yearly 0.4 percent of their salary for each $1,000 they had borrowed. (Tuition was considerably lower then.) Each borrower had to continue paying until the debt of their entire graduating class was repaid. The program unraveled when high-earning graduates realized they would have to repay far more than they had borrowed, subsidizing not only students in low-paying professions, but the 15 percent of graduates who were deadbeats. Few students realized how many classmates would renege on the loans.
Even where controversial social policy issues have been resolved, collection of debts has often been a problem, especially in developing countries with poorly functioning or nonexistent tax and credit systems. In the 1980s, Brazil, Venezuela, and Kenya each had loan programs with roughly 90 percent default rates. In an even worse case, an official body in Ghana recently reported that out of $27.5 million loaned to more than 400,000 college students since 1988, only $1.1 million has been paid back. "In many cases," says Salmi, "it would have been cheaper to substitute loans with outright grants or scholarships." But, he adds, "many countries have learned from their mistakes."
Jamaica's government-sponsored loan system was near collapse three years ago because only about a third of loans were repaid. The biggest deadbeats were not low-income students, but those who became physicians and lawyers. As part of efforts to make the system more financially viable, the Student Loan Bureau began an advertising campaign appealing to students' civic duty, and published "shame lists" with the names and photographs of those with outstanding debts. Within months, repayments improved substantially.
Even the United States and Canada were plagued by high rates of default in the 1980s. At the end of the decade, U.S. officials began to refuse loans for study at institutions with graduates who had very high default rates—generally for-profit colleges with poor programs that did not lead to good jobs. The default rate for most student loans—government guaranteed but provided by commercial lenders—was 21.4 percent in 1989. Now, the rate is 5.6 percent. A strengthening economy contributed to the improvement.
A number of poor-quality, for-profit institutions that lost the right to provide federal loans to their students were forced to close. The loan system thus played an important secondary role as an instrument for quality promotion. Some loan programs in developing countries, such as one in the state of Sonora in Mexico, have used a similar approach to try to steer students to stronger institutions.
The world's first national student loan program, according to Salmi, was established because one graduate wanted to share his good fortune with others. In the late 1940s, Gabriel Betancourt, a young Colombian from a poor family, persuaded the manager of the company he worked for to lend him money to study abroad. He was so grateful for the opportunity that, after graduating, he successfully lobbied the Colombian government to establish a permanent loan mechanism. In 1950, he became founding director of the Colombian Student Loan Institution. The institution continues providing loans today, but only to 6 percent of students—down from a high of 12 percent—due to a lack of government support.
In many poor countries with largely black market economies and no formal income taxes, economists are skeptical about the possibilities of creating viable loan programs. "Without any means of tracing income, loan programs are not going to work, except on a small scale," warns Bruce Johnstone, a professor and director of the Center for Comparative and Global Studies in Education at the State University of New York at Buffalo.
Creating the Infrastructure
Although this means abandoning the pretense of making higher education available to rich and poor alike, Johnstone says very poor countries may have to settle initially for modest loan programs, perhaps providing the money only to those who can provide collateral, or to graduate students, since they would be more likely to obtain gainful employment after graduation. For many poor countries, especially in Africa, only now contemplating the controversial decision of introducing tuition, the question of whether broadly available loans can work remains unanswered. But the World Bank, stung by past criticisms that its policies have hurt the poor, is committed to the idea. "No country should introduce cost sharing," says Salmi, referring to tuition payments, "without a proper mechanism for student loans and student aid."
The United States has traditionally been the world leader in terms of the creation, implementation, and administration of student loan programs for college and university education and, progressively more, for graduate and professional education programs. As the cost of education has risen, so has the ceiling for student loans. There have been special loan categories created for graduate students, particularly those in the medical and health professions. The variety of grant and scholarship funds and sources has grown through the decades as well, but has not kept pace with the exponential growth of the student loan industry. Loan programs have been created that are not based so much on financial need as they are on available resources in comparison with educational and ancillary costs, loans for parents who are helping to fund their children's education have been implemented—those are geared to middle class and wealthier families who are willing to pay substantially higher interest rates in order to assure their children's undergraduate educations. There continue to be specific loan programs for the financially neediest students, which generally are offered at lower interest rates than are other types of loans. Guaranteed student loan programs have become popular; they are offered by banks and other financial institutions, but are backed by federal funding.
The financing of higher education has become a vast and complicated machine and the United States remains the world leader of the industry. The National Association of Student Financial Aid Administrators (NASFAA) was created in the late 1960s, and was tasked with oversight of the mechanics of the process—keeping track of the vast amounts of student and financial data, and making certain that all of the educational financing processes occur in as smooth a fashion as possible. Although student loans now have funding originating all over the globe, as students from more and more countries navigate the business of educational financing, the United States Department of Education still stands at the forefront of loan origination. Among the biggest problems with the student loan industry, worldwide, has been the rate at which student loans are defaulted, either because young college graduates are not making enough money with which to survive, run a household (of whatever dimensions), finance the beginning of a career and an independent life and make monthly student loan payments, or because the borrower simply walks away from the obligation after graduation and hopes to successfully avoid repayment. Much of the published research, and this appears to be a universal phenomenon, regardless of the student borrower's country of origin (see references for Boddington and Lea, below), suggests that students habitually underestimate the amount of debt and fees to be repaid, the length of time that it will take to pay back the loans and attendant interest, and the amount of liquid assets they will have to work with—in short, they grossly miscalculate how much they'll make and how big and long-lasting the bite from the loan repayments will be. At the same time, the recent graduates are attempting to create a career trajectory and life path, which typically costs more than anyone expects—for housing, food, work clothing, commuting expenses, and the like, when the individual is often living a wholly independent existence for the fist time and is struggling to learn how to be an autonomous adult. Recent graduates are coming into the start of their adult lives already significantly burdened with educational debt.
The world is gradually becoming more and more organized around debt—first at the national and local government levels, and now at the individual level. With credit debt an exploding worldwide phenomenon, it seems to add an enormous personal challenge and to set a rather dangerous example for the way in which to conduct the business of life, to begin adulthood and professional life already in a financial deficit position. Student loans have, indeed, become a very slippery lifeline.
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