The day after Christmas, Bernie Sanders asked a question on Twitter: “You have families out there paying 6, 8, 10 percent on student debt but you can refinance your homes at 3 percent. What sense is that?”
Finance types may snicker. But I’ve seen this question asked fairly often, and it seems worth answering, respectfully, for people whose expertise and interest lie outside the realm of economics.
The short answer is: “Loans are not priced in real life the way they are in Sunday School stories.” In a Sunday School story, the cheapest loans would go to the nicest people with the noblest use for the money: single mothers who need money to buy their kids a Christmas present, say.
That’s splendid for the recipient. But what about the lender? Let’s say you had $150 that you really needed to have at the end of the month, say to pay your rent. Would you want to lend it to the single mother whose income is stretched so tight that she needs to borrow money for Christmas presents or would you want to lend it to some heartless leech of a securities litigator with an 800 credit rating who happens to have left his wallet at home?
C’mon. You know the answer. You just don’t want to say it. If you really need the money – if you cannot afford to turn your loan into a gift – then you lend it to the better credit risk with the higher income, not the person who may find herself too short to pay you when the loan comes due.
In aggregate, most of the money in your savings account is loaned out using this cold calculus, and unless you could afford to have the contents of that account suddenly vanish, you want it to be. That’s why poor people, on top of all the other unfairness heaped upon them, pay higher interest rates. And that is why secured loans, like mortgages, get lower interest rates than unsecured loans, like credit card balances and student loans.
A 2-for-1 risk
Student loans are two-for-one in terms of risk: They are frequently made to people with no income, no credit history and somewhat imperfect prospects; and they carry no guarantee of payment other than the borrower’s signature. If someone fails to pay an auto loan, you can take their car away. This ensures repayment in two ways: You can auction the car and recover some of the money you lent out, and people need their car and will scrimp on other things in order to keep from losing it.
The immediate personal costs of failing to pay your student loans, on the other hand, are pretty minimal, and people are going to take that into account when they decide whether to pay you or the auto finance company. That’s why the government has to guarantee these loans; the low-fixed-rate, take-any-course-of-study-you-want-at-any-accredited-institution, interest-deferred-in-school is probably not a financial product that would exist in the wild.
Secured loans have thus always carried lower interest rates than unsecured loans and will do so until the heat death of the universe renders moot such questions.
Now, Sanders may actually be asking a deeper question: How can society make it easier to get a home than to get the priceless boon of an education? If that is the answer that the cold math of the market gives us, then maybe we need some alternative to the market, such as, I dunno, socialism? Or at least endorsing Elizabeth Warren’s scheme to lower the subsidized rates on loans?
Why not socialism?
Fair question, to which we may pose several fair answers.
▪ Government-subsidized student loans seem like a fairly stupid idea that may well have done students no good at all, driving up tuition and thereby paying for the swelling level of college amenities, the swelling ranks of for-profit colleges of dubious value and the swelling number of administrators at our nation’s institutions of higher learning. That’s not a sterling argument for further well-meaning government intervention in the sector.
▪ While it is cheaper to pay a mortgage, it is not easier to get one. They’re very sticky about ensuring that you repay them. Most college students could not make it through the amount of underwriting that goes into writing a typical mortgage these days.
▪ Unless we are going to go pretty far in the socialist direction, we’re stuck with prices as the main way to allocate economic activity. As long as we have prices, the government will have a budget. And reducing the interest rate on loans with a high delinquency rate compared with other loans means that we will have less money to do something else.
Giving people free tuition would also mean that the government would have less money to do something else – a lot less money. Sanders tries to deal with this problem by conjuring hundreds of billions worth of imaginary tax revenue out of thin air, but, alas, the actual president will have to find real money, taken from some other use. Is subsidizing the folks who are going to end up as the best-off members of society really what we would choose to use that money for?
More people require shelter than college diplomas. More Americans own homes than a sheepskin on the wall. If we’re going to be subsidizing anything, why choose the needs of the few over the many?