June 18, 2015
A number of recent analyses purporting to show the negative effects of student loans compare group A, which has student loans and a bachelor’s degree to group B, which has the same level of education but no student loans (see here for an example). Not surprisingly, the studies find that the folks who have a college degree but no student loans are doing better on a variety of measures. Unfortunately, many of the studies improperly conclude that student loans are causing the bad outcomes.
The problem is that the likely alternative to student loans and a college degree for people who need to borrow to afford college is not a free college degree. The likely alternative is no college degree and no student loans—i.e., lower earnings, and eventually, a lower net worth.
Among those who will eventually graduate from college, those who will graduate with no student loans are very different from those who will graduate with student loans. These differences are present before they even set foot on campus.
Why do some people graduate from college with no debt?
1) Their parents are rich and pay for college—and most likely provide additional financial support after college
2) Their parents are not rich but are extremely devoted to their children’s education and find a way to pay for college—and most likely provide additional support after college
3) The students are exceptionally talented academically, athletically, or artistically and obtain large scholarships
4) The students are unusually hard working and market savvy and find a way to earn a lot of money while in college
5) The students live in a wealthy city or state that generously funds public services such as higher education, and probably also funds other public investments (Note that most public colleges are not generously funded and have lower completion rates than resource-rich private colleges).
These “student loan studies” are not studies of the effects of student loans. They are studies that find that people who are more talented, harder working, come from wealthier and more supportive families, and live in richer communities with more enlightened governments are more successful. This is neither surprising, nor is it relevant to student loan policy.
Eliminating student loans won’t magically give everyone rich, devoted parents, boost students’ intellectual, athletic, or artistic abilities, or turn the least developed and most mismanaged parts of the U.S. into centers of economic activity and paragons of efficient public administration.
Criticisms of student loans seem to be motivated by an idealized conception of public, taxpayer funded higher education. In practice, these systems are too often characterized by weak, underfunded institutions, misguided political interference (for an example of left-wing interference, see here; for right wing interference, see here, here, and here) and micro-management (here and here) by political leaders , price controls (here and here, and here), disruptive budgetary uncertainty (here, here and here), and resulting shortages (here, here, here, here, and here).
This does not mean that we should abandon the goal of a well-funded public higher education system where academic freedom is protected, but it would be imprudent to put all of our eggs in a single basket, particularly one that political leaders frequently raid to close budget gaps.
Scaling back student loans will undermine investment in higher education, to our collective detriment. Without access to credit, students from modest backgrounds will too often be trapped in the under-resourced institutions that our tax-adverse political systems is willing to support (or denied access altogether because of enrollment caps) instead of at least having the option to pursue the higher quality education that is ultimately in their best interests.
June 16, 2015
So how should our understanding of student loans apply to law students? Mortgages are routinely repaid over 30-years, even though owner-occupied housing is close to pure consumption (most of the value of housing is consumed as imputed rental income, with appreciation averaging only around 1 percent above inflation). Legal education typically provides a much higher rate of return than real estate, and is probably closer to investment than consumption.
Rather than focus on initial salaries at graduation alongside student loan balances, it would be more appropriate to emphasize student loan debt service payments, assuming students pay their loans over several decades and with payments that match the expected trajectory of earnings. This would be an apples-to-apples comparison—initial cash flows compared to initial cash flows.*
It also makes sense to report student loan payments in real terms by subtracting expected inflation (typically around 3 percent) from the nominal interest rate before calculating loan payments.** (As inflation increases wages and the prices of goods and services, a nominally flat debt payment becomes less valuable in terms of what the money can buy and how much work is necessary to earn enough to make the payment). Adjusting for inflation won’t take into account the increase in real earnings (above and beyond inflation) that typically comes with additional work experience and secular increases in economy-wide productivity, but at least takes into account increases in earnings that match inflation.
$100,000 in debt repaid in equal installments monthly over 30 years at a 3 percent real interest rate (6 percent nominal) comes to $5,059 per year ($422 per month) in real terms. In nominal terms (without adjusting for the power of inflation to make debts easier to repay), the payments are $7,200 per year ($600 per month).
With a graduated extended repayment plan over 25 years, the real initial monthly payments come to $3,420 per year ($285 per month). In nominal terms (without adjusting for the power of inflation to make debts easier to repay), the initial payment is around $6,000 per year or $500 per month.
Law graduates typically earn around $60,000 to $75,000 per year to start and have debt service payments of around $3,400 to $7,200 per year. Recent law graduates have much more cash at their disposal than most bachelor’s degree holders of a similar age even after paying down their loans.
Law students’ incomes can support their debt service payments, as demonstrated by the exceedingly low student loan default rates for recent law graduates. It is time for the ABA to rethink how law schools disclose debt balances and student loan repayment obligations so that students are not mislead into underinvesting in education.
Journalists and education experts should also be careful to discuss student loans using apples-to-apples comparison—cash flows to cash flows, and lifetime present values to lifetime present values.
* If student loan balances or initial cost of education are presented, these should be compared to the expected present value of the boost to earnings from the degree over the course of a lifetime. Thus, for example, whenever reporting that law school costs around $100,000 on average, it should also be reported that the average value before taxes and tuition is around $1,000,000 and that the median value is around $750,000.
** Part of what graduated loan repayments accomplishes is to make real payments closer to level. If nominal payments remain flat, as in standard fixed repayment loans, in real terms, payments decline over time and repayment of the loan is front-loaded.
Tom Friedman's latest New York Times column uses the labor market for executive assistants and executive secretaries to illustrate dubious claims about credentialing and over-education. Friedman argues that since most current executive assistants and executive secretaries don't have bachelor's degrees, employers should not try to upgrade the workforce by hiring new executive assistants and secretaries with bachelor's degrees. After all, executive assistants without bachelor's degrees can do the job, so who needs a bachelor's degree?
The problems with this reasoning should be obvious.
First, education is only one of many factors that are valued in the labor market. Some individuals who are smart, hardworking, personable, physically attractive, or fortunate, but have limited education, will inevitably be as successful or more successful than other individuals who are highly educated but less gifted in other respects. This does not in any way challenge the extremely strong evidence that a bachelor's degree can improve labor market outcomes. It simply means that we are dealing with a heterogeneous population.
If two homogenous groups who were initially equally strong on non-education factors were given different amounts of education, the more educated group would typically be more successful in the labor market. Labor economists who have studied identical twins routinely find that twins with more education are more successful than their less educated counterparts. When labor economists control for unobserved heterogeneity within education levels using fixed effects models rather than OLS regression, "over-education" effects on earnings diminish or disappear. In other words, highly educated folks who are about as successful as those with less education--and end up in the same occupations as the less educated--tend to be weak on factors other than level of education. But even within occupations that combine the worst of the more-educated with the best of the less-educated, those who are more educated still tend to earn more. Since profit-maximizing employers are not in the habit of handing out money for nothing, this suggests that the more educated are better at their jobs.
In sum, education many not always be enough to make you more successful than your neighbor or coworker, but it can make you more successful than a less educated version of yourself.
Second, the fact that something was "good enough" at some point in the past does not mean it is good enough today. Rising standards typically involve both increases in quality and commensurate increases in cost. In inflation adjusted terms, the average new car today costs about 10 times as much as a Ford Model-T in the late 1920s. But the average new car is faster, safer, more reliable, and easier to operate. Similarly, as education increases, so does the productivity of labor and the cost of labor--wages or earnings. Highly educated workers today are far more productive than their counterparts decades ago, and as a result, they earn more.
It is interesting that Friedman chose executive assistants and executive secretaries--a field where most workers have less than a bachelor's degree--as an example of supposed "over-education." According to the Bureau of Labor Statistics Occupational Employment Statistics, employment of executive assistants and executive secretaries is collapsing. Employment fell by more than half between 2007 and 2014, from over 1,500,000 workers to barely more than 700,000. In other words, the level of education that most executive assistants and secretaries had in 2007 was not enough to make it in the labor market of 2014.
Among secretaries, those with higher levels of education still earn more than their less educated counterparts after controlling for race. Employer hiring priorities cited by Friedman suggest that those who are more educated are more likely to keep their jobs or find new ones.
This is consistent with general trends in the labor market. Low and middle skill workers with limited educations are the hardest hit by automation, outsourcing and layoffs, while their more educated counterparts are navigating the recession and changes in the labor market more successfully. (During the 2007-2014 period, employment of a group of highly educated workers, lawyers--supposedly the victims of job-destroying structural change--continued to grow faster than overall employment).
For another angle on Friedman's column, readers may be interested in Frank Pasquale's critique. Pasquale discusses apparent bias in the New York Times' Higher Education coverage and argues that as newspapers struggle to adapt to a world replete with free online content and greater competition for advertising dollars, business priorities may be overriding traditional news values. Given the nearly 20 percent decline in employment for reporters and correspondents between 2007 and 2014, journalism does appear to be under serious financial pressure.
June 15, 2015
A shorthand approach sometimes used to compare the cost and benefits of higher education—comparing student loan balances at graduation to first year earnings—can be seriously misleading. The implication of this approach is that student loans have to be repaid in full shortly after graduation, and that graduates’ low initial earnings will persist for the rest of their lives.
This is an apples to oranges comparison. An investment in education pays dividends throughout one’s life. First-year earnings are one small, unrepresentative, slice of lifetime earnings. Comparing a lifetime investment to one year of expected returns on it feeds ignorance about how student loans and lifetime earnings actually work. It thus risks misleading prospective students into making financially disastrous decisions to underinvest in education.
Student loans are meant to solve a specific problem—the costs of education come as a series of large upfront payments for tuition and living expenses, while the benefits accrue later in life in the form of higher earnings. Except for the minority of students who are fortunate enough to have rich and generous parents who cover their tuition, students generally have two options—save or borrow.
Saving is inefficient because it requires students to work for many years with a lower level of education and for much lower wages, and to complete their degrees much later in life. Completing a given level of education earlier helps maximize the number of years of expected higher earnings with a higher level of education. Borrowing to invest in education is therefore more efficient than saving to invest in education. Some of the benefits of financing accrue to the student borrower in the form of higher lifetime earnings compared to saving, and some of the benefits accrue to the lender in the form of interest and fees. Another approach to financing higher education—more popular in Europe, Australia, and Canada than the United States—features higher public spending and higher tax burdens, sometimes with a tax-like percent-of-earnings fee explicitly tied to university education. The social democratic approach, like the U.S. approach, involves providing something of value up front in return for a fraction of graduates’ incomes later.
Student loans enable students to pay for their own education by converting the cash flows associated with investment in education from large upfront payments into a series of much smaller payments spread out over time. Ideally, these payments should closely match the timing of the benefits of education—that is, the timing of the boost to earnings from education.
Because the benefits of education accrue over the course of a career—perhaps 40 years or more—and earnings typically do not peak until middle age, the costs of education should ideally also be spread over a similar time frame.
The prospect of high payments needed to pay back loans very quickly ex-ante could cause prospective students to underinvest in education. As life expectancy and career length increase, so should initial investment in education.
If this goal of matching the timing of cash flows is accomplished, then at every point in time, with more education, students will have more cash at their disposal. The boost to earnings from education will more than cover student loan debt service payments, and the initial borrowing will enable students to maintain a decent lifestyle while pursuing studies instead of working full time. (For a discussion of the advantages of leveraged investments early in life, see Ayers & Naelbuff).
That is one important reason why federal student loans can be repaid over 25 to 30* years (so-called “extended” repayment). Plans are available under which monthly payments start low and increase over time to match the typical trajectory of lifetime earnings (“graduated” or “graduated extended” repayment), or in which payments dynamically adjust up and down with actual borrower earnings (if earnings fall below a certain level) to better match cash flows (“income-contingent” or “income-based” repayment).
Because these extended and income adjusted plans are better tailored to the purpose of student loans—matching positive and negative cash flows—one of these plans should be the default option for student borrowers instead of the now “standard” 10-year repayment period. 10-years to pay for an education that provides benefits over 40 years makes little sense. For law graduates, real earnings typically continue to grow for 30 years after graduation.
* Consolidated loans can be repaid over 30 years, but some consolidated loans may not be eligible for income based repayment plans.
Paying loans back slower typically will not affect the economic value of education, notwithstanding the fact that nominal interest payments will increase. Paying loans back faster or slower typically will not affect the economic value of education as long as two conditions are met:
- Interest rates remain unchanged regardless of whether a loan is repaid over 10 or 30 years (this is the case for federal student loans, but not for mortgages or most other debt instruments most of the time)
- The interest rate on student loans is appropriate, in that it matches up with default and loss risk levels for lenders, the opportunity cost of capital, and time preferences.
If condition 2 holds, then the interest rate will equal the discount rate which is used to convert cash flows occurring at different points in time into the same currency so that they can be compared. If the discount rate is 6 percent, then there is no valuation difference between paying $1,000 today or paying $1,060 one year from now, just as there is no difference between paying one U.S. Dollar or the equivalent in Euro cents. If students choose to refinance or pay their loans back faster than they are legally required to repay them, this suggests that the interest rate on student loans is too high.
June 12, 2015
The Department of Education has been overcharging low-risk professional school students for federal student loans (relative to the market rate) while keeping rates low for undergraduates who are far more likely to default. (For previous coverage, see here, here and here).
Bloomberg BNA's Bankruptcy Reporter describes the predictable consequences of this politically driven mispricing: Professional graduates are refinancing into less expensive private loans and removing themselves from the government's risk pool.
There is a simple solution that will shut down what Bloomberg describes as an "exodus of top borrowers" while preserving student lending profits for the benefit of taxpayers. The government should charge low risk graduate students less.
Update, June 13, 2015: Jordan Weissmann at Slate covers the story.
May 25, 2015
...while undertaking additional cost-cutting measures. It appears the School enjoys some strong support in the local Charleston community.
May 19, 2015
A curious sign of the times: Charleston Law students, acting as "creditors," seek to put school into receivership
May 14, 2015
According to a faculty member, the Law School ran nearly a five million dollar deficit this year, and the Dean has pledged to cut $2.1 million of that next year, with a combination of moves: the elimination of all sabbaticals, all research stipends, a 5% salary cut for senior staff, and a 10% salary cut for all faculty. To make matters worse, the Dean, according to one source, "forbade anyone from speaking to the press about this. The materials he passed out carried two watermarks, one large across the text, and another secret one (or so he said), with each faculty member's name so he will know who the leak is, he said." Since everyone familiar with legal education knows that many law schools are struggling with financial problems, it's mysterious (and counter-productive) for a Dean to make such a threat.
Pace faculty are concerned that there has been no attempt to buy out faculty (as other schools have done) and fear a further salary cut is in the offing before long. The elimination of sabbaticals also has a number of Pace faculty perplexed, since with a reduction in its class size, Pace has excess teaching capacity, so it's not like sabbaticals require hiring adjuncts or visitors, so they do not add to costs.
UPDATE: Prof. Alexander Greenawalt (Pace) writes:
I have not polled my peers but I believe that most of my colleagues would agree that there are serious inaccuracies in the report you received. Of course I’m not thrilled to have my salary cut, but the truth is that we are part of a university that is continuing to support us, and I still have a great job at a great law school. The main thrust of the dean’s remarks was that he is implementing budget cuts that will reduce our deficit without compromising the quality of the education we provide our students. On that score, I believe he succeeded. We are not the first law school to experience a faculty salary cut, and I don’t think this is a sign that we are a sinking ship.
As to the specific allegations, the document in question is an internal memorandum written by my some of my faculty colleagues identifying possible budget cuts, several of which have not been adopted. I think it’s obvious that any law school would treat this as a confidential document. I doubt that my colleagues who authored it wanted it made public, and I think the dean would have been well within his rights to limit our access to it, for example by making it available for review only in hard copy in the dean’s suite. Instead he decided to distribute individual copies, while taking measures to discourage (without prohibiting) public disclosure. I haven’t picked up my copy yet, so I can’t tell you what it looks like or what watermarks it might have. Perhaps he should have handled this distribution differently, but my honest belief is that he was acting out of a desire to be transparent rather than punitive.
In particular, I want to emphasize that there were no threats of any kind. David did not forbid communications with the press, and indeed when asked about this he was quite clear that we were free to do what we wanted. He did ask that we not leak the document to the press, and I think that’s a reasonable request. Certainly, he did not specify any consequences if we did.
Regarding sabbaticals, David [the Dean] was clear that they will still be available for important scholarly projects.
I can’t speak for my anonymous faculty colleague, and certainly I am not accusing that person of dishonesty, but obviously we have very different recollections!
I thank Prof. Greenawalt for contacting me about this. My source stands by the original account. I think some of these issues may be matters of interpretation. I do not think Pace is a "sinking ship" at all; it has an unusually strong faculty for a regional law school, and, as I noted originally, is facing the same issues that most American law schools are now facing.