Student Loans at 8.5%: A Government Created Crisis

This past Friday, May 25, the Wall Street Journal published an article about an orthodontist who currently has over $1 million in student loan debt.  Dr. Mike Meru, the orthodontist, pays over $1,500 per month, but in about two decades, his balance is expected to balloon to $2 million.  His original principal balance was $601,506.  As stated in the article, “Any balance remaining after 25 years is forgiven, effectively covered by taxpayers.  The forgiven amount is then taxed as ordinary income.”

The WSJ projects that by the time Dr. Meru’s loan is forgiven he will have paid approximately $1.6 million.  Yet, the majority of comments in response to the article express little to no sympathy about Dr. Meru’s dire straits, with many vilifying him for spending any of his $225,000 salary on pleasures or luxuries of any type.

Yes, Dr. Meru is an avid outdoorsman (as judging by his Instagram account), he recently took his family on vacation to Havana, and he bought a used Mercedes-Benz while in school and currently drives a used Tesla.  He could live more of a pauper lifestyle on his $225,000 salary that supports his family of four, but should his loans really be a jail sentence that restrict any life pleasure?

The emphasis and focus on these facts do Dr. Meru and all student borrowers of the millennial generation a disservice.  Understandably, a good journalist reports on all relevant and material facts, even those that may undermine a subject’s story.  With that said, in an investigative piece like this one, it is also the duty of the journalist to hammer home the crux of the story.  Namely, that government issued student loans have unrealistic and unreasonably burdensome interest rates.

Gory Student Loan Details

• Borrower Age.  As in Dr. Meru’s case, most borrowers are either 18 years old (if borrowing for undergrad) or 22 years old (if borrowing for graduate school).  The government effectively allows graduate students to borrow any amount to cover tuition and living costs, with almost no controls to help ensure people do not get in over their heads.  Do we really expect even the most financially savvy of 22 year olds to forecast their long-term solvency and financial health?  Do young students really know what they’re getting themselves into?
• Quality of Education.  For graduate schools in particular, the government gives almost no consideration to the quality of the school the borrower plans to attend.  You can get a loan to attend Harvard as easily as you can the University of Phoenix, even though the job prospects and projected salaries are drastically different.
• Untethered Interest Rates.  A law passed by Congress in 2001, which went into effect in 2006, untethered student loan interest rates from Treasury rates.  In conjunction, Congress lowered the costs for undergraduates, but similar relief was not granted to graduate students.  In fact, while the Federal Reserve was lowering interest rates to combat the recession, rates for graduate students reached their apex at 8.5%.
• Compounding Interest.  Warren Buffet has called this concept one of the greatest innovations of mankind.  When you have taken out a loan to attend graduate school, however, you need to be aware that you’re on the other side of this grand innovation.  While investors love how interest compounds and multiplies, borrowers must cope with its ever-increasing weight, especially while they’re in school making no money and still accruing interest (that compounds!).  You may say, get a job, take out fewer loans, and figure it out, but if you want to survive an intense graduate program while eating more for dinner than peanut butter and white bread, side jobs and fewer loans are not always realistic.
• Soaring Costs of Higher Education.  Gone are the days where you can work your butt off through school and graduate debt-free.  Many undergraduate programs are now well over $50,000 per year, with graduate programs costing even more.  The government continues to issue a limitless supply of student loans without implementing any checks on those responsible for the soaring costs of higher education – the colleges and universities that make millions of dollars on the backs of student borrowers.
• The Job Market and Forbearance.  While the Federal Reserve was lowering interest rates for seemingly everything but student loans, the job market continued to suffer in the wake of the recession.  People pursuing higher education often graduated without a job, even when they performed reasonably well in the classroom.  One option afforded to borrowers after loan grace periods end (typically six months after graduation) is forbearance.  This option allows the borrower to press pause on loan payments while they apply to jobs, but in the meantime, the loans still accrue interest, which eventually capitalizes to the principal of the loan.  With interest rates at nearly 8.5%, think about the extra burden that places on a young person trying to start a career, family, and reasonably decent life.
• Loan “Forgiveness”.  Much of the hype and hysteria in the comments responding to the WSJ article centered on the government’s “forgiveness” of Dr. Meru’s loans after 25 years of payments.  What the article did not do a great job of explaining, however, is the fact that not only will Dr. Meru owe the IRS taxes for any balance of the loan that is forgiven (it’s considered taxable income in the eyes of the IRS), but he will have already paid some $1.6 million at that point, or 2.6 times the original principal balance of the loan (which was approximately $600,000).  If that is considered “forgiveness” and unfair to taxpayers, I want to meet the investor who is disappointed about a 166% return on an investment made 25 years ago.

Path Forward

Congress and the American people need to ask themselves: do we really want an entire generation of people saddled with exorbitant debt that uncontrollably grows because of unreasonable interest rates?  Almost nobody pays 2.6 times the original principal of a loan except students.  Even a mortgage for $600,000 at current rates (around 4-5%) would only cost a borrower some $365,000 over the life of a 25 year mortgage.  Auto loans do not come close either.  Yet the government has made it a point to incentivize and encourage people to buy homes and cars, which are staples of the American dream.  Does aspiring to better your life through education not fall in the same category?

The WSJ article on Dr. Meru does not do justice to the perils inherently embedded in the student loan crisis.  Although there is a certain level of caveat emptor (buyer beware), as a society we have always made it a point of protecting people against themselves.  Why can we not add more reasonable controls around student borrowers and the schools that benefit from government issued student loans?  Why does the government need to charge 8.5% on some student loans for graduate students when loans for homes and cars are often less than half that amount (at around 4%)?  And in moments of recession and crisis, why do we penalize those who pursue higher education in an effort to help the economy and themselves by charging them unreasonable interest rates while they’re looking for work?

Some may still argue that the Dr. Merus of the world are simply freeriders and takers, using a student loan system to their advantage.  If the Dr. Merus out there are paying some 2.5 times the original amount they borrowed, in addition to income taxes on any “forgiven” balance, and they contribute positively to society, it seems hard to criticize their borrowing behavior.  After all, in a country built on aspirations and dreams, we should want the younger generation to pursue higher education and incentivize them to do so.  If we do not afford people the opportunity to take out student loans, higher education will be limited to the fortunate one percent, forcing America further into an educated aristocracy abyss of no return.  We should fear that outcome far more than “forgiving” Dr. Meru’s remaining student loan balance.

*For a recent article on millennials, the job market, and student loans, click here.