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Give colleges stake in debt.

Byline: The Register-Guard

Correction (published June 13, 2015): A June 12 editorial overstated the student loan default rates at the University of Oregon and Oregon State University. According to the U.S. Department of Education, the 2011 default rates at the universities are 5.8 percent and 5 percent, respectively.

Economists call it moral hazard: One party participates in an activity that produces benefit because another party bears the risk. Moral hazard has helped student debt balloon to $1.3 trillion - colleges and universities end up with the money, while students bear the burden of repayment and the federal government carries the risk of default. If colleges bore at least a small part of the risk, it's likely that many students' debt would become more manageable and the default rate would go down.

Douglas Webber, an assistant professor of economics at Temple University, proposed that colleges share the risk of student loan defaults in a June 8 essay in the Chronicle of Higher Education. He said that if institutions of higher education were responsible for 10 percent or 20 percent of the cost of defaults, they'd work harder to ensure there were fewer of them. Any such efforts would be good for students and for student loan programs, which must charge higher interest rates to cover defaults.

Currently, few colleges or universities face any real penalty for defaults. Schools whose students' default rate exceeds 30 percent for a three-year period, or 40 percent in a single year, can be declared ineligible to participate in federal loan and grant programs, but few exceed those thresholds - 21 colleges last year, 20 of them private for-profit colleges. Most institutions never approach the cutoff level. The University of Oregon's default rate for students who began loan repayments in 2011, for example, was 14.3 percent, and for Oregon State University it was 14.7 percent.

Student loan default rates are declining as the economy recovers. They should decline still further as a result of new income-based repayment programs and improved loan-servicing regulations instituted by the Obama administration this year. But default continues to damage the credit ratings and job prospects of hundreds of thousands of former students, and adds to the cost of student loan programs. And because student loan debt has grown to exceed all other non-mortgage debt - including credit card debt and vehicle loans - the effects of any reduction in defaults would be widely felt.

The problem of moral hazard is most pronounced among for-profit colleges, which enroll 12 percent of students but account for 44 percent of student loan defaults. The worst of them encourage students to borrow heavily, and then give their graduates credentials that seldom lead to jobs with salaries that will allow them to repay their loans. These schools, in effect, sell a defective product on credit, and neither the customer nor the lender has any recourse. If colleges were responsible for a portion of the cost of defaults, they would have an incentive to ensure that their degrees are worth something.

Students at public institutions could also gain from risk-sharing. Default rates are lowest among students who graduate, so schools would gain a strong motivation to strengthen their student retention programs. Colleges might also do a better job of counseling students about the use of credit and providing realistic information about postgraduate career options.

One concern is that if colleges shared the costs of bad loans, they might engage in a form of educational red-lining by denying admission to low-income or minority students with higher-than-average chances of default. Webber suggests countering this possibility by using part of the money from colleges' default penalties to pay bonuses for each low-income and minority student who graduates. A properly balanced set of penalties and bonuses would reward schools that succeed in educating under-privileged students, and the students themselves would benefit from an effort to reduce dropout rates.

A second concern is that colleges, in an effort to avoid loan default costs, might steer students away from courses of study that lead to low-paying careers - which include a number of socially, and ultimately economically, productive fields. But students who choose such fields deserve a realistic appraisal of their job prospects. If a college can't show that a debt-funded investment in a particular course of study will pay off, students should know from the start that their rewards after graduation are likely to be nonfinancial.

Student debt has exploded because the cost of college has climbed steeply, doubling between 2005 and 2012. That's why 60 percent of students at four-year colleges are forced to borrow, and it's why the average borrower's debt upon graduation is $29,000. Students take on that load because they believe in the promise of education. Their alma maters, having taken all that borrowed money, ought to have at least a small incentive to see that the promise is kept.
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Title Annotation:Editorial
Publication:The Register-Guard (Eugene, OR)
Date:Jun 12, 2015
Words:812
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