Forgiving Student Loan Debt Would Create Moral Hazard, Exacerbate Problems: Moody's

Wiping out student loan debt would provide a modest bump to the economy, but could risk "moral hazard" which would eventually make the problem worse, according to Moody's Investors Service.

The opinion comes as Democratic presidential candidates Bernie Sanders and Elizabeth Warren dangle the prospect of forgiving some or all of the $1.5 trillion in outstanding education debt. Both candidates have also proposed free free college.

Moody's, however, think the effects of wholesale debt forgiveness at a macro level would be fairly muted.

"In the near term, we would expect student loan debt cancellation to yield a tax-cut-like stimulus to economic activity, contributing to a modest increase in household consumption and investment," said William Foster, the firm's senior credit analyst. "The magnitude of the stimulus would depend on the size of the debt relief and income level of the beneficiaries."

In dollar terms, Foster cited studies showing that canceling debt would add $86 billion to $108 billion a year to GDP over a 10-year period. Less aggressive measures to forgive some loans and restructure payments for others would amount to $120 billion over a decade.

In a $21.5 trillion U.S. economy, those kinds of gains won’t move the needle very fair [sic] from a broad sense. -CNBC

That said, CNBC notes that the issue of student debt 'and its role in growing wealth inequality' has been seized upon by Democratic candidates, and could eventually lead to a 'fundamental change to the way higher education is financed in the U.S.' due to the disproportionate impact on younger people.

"Over the longer term, debt forgiveness could lead to an improvement in small business and household formation, as well as increased homeownership," Foster continues in the note. "However, it could also increase the risk of moral hazard and the accumulation of even higher student debt burdens."

Future borrowers, for instance, might be encouraged to run up big loan balances on the assumption that their debts will be forgiven at some point.

It’s also unclear how much forgiveness would address wealth inequality. The New York Fed estimates that about two-thirds of outstanding debt is currently held by the upper-half of earners. -CNBC

Last month a former official working for the agency administering the country's federal student loan program resigned, and has endorsed canceling most of the country's outstanding student debt.

Calling the system "fundamentally broken," A. Wayne Johnson - appointed in 2017 by Education Secretary Betsy DeVos, says that repayment trends suggest most student loan debt will never be repaid, according to the Wall Street Journal.

His solution? Forgive up to $50,000 for anyone with federal student-loan debt, which would amount to a bailout of approximately $925 billion. The plan would wipe out the debt of nearly 37 million borrowers. He would also advocate for a tax credit for up to $50,000 for people who have already repaid their debt.

Interestingly, that's the exact amount Elizabeth Warren's plan would forgive; $50,000 for anyone with under $100,000 in annual household income (and less for those above that amount).

"It’s a problem for all of us," said Warren in April, adding: "It’s reducing home ownership rates. It’s leading fewer people to start businesses. It’s forcing students to drop out of school before getting a degree."