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Student Loan Forgiveness: Who Pays?

Tyler Durden's Photo
by Tyler Durden
Friday, May 06, 2022 - 05:20 PM

Via SchiffGold.com,

Student loan forgiveness has been in the news lately.

There are a number of different plans being floated, from blanket debt repudiation up to various amounts, to more limited income-based schemes.

But nobody ever talks about a key question: who is going to pay for it?

Well, you will.

I think most Americans think Joe Biden or Congress can just wave some kind of magic wand and student loan debt will just disappear. Poof! No harm, no foul. In fact, I think a lot of people believe student loan forgiveness will stick it to the evil banks who lent out all of that money.

But it doesn’t work that way.

Most student loans are backed by the federal government. That means the taxpayer is on the hook. The “evil” lenders will still get their money. The only thing that would change is who foots the bill. Instead of the person who signed their name promising to pay off the loan, the American taxpayer will get stuck with the bill.

A lot of people object to student loan forgiveness because they view it as “unfair.” After all, the borrower willingly took out the loan. This is certainly a valid objection. But most people don’t care about your moral scruples. They’ll just call you uncaring and move on.

But the economic ramifications are a little harder to ignore – if you understand them. And they will impact everybody whether they think they care now or not.

Remember those stimulus checks?  Everybody was thrilled to get that “free” money. But you’re paying for those stimmy checks today through the inflation tax. Most people seem less than pleased.

The Scope of the Problem

Currently, 46 million Americans have outstanding student loans. Of that number, 45.4 million hold federally-backed loans. The total student loan bill stands at $1.75 trillion.

In 2020, the US government stopped defaults and allowed borrowers to pause payments due to the COVID-19 pandemic. At that time, 11.1% of student loans were 90 days or more delinquent or were in default. This doesn’t count the people who were in various deferment programs and were not counted as delinquent.

President Biden recently extended the payment pause until September. It was the sixth extension since authorizing the initial deferment.

“We are still recovering from the pandemic and the unprecedented economic disruption it caused,” Biden said, in an April 6 statement announcing the latest pause.

(On a side note, the president keeps telling us how strong the economy is. Something here doesn’t make sense here.)

Ironically, the blame for this glut of student loan debt falls squarely on the shoulders of the US government – the same people promising to fix the problem. Had Uncle Sam not guaranteed all of these loans, lenders would have never been willing to loan a bunch of college kids money to begin with.

Ramifications

Student loan debt forgiveness sounds good, but it will have a slew of nasty consequences.

For one thing, loan forgiveness would likely raise the cost of college even higher.  The widespread availability of student loans drove up college tuition in the first place.  Studies have shown the influx of government-backed student loan money into the university system is directly linked to the surging cost of a college education.

As Peter Schiff pointed out in a podcast, loan forgiveness would be like Christmas for colleges and universities. College administrators will figure, “Now we can really raise tuition because our students know they can borrow the money and they won’t ever have to pay it back.”

Peter said it won’t likely be a one-time thing. This will create a moral hazard.

If they do it once, they’re going to do it again. Everyone is going to expect it. … The moral hazard there is nobody is going to pay for college. Nobody is going to work to try to avoid going into debt because you’re an idiot. Take on the debt! It’s going to be forgiven.”

The second problem is the US government doesn’t have any money. It will have to borrow billions more to pay for any loan forgiveness scheme. Borrowed money has to be paid back by taxpayers, either in the form of higher taxes or inflation – likely both.

Student loan forgiveness would also pour more gasoline on the inflationary fire. It would be another massive stimulus program. If the Fed forgave $1.7 trillion in student loans, it would basically be like dropping $1.7 trillion from a helicopter.

Again, think back to the coronavirus stimulus.

When you consider the mechanics of loan forgiveness, it becomes clear why it would be inflationary.

Under normal circumstances, when somebody defaults on debt and simply doesn’t pay, it is a gain to the borrower, but a loss to the lender. This isn’t inflationary. The extra money the debtor saves on debt payments and now has to spend is offset by the money the lender will never have to spend. But when the government backs the loan, the calculus changes. Borrowers will have extra money since they no longer have to pay on the loans. Lenders will get their money because the government will pay the balance. And of course, the government will borrow that money and the Fed will monetize the debt.

In the cases where the government issued direct student loans, it effectively printed money that will never go come out of circulation because the student now doesn’t have to return it to the government.

In effect, loan forgiveness is not much different than quantitative easing.

But unlike QE, the money will flow into Main Street instead of Wall Street. That means this inflationary action would be more likely to show up in consumer prices.

Student loan forgiveness sounds good. It’s politically popular. But it is bad economics. And economics doesn’t care about anybody’s feelings.

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