Let’s consider student loans for a moment. Many of the candidates for president have promised relief of some sort from the high cost of college tuition.  That’s not surprising considering that 40 million Americans currently hold student loans and that debt incurred for education now lags only mortgage debt as a source of consumer indebtedness—logging in at the astonishing total $1.2 trillion. And, here is the rub, most of that debt has been loaned directly by the government and, as the current policy debate illustrates, students who borrow from the government don’t necessarily have the same expectations and sense of repayment obligation to their lender – as those receiving loans from a private financial institution.

Decisions made in the 1990s to transform the US government’s role in providing student loans, from that of a guarantor to a direct lender, were driven primarily by budgetary rather than policy considerations. Direct lending had a clear advantage because it had a dramatically lower price tag than the guaranty program at the time. And when private lenders became reticent to assist students during the darkest days of the 2008 financial crisis, direct loans from the government became the primary source of student loans in the US and the guaranteed student loan program was abolished.

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The prevailing wisdom at the time was that the government could step in and perform the same role formerly played by private financial institutions, absent the costly subsidies exacted by those lenders, without much else changing. But the direct loan takeover has resulted in conspicuous federal involvement where expectations on the part of borrowers may have fundamentally shifted from that of debtor-lender to one that perhaps more closely resembles lending arrangements among family members. When loaning money to your brother-in-law, you may have hopes for repayment but you also realize prospects will dim if he loses his job, gets sick, retires, or maybe even has to pay for one of his kids to attend college. You’ll have no real choice but to accommodate his ever-changing life circumstances. The government may be putting itself in that same familial position as it services the loans of its millions of student borrowers.

By stepping directly into the student loan market, the government seems to be trying to play the role of a benevolent agent with the goal of enabling students to pay for college under the best terms possible. Few restrictions have been placed on program eligibility and little consideration is given as to whether a borrower can repay. In contrast, a theoretical market-based approach would be more concerned with whether those taking out loans can complete a degree and repay loans granted. Underwriting criteria such as high-school grades, test scores, and potential earnings of majors are among multiple factors that would determine eligibility for loans.

The justification for federal involvement in the credit marketplace, as discussed each year in the Analytical Perspectives volume of the President’s Budget, is based largely on market failure. Policy choices, however, can be driven by the simplicities of budget scorekeeping rules rather than by such abstract economic principles. The budgeting rules used for credit programs, which exclude operating costs, can incentivize the government to embrace direct lending rather than provide marginal inducements to spur private lending.

Policy decisions are most appropriately made when considering the best possible public sector role and likely economic costs and benefits, rather than simply determining whether the government can provide a good or service more cheaply than the private sector. While the abandonment of guaranteed student loans in favor of direct lending might appear to make budgeting sense, it has cemented the government’s role as lender of first resort for students. As student borrowers come to view their lender as being increasingly altruistic, taxpayers could ultimately suffer the consequences of being a rich uncle to far too many.


Doug Criscitello is Executive Director of the MIT Center for Finance and Policy at the MIT Sloan School of Management.