The Pernicious Effects of Student Loan Forgiveness

Senate Minority Leader Chuck Schumer recently suggested that as one of his first acts as president, Joe Biden should wipe out $50,000 of student loan debt for every borrower by executive order. But what kind of impact would this have on the US economy?

It would certainly benefit a lot of people. But somebody would have to pay the bill. And that somebody is everybody else.

Biden has proposed a more modest plan to forgive $10,000 of outstanding student loan debt for all borrowers. Even this more limited approach would erase about one-third of student loan debt.

Forty-five million Americans now owe roughly $1.7 trillion in student loan debt. Total outstanding student loan balances have surged by $54 billion year-on-year, even while college enrollment has dropped 10.8% since 2011. More than 1 in 4 student loan borrowers are either in delinquency or default.

Student loan debt forgiveness is wildly popular. But most people don’t realize that the debt doesn’t just vanish into thin air. Biden can’t wave a magic wand and just make the debt disappear. The lenders will still get their money. Student loan forgiveness simply means the federal government (i.e. the taxpayer) will pay the balance instead of the borrower.

US taxpayers are already on the hook for a $435 billion loss on the $1.37 trillion in student loans that were on the government’s books at the beginning of this year, according to an internal study by the Department of Education. That’s before any loan forgiveness program that might come down the pike under the Biden administration. And the massive number doesn’t account for any student loans issued going forward.

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.

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 recent 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 with this loan forgiveness plan is that the US government doesn’t have any money, so 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.

And that brings us to the most significant impact of student loan forgiveness — its inflationary effect. As Peter pointed out, this is another massive stimulus program. If the Fed forgave $1 trillion in student loans, it would basically be like dropping $1 trillion from a helicopter.

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. As Peter said, this is pure inflation because there are no losers.

The borrower doesn’t have to repay his loan, but the lender gets paid. He just gets paid by the government. So the money supply expands by that extra money because now both the borrower and the lender have the money.”

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.

It would certainly be a win for those who get out from under student loan debt. But as Peter said, it’s not a freebie.

Somebody’s got to pay. And that is everybody else who didn’t have a loan that was forgiven. Because the people who have their loans forgiven, now they can go buy stuff they couldn’t buy before  because they were paying off their loans. But in the process, they’re going to bid up the price for everything. And so now all the people who didn’t have any loans who were buying stuff are now going to have to buy less stuff because the price of everything is going to go up.”