Federal Student Aid Contributes To Rising Tuition Costs
August 7, 2015

Student loan debt affects approximately 40 million borrowers in the United States, even as it continues to breach the $1.2 trillion mark. The Class of 2015 has earned the dubious distinction of being the most indebted class. As the costs of tuition continue to increase with each passing year, it is likely that the Class of 2016 will take over that tag once they graduate. In response to the ever-increasing burden of student loan debt on students, the government usually implements measures such as reducing interest rates, introducing new student loan forgiveness schemes or enhancing the ease with which students can avail of federal student aid. Unfortunately, this might not be doing much to alleviate the burden of debt that students often have to bear.

Federal Reserve Report Highlights that Federal Student Aid Increases Tuition at Colleges and Universities

Economists David Lucca, Taylor Nadauld and Karen Shen prepared a new report for the Federal Reserve Bank of New York. Preston Cooper writes that the report highlights the manner in which federal student aid programs actually increase tuition in colleges and universities across the country. According to the report:

  • Each additional dollar of Pell Grants given to low-income students to pay for college, increases tuition by 55 cents
  • Each dollar of Direct Subsidized Loans (or need-based loans for which the government pays the interest while the borrowers are in school) increases tuition by 65 cents

It is worth noting that the increase in tuition typically varies based on the type of school attended by the students. However, private four-year schools usually register the largest increases in tuition per dollar of federal college aid.

In addition, the report released by the Federal Reserve Bank of New York also reveals how the “sticker price” of tuition equates to a higher amount that students and their families end up paying. Typically, the “sticker price” of tuition translates at a high rate, ranging from 37 percent to 94 percent in the lowest and highest quartiles respectively. This means that students in the highest quartile would need to pay 94 cents more on each dollar of tuition increases brought on by federal student aid. As such, federal student aid does not merely increase the price tag of a college education. It ensures that students pay for the increase as well.

Education Market Behaving Similar to Housing Market in the Days Before the Great Recession

The authors of the report also contrasted the education market of today with the housing market, in the days leading up to the financial crisis of 2008. Both markets remain heavily financed by loans i.e. mortgages for housing and student loans for education. In addition, the government heavily subsidizes lines of credit for both markets. Once the housing bubble burst, it nearly brought down the global financial system.

Financial experts have been highlighting the fact that a similar bubble is developing in the education market too. This is borne out by the fact that private four-year schools have increased tuition by 41 percent since 2000. The fact that Americans collectively owe over $1.2 trillion on their student loans only serves to emphasize this further.

Credit markets typically have safeguards in place to ensure that the borrowers utilize the funds properly. At the same time, these safeguards enable lenders to recover their investments. For instance, if you take out a mortgage for purchasing a house, you will need to put up the house as a collateral. But such safeguards are virtually non-existent in the world of student loans.

Therefore, if a student borrower defaults on a student loan, the college suffers no impact. It remains immune to the risks of students defaulting on their loans. This is why colleges continue to increase their tuition and fees indiscriminately, knowing that one way or another, they will never have to shoulder the burden of the loan. As long as the student is current on the loan, the student will bear the financial burden of the loan. If the student defaults on the loan, the government would bear the financial burden.

Financial experts and activists have been calling for reforms in the education sector for long. They know that the current education system does not have the necessary safeguards in place to ensure that the costs of investment do not end up outweighing the benefits. The report from the Federal Reserve Bank of New York only serves to emphasize this further. If the lawmakers continue to skirt the issue, the price tag of higher education will eventually spiral out of control.