My article published in The Australian newspaper today:
IF there is one thing we should have learned from the global financial crisis, it is that free markets, deregulation and government-subsidised debt ultimately end up creating financial bubbles.
It is happening with US student debt and it will happen here if we continue down the deregulation path being proposed by the government.
Education shouldn’t be confused with choices people make when buying milk and bread, as some would have you believe. Education is closer to choices people make when buying a house or investing in superannuation, but much more complex.
What we should have learned from the GFC is that when housing credit limits are increased, choices are not made within the credit limit but at it. Imagine if everyone’s credit limit were doubled overnight. How many people would be content with their present home? It doesn’t take too many people choosing to upgrade before prices start to rise. Prices fall only when people face constraints. Loosening access to debt frees people from constraints.
This is what is happening in the US. Student loans have increased fivefold since 2009 from about $150 billion to nearly $750bn last year while average household wealth remained stagnant. US government-subsidised loans allow students to access higher credit limits than normally would be available.
In Australia, income-contingent loans, commonly known as HELP or HECS, are used to address policy objectives of equity and opportunity, as is the US’s subsidised student loans system.
However, the systems are very different. Financially, it is a misnomer to call income-contingent loans debt because they’re not. Unlike normal loans, they protect students from the downside risk associated with their education choices. They work like financial options; when students take on an income-contingent loan, they are really buying a call option on their investment in education.
A call option gives the buyer the right to benefit from investment gains without the obligation to pay any losses that may occur. The government as the seller of the option is insuring the student against any downside risk associated with their investment choice. HECS is effectively a zero premium call option but one in which the government benefits via higher taxation from those who are rewarded from their investment.
If the government offered zero premium call options on housing investments, participating in any gains through a higher tax rate, how many call options and properties would you buy? The rational answer is as many as possible with no limit.
Why would choices in education be any different? Through HECS, disadvantaged youth are able to exercise choice in education independent of wealth constraints. The system also protects women against the downside earnings risks associated with having children.
Being able to resolve differences in individual life histories is the key reason income-contingent loans are a superior policy solution than the traditional approach of subsidising student debt. However, they were not designed to work in a deregulated, uncapped, free market.
The optional nature of contingent loans — to benefit from gains but avoid paying the losses — also leads to the potential for moral hazard problems associated with easy access to debt that you don’t necessarily have to pay off. There exists an incentive for higher education providers to raise prices and use some of that in the form of increased marketing.
However, providers may hike prices significantly and still remain attractive to students by giving part of the price rise back to the students as living expense scholarships. This problem is similar to cash-back offers on consumer goods. Cash-backs are most attractive to credit card users than those who pay upfront.
Disadvantaged students will be at greatest risk from these inducements because their need for cash to cover day-to-day living expenses is a salient concern. The potential for similar marketing techniques to blur the line between cash-backs and scholarships should not be discounted.
That the nature of contingent loans is misunderstood or ignored suggests that proposals for the deregulation of higher education are driven largely by ideology than a genuine concern for improving economic outcomes.