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Does Public Policy Encourage Poor Choices?

Americans now hold close to $1.2 trillion in outstanding student loan debt making it the second largest form of consumer debt after home mortgages. What are the implications for housing markets, household formation, and economic mobility for the next generation? Are there creative approaches to reduce the burden?

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By Mark Calabria

More than any other group, the great housing boom and bust of the 2000s was driven by younger households. At the previous bottom in 1995, the homeownership rate of households under 25 was just under 16 percent. This figure soared to almost 26 percent by 2005. By comparison households aged 50 to 54 saw their rate of homeownership increase by just over a single percentage point during this time. 

In retrospect this differential change across age groups should not have been surprising. Among other drivers, the boom and bust was pushed forward by a loosening of underwriting standards in the form of lower credit scores, lower down-payments and higher debt burdens. All of these constraints bind younger households more than older. The average credit score for someone under 25 is well into subprime territory. Obviously younger household also have had less time to save and their incomes tend to be lower than older households.

Just as the post-crisis retrenchment in lending has disproportionately impacted younger households, so will student loan burdens. First of all, defaults on student loans will drag down credit scores, making many households ineligible for credit, at least until they repair their credit. For those who remain current, which will be most, student debt payments will eat into disposable income, reducing the ability to save for a down-payment or service other debt, all else equal.

Of course “all else” is rarely equal. To the extent that student loans allow individuals to obtain degrees that would not have otherwise, then the increased income from a degree should allow for more spending on housing rather than less. So on at least one margin, the increase in student debt is a positive sign, not a concern for either housing or public policy more broadly.

Unfortunately too many students take on debt and do not complete their degrees. Or they obtain a degree for which there is not a big market. To the extent that public policy encourages poor choices, such as by underpricing student debt, those policies should be reversed. We should not, however, reverse the obligation to re-pay. Shifting the debt burden from students to the taxpayer solely so students can swap student debt for mortgage debt would be irresponsible and unfair. It would also send students the worst message possible in terms of taking on future obligations. Someone relieved of their debts by the taxpayer is likely to act as if their future debts are also simply options rather than obligations.

Mark Calabria is director of financial regulation studies at the Cato Institute

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