Last month, President Biden said that he’s still considering
canceling some student loan debt; perhaps fulfilling his campaign promise to
eliminate $10,000 per borrower. For anyone losing sleep over the massive pot of
outstanding student loan debt in the U.S. economy, that might seem like a good
thing. But the reality is that a move like the one being considered would
likely result in a worsening of circumstances, with tuition rising more quickly
than before and borrowers quickly amassing debts in excess of the level we see
today.

The driver of that counterintuitive dynamic is a phenomenon called
moral hazard. Moral hazard describes the nature of people to take excessive
risks when they are protected from the consequences of their actions. In this
case, a student loan cancellation event, like the one being considered, creates
an implicit guarantee that future students won’t be on the hook to pay back
what they borrow. Students choosing where to enroll, how much to pay and how
much to borrow for future semesters will have in mind that the amount they’ll
actually pay is likely less than what they signed up for. Economically rational
people will respond to that dynamic by choosing more expensive programs of
study and borrowing more than they would have otherwise. The result: a pool of
outstanding student debt growing even more quickly than before. 

In economics parlance, this change in willingness to spend is
called an increase in demand. And as any armchair economist knows, increases in
demand have an unambiguous effect on prices. A rise in demand will result in a
rise in price. We tend to think of colleges and universities as benevolent
institutions, but they are also economic entities that must respond to the
incentives in front of them in order to survive. So it won’t just be predatory
institutions that raise prices in response to this run-up in demand — it will
be all of them.

Estimates from the Committee for a Responsible Federal Budget indicate that it would take just three years for the outstanding student loan balance to return to its current level if we were to cancel $10,000 per borrower. That’s without taking into account increased rates of borrowing caused by moral hazard or the subsequently higher tuition costs. In reality, we’d be back where we are today before we know it (though precise estimates are impossible because it would require accurately predicting the intensity of change in student behavior).

For this reason, student loan cancellation alone isn’t an option. Congress should pass legislation to stop the administration from taking this politically motivated step. If that fails, they’ll need to act quickly to stop the ballooning of student debt through more aggressive means. Constraining the availability of student loans, as fraught as that option might be, will be the only option to protect borrowers from amassing further unaffordable debt that taxpayers will be on the hook to pay.

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