Two recent events in the financial area show the potential perils of the government getting involved in essentially financing an industry, and what can go wrong if financial regulations fail to cover a segment.
First, the idea of federal backing of student loans. By now everyone knows about the Texas billionaire, Robert Smith, who told this year’s graduating seniors at Morehouse College he would pay their student debts. Published reports said the gift could be worth $40 million.
That got me thinking. Why does any class of 400 students at any college anywhere rack up $40 million in student debts, or $100,000 apiece? It’s not just Morehouse. The Education Department sits on a portfolio of student loan receivables that totals $1.5 trillion. Recall that under a 2010 law the federal government made itself the sole lender of federally-backed student loans.
Education’s National Center for Educational Statistics publishes more statistics that you could shake a chalkboard pointer at. But to answer my rhetorical question above: Basically college is too expensive for millions of students or their parents to pay for. Students graduate with big debts, and average initial job incomes aren’t high enough to let them pay back their loans.
College prices go up, up, up, regardless of what the rest of the economy is doing. Meanwhile, we keep hearing how important it is to have a college degree. Yet so many of the degrees seem worth ever less in terms of career and earning power of those who borrowed to get them.
Suppose there were no college loans available and enrollments started crashing. Maybe that would produce real discipline and competition in one of the most arcane and least transparent industries there is. Such competition could drive down prices, as it often does in other industries, while improving quality.
Federal loans and related programs make higher education more widely accessible. Since their inception during the LBJ administration, they’ve expanded the market.
Even free marketeers understand that no market works with the transparency and efficiency of theory. Reality is always a little messy. Markets are capable of great outcomes but they are also capable of pretty bad distortions. The car industry created the modern era. But it also added a lot of pollution. Beyond that, there are people who, for one reason or another, are unable to participate fully in economic life. We try not to push them to the gutter.
So we institute regulations and programs to mitigate the bad effects. Such regulations and programs are hard to get right. They sometimes produce abuses of their own. Over time, the market of ideas and the cross-oversight we’ve built into the system tends to correct them.
Should the government even have a role in higher education finance? I don’t have the answer, but the demand-side financing activity provides little incentive for colleges and universities to try anything efficient. Loans cover schools no matter whether their prices are worth it or if the graduate has any prospect of lucrative employment.
Banking and credit is a sister to college finance where the right degree of regulation is a moving target. I love credit cards as much as the next guy, but without regulation, Lord knows what rates we’d pay. The government and banks have existed in tension since the beginning.
A recent New York Times story details another example of where government regulations of the financial sector should have helped a terrible situation, but they weren’t applied properly or uniformly.
Taxis in the Big Apple have long been problematic. There’s unlimited demand for cab rides, but a regulated number of cabs and medallions under which they operate. The story details the Bloomberg administration’s desire to boost revenue from medallion sales. The process degenerated into a hyper-inflated market, with immigrants to the U.S. assuming million-dollar medallion mortgages they could never hope to pay off.
You could say, well tough luck for the immigrant who thought he could make a living driving a cab on which he had a million-dollar mortgage. But the city government pushed the auctions and operated a marketing campaign to extol the value of taxi medallions. This during the rise of Lyft and Uber. By last year, medallion prices had crashed back to 2006 levels. The city had gotten its revenue, but the medallion owners were left with their underwater mortgages. And some of the lenders failed.
In New York, the municipal government presumes to control the supply of a product or service, while also regulating the heck out of it, controlling prices, and reaping the benefits when it decides to increase the supply. It manipulated the market, according to the Times story. The hapless taxi drivers paid the price. How must that look to an any immigrant, yearning for the land of free enterprise?
Federal regulation should have helped prevent the taxi medallion debacle but it didn’t. The Times reports that credit unions that specialized in medallion loans — who knew there even was such a thing — were under-regulated by the National Credit Union Administration.
Just this past March, the NCUA’s inspector general issued a “material loss” report on several of the credit unions that failed because of their “significant concentration of loans collateralized by taxi medallions.” The report states in part, “We also determined NCUA may have mitigated the loss to the Share Insurance Fund had they taken a more timely and aggressive supervisory approach regarding the Credit Unions’ concentration risks in their loan portfolios.” No-down-payment loans, loans with insufficient collateral or simply poor risk loans fed the problem. The whole affair is like a taxi version of the housing loan crisis.
How New York handles its public hack market is out of reach of the federal government, but better application of existing federal regulation might have prevented a harmful distortion.