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Canceling Student Debt and Moral Hazard

What’s Fair?

Moral hazard refers to a situation that arises when an individual has the chance to take advantage of a financial arrangement or situation, knowing that all the risks and consequences will fall on another party. In a sense, it allows one party to take advantage of another.

Moral Hazard at Work

A good example of moral hazard at work is The Great Recession during 2007-2009, when bank failures and fraud shook the banking community and economy of the U.S. Many people blamed excessive risk taking for the mess. One reason it may have occurred is the “moral hazard” effect.

The underlying problem was that banks used so-called “collateral debt obligations (CDOs) to repackage individual home mortgages, some of which were being funded without an acceptable credit rating to make it easier for questionable buyers to share in the American dream. However, banks knew that many of these repackaged loans had a risk level above what was safe or prudent.

Banks were willing to make the loans because they sold them off to investors on the secondary market. By doing so, an investment bank such as Lehman Brothers transferred the risk of nonpayment to unsuspecting third parties so that these loans to uncreditworthy borrowers became worthless during the recession. Lehman knew the bank would not be responsible if the homeowners defaulted so they took advantage of moral hazard. However, in the end Lehman got burned as well and ultimately failed.

Should the Government Cancel Student Loan Debt?

The student debt situation has elements of moral hazard because if $10,000-$50,000 of debt is cancelled by President Biden, or Congress for that matter, then the risk of nonpayment, at least on federal loans, will be transferred to the government and ultimately to taxpayers—you and me!

Cancelling any amount of student debt can be questioned from a moral point of view. It’s not fair that today’s students may get away without paying their full student loan debt while those students who played by the rules and paid their debt in full did not get the same break. Moreover, student’s entering college now may come to believe that taking out student loans will have no consequences because they, too, will be forgiven, at least for some amount, so why not apply for the loans and get a university education. The end result is the federal student loan program will get burned because the risk is transferred from the students to the government and guess who foots the bill.

It is true that we have a problem in society where student tuition has gotten out of hand even in public institutions. Having worked in academia for over forty years, I believe the reason is a bloated administration with ever-expanding programs, initiatives, and special interest topics being added to the curriculum to accommodate a particular point of view or interest group, often with political influence. This means more administrators, more faculty, more staff support, and more resources needed to run these programs. The answer is to consolidate many of these new programs into an existing academic department. Student loan forgiveness

Harvard University Poll

A recent national poll by Harvard University shows that student loan debt has doubled since 2010. In addition to a bloated administration, another cause is giving released teaching time to high-quality-research-professors so they can publish and not perish. The result is part-timers are hired and paid to teach the classes these top-notch researchers should teach. I know of many research-oriented universities where top scholars teach one or no courses each semester.

Here are key results from the Harvard study:

  • Most young people surveyed (85%) are in favor of government action on student loan debt.
  • More than one third (38%) of the 2,024 young Americans surveyed favor total debt cancellation.
  • Meanwhile, 27% favor the government assisting with repayment options without any debt cancellation.
  • 21% favor debt cancellation for those with the most need.
  • 13% believe the government should not change current policy.
  • While support for full cancellation has increased 5% since 2020, preference for the government helping with repayment decreased 8%.

It does not take a genius to see that those who support the loan forgiveness program mostly are those who would expect to benefit from them if student forgiveness is enacted or accomplished through executive order. After all, we tend to act in our own best interests, and not based on what’s fair or right or where there are consequences for one’s actions, all ethical reasons for taking one act over another.

What Will President Biden Do?

Everyone is waiting to see what President Biden does. He promised a decision this week or next. The progressives in the Democratic party want at least $50,000 debt to be forgiven, all the way up to 100%. Biden has heretofore talked about $10,000 in relief. This is a drop in the bucket to be sure.

Some say the loan forgiveness program should only be for minority and low-income individuals. Once again, this raises the fairness issue. Yes, more well-off students can better absorb the debt but why should they be penalized by not sharing in the largesse? Also, by setting up a means test we could be inviting fraud in providing income levels by borrowers.

Finally, if we forgive student debt, especially if it is means-tested, why not do the same for home mortgage debt? The problem is by creating a student debt forgiveness program, we would be starting the slide down the proverbial “ethical slippery slope” where one action might lead to another, and some groups might feel discriminated against for not being part of the giveaway.

Blog posted by Dr. Steven Mintz, The Ethics Sage, on May 2, 2022. You can sign up for Steve’s newsletter and learn more about his activities on his website  (https://www.stevenmintzethics.com/) and by following him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.

Steve has written a book on being a more ethical person, Beyond Happiness and Meaning: Transforming Your Life Through Ethical Behavior. It is available at Amazon or on his website