Florida’s Second Subprime Crisis: Student Loans | Mercatus

Under the banner of making the dream of home ownership real for working class Americans, Federal lawmakers established Fannie Mae and Freddie Mac in 1938 and 1970 respectively. Beginning in 1996, the Department of Housing and Urban Development told Fannie and Freddie that more than 40 percent of their loans had to go to low-income borrowers. Tax breaks followed. Finally, starting in the early 1990s, the Federal Reserve pushed interest rates to historically low levels, making mortgages cheaper.

The net result was predictable: People took out more mortgages, increasing numbers of mortgages went to low-income people, and the government became a major lender in mortgage markets. In 1990, Fannie and Freddie held one of every four outstanding mortgages. By 2003, they held almost half of all mortgages. Between 2001 and 2006, the fraction of new mortgages that were subprime tripled.

And housing prices soared—just as one would expect from a market flooded with cheap money. With the government using Fannie and Freddie to transfer mortgage risk from private banks to U.S. taxpayers, and with the U.S. Congress minding the store, mortgage lenders didn’t have to care about the riskiness of the loans they made. All private banks had to do was to make loans, pocket the profit, and push the loans down the line where the government waited to pass the default risk on to taxpayers.

The same pattern is repeating in the higher education market.

Congress established Sallie Mae in 1972 to encourage banks to offer more college loans. The Affordable Care Act of 2010 allowed the government to loan money directly to students. The following year the Taxpayer Relief Act extended tax breaks to student loan borrowers. By law, lenders cannot deny Stafford and Perkins loans (types of federal student loans) based on the borrower’s credit or employment status. What other reason is there to deny a loan? Predictably, the Federal Reserve kept interest rates at historically low levels, making college loans cheaper. And the price of a college education soared.

Government meddling has again separated profit from risk. Universities get to keep the tuition profits while taxpayers are forced to shoulder the risk of students not paying back their loans.

In the end, this bubble will be worse than the last. Unlike homeowners, students facing crippling debt cannot sell back their asset (their education) or declare bankruptcy. The simple fact of the matter should be obvious by now: Government created this mess, in both instances, by forcing the market to provide loans it would not have granted otherwise. This is the breeding ground for bubbles, and this one will burst just as they all do.

(Emphasis mine).  via Florida’s Second Subprime Crisis: Student Loans | Mercatus.

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