The student debt crisis as a macroeconomic phenomenon

The problem was the Great Recession, not anything about colleges

By Matthew Yglesias — Read time: 10 minutes

Although the Biden administration’s student loan forgiveness programs have generated tremendous disagreement, there seems to be a consensus that the big buildup in student loan debt is a big problem. The disagreement is mostly about the nature of the solution, with folks on the left broadly preferring more subsidy while folks on the right broadly preferring vague anti-education posturing. In fact, everyone is so mired in this dispute that I think it’s rarely acknowledged that net tuition peaked a bit over a decade ago and that both federal loans and federal grants have been declining.

I want to propose a different interpretation of the debt problem.

There are some very serious policy questions about graduate student debt that speak to the existence of a pretty large number of programs that probably shouldn’t exist at all. But in terms of undergraduate debt, I think we are looking at two things: a demographic bulge and bad macroeconomic policy that happened to collide in what amounts to a really bad coincidence.

The single most common year for an American to have been born was 1991, with large numbers of people born on either side of that peak.

And all of these people born in 1991 turned 18 in 2009, the low point of a recession that started in 2007 and didn’t really generate a healthy labor market until 2014 or so. In other words, a huge number of people ran headlong into a catastrophic failure of macroeconomic stabilization policy.

States raised tuition because they were broke due to the recession.

Students enrolled in large numbers despite the tuition hikes because it was hard to get a job.

Graduates earned lower-than-expected pay because they were graduating into a weak labor market.

This is all genuinely very bad. But it’s not bad education policy, it’s bad recession-prevention policy. And the lessons to be learned are about the importance of stabilizing the economy, not about the need for any dramatic changes to the education system.

A governor’s eye view

Imagine that you’re a governor in the midst of the Great Recession. Tax revenue is plummeting due to joblessness, falling property values, and consumers pulling back on luxuries like travel and dining out. You’re a progressive, so you propose an “emergency millionaires tax” on a temporary basis, but that doesn’t bring in enough revenue to plug the hole in your budget. You need to cut.

So you start with the low-hanging fruit.

And looking at the list of things that could be cut, raising tuition at state colleges and universities is very attractive.

Grants and scholarships still exist, so the poorest people will be largely insulated from harm. And while this shows up on the State U balance sheet as a spending cut, from the perspective of a unified state government budget, what you’re really doing is increasing revenue. Federal funds flow to colleges and universities through students, and that frees up state funds to keep the K-12 schools running and avoid kicking people off Medicaid.

Again, you’re a progressive governor, so you don’t love the idea of raising tuition. But it’s the least-bad option — nobody needs to be laid off, and nobody needs to be kicked out of school. The institutions continue to exist and continue to provide a valuable service to the community. It’s just that instead of the money coming from the state government, it comes in the form of loans from the federal government. And that’s exactly what your state needs: an injection of credit. If it was possible to borrow some huge sum of money from a low-interest National Macroeconomic Stabilization Fund you’d do that. But there is no such fund, and the Fed wasn’t interested in intervening in the state or local bond market at that time. What existed was student loans, so the smart play was to take advantage of that.

Access to credit is very valuable

If you face a financial emergency and need to borrow a bunch of money, it’s very lucky to be a homeowner with some equity built up in your house.

Because houses are so durable and so hard to hide, they are one of the absolute best things for a bank to repossess. This means that banks place a lot of value on them as security for a loan and will give you a relatively favorable interest rate if you borrow against your home equity. If you’re not a homeowner and you need to borrow money in a rush, then you’re left with less attractive options like a car title loan or taking jewelry or other durable goods to a pawn shop. You also might find yourself relying on the very high interest rates charged for unsecured credit. You don’t need to put anything up at all to use your credit card for a loan, but you’ll pay a very high interest rate. And if your credit’s not good enough for a credit card, you need to go to a payday loan shop where the rates are terrible.

The point of all this is that while borrowing money can be expensive, it’s often a very useful thing to do. And when people are able to get access to credit on favorable terms, they tend to do so.

But during a financial crisis like we had back in 2007-2009, access to credit tends to dry up.

Ideally, the Federal Reserve would simply prevent that kind of crisis from occurring by stabilizing expectations of nominal income growth. But if that doesn’t happen or it’s not possible through monetary policy alone, what ought to happen is the federal government steps in and borrows a ton of money. Because in a crisis, everyone wants to lend money to the federal government. And of course during the Great Recession, Uncle Sam did borrow a lot of money; we have “automatic stabilizers” that make that happen. And Obama signed the American Recovery and Reinvestment Act that borrowed hundreds of billions in an effort to stimulate the economy. But large as ARRA was, it was much smaller than the hole in the economy.

The way the student loan program is designed, though, it can expand without affirmative legislation. You just need state governments to raise tuition and students to want to go to college. So that’s what happened. If aggregate student lending was capped, states would have had to do more furloughs and layoffs, and the overall economy would have been even weaker.

Unemployment is very painful

The fact that it was convenient for state governments (and the overall economy) for people to take out big student loans doesn’t explain why people would actually do it. The answer is that it was also good for them.

Good not just in the sense that a college degree can be useful, but good in the sense that if you turned 18 in 2007, 2008, 2009, 2010, or 2011, you faced a terrible time for a person with no work experience to be seeking a job. Unemployment is a really awful experience. It’s bad to not have money, of course, but even beyond the lack of funds, the psychological experience is painful. Unemployed people often become depressed and tend to suffer from all kinds of health problems. Some of this is material deprivation, of course, but an important element of it is sociological and psychological.

An important German study that takes advantage of some features of their benefit systems shows that unemployed workers are happy when they reach retirement age and can shift their social identity from “unemployed” to “retired,” even though nothing about their financial situation changes. The ability to enroll in school plays a similar kind of role. “I’m a student at X getting my degree in Y” is a perfectly respectable self-conception and a perfectly respectable thing to tell other people. Your parents aren’t embarrassed that their kid is in college, and you can hold your head high amidst peers. Being in the dating pool as an unemployed guy is bad — as a college student, it’s fine.

And then the way college bundles a bunch of different things together and interacts with credit further incentivizes attending during a downturn.

When the economy is hammered, it’s good to buy things with cheap credit if you can. And colleges will not only sell you access to classrooms and coursework, they will sell you “room and board” and access to fun activities. I think there’s an overstated tendency to emphasize ridiculous-sounding things like campus climbing walls when the most important student amenities are banal — housing and food and some places with comfy chairs where you can hang out. In a healthy economy you could gain access to that stuff by working (it’s not like student housing or meals are so great), and the only reason to buy it as part of a college bundle is a genuine desire to attend college. But the recession destroyed outside options and pushed tons of people into school, even as tuition rose.

Graduating into recessions is bad

When you graduate into a recession, you not only tend to get a worse job right after school, but the impact of that worse initial job is incredibly persistent. Jesse Rothstein finds that “the long-run cumulative effect of the recession on graduates’ employment is more than twice as large as the immediate effect.” Hannes Schwandt cites four other papers showing a long-run economic impact and extends the work to demonstrate that graduating into a recession leads to “negative consequences later in life for socioeconomic status, health, and mortality.”

That’s the hammer blow for student debt explosion. We had, all at once:

An unusually large youth cohort

Facing unusually high net tuition due to state budget cuts

Enrolling in college at unusually high rates due to poor outside options

With unusually low earnings due to graduating in a bad environment

That is really bad! The members of Congress who declined to provide additional fiscal stimulus should feel really bad. The Federal Reserve officials who declined to provide adequate monetary stimulus should feel really bad. And the people who spent 2010-2013 hyping-up national debt panic and corralling the political system into “grand bargain” talks should also feel really bad. It was a huge policy disaster, the enormity of which I think we, as a society, have still not fully comprehended.

But once you do, I think the higher education system looks less like the generative factor of the crisis.

It’s bad that homeless people have to sleep in the park downtown. But that’s primarily a housing policy problem reflecting scarcity of dwellings that naturally falls hardest on people with other problems. It doesn’t reflect poorly on the people in charge of running the parks, who are being inundated with tough cases because of failures elsewhere. By the same token, higher education became a shock absorber — both for state government fiscal problems and for individuals — amidst a catastrophic crash. Our resolve should be to achieve better macroeconomic policy next time.

We still need to fix this problem

Many economists have come to recognize that the inadequate policy response to the Great Recession was an enormous problem. And a bunch of smart, center-left policy hands put together a fantastic edited volume titled “Recession Ready” that proposed ways to incorporate more robust automatic stabilizers into the American policy framework and prevent something like that from happening again.

Then Covid-19 came, and people sprang into action full of resolve not to repeat the mistakes of the past. But instead of implementing any of these on-the-shelf automatic stabilizer ideas, they just decided to go super-big on discretionary stimulus. All things considered, I think the results of that have been better than the results of under-stimulus. But it’s generated a lot of inflation and backlash, and now I think the conventional wisdom pendulum is swinging back to “eh … maybe a prolonged recession isn’t so bad.”

I think that’s setting us up for future tragedy. The right response to overshooting the mark is the same as the right response to undershooting it — we need to stop relying on congressional guesswork. Here are some ideas from the book that would have helped enormously during the Great Recession:

Matt Fiedler, Jason Furman, and Wilson Powell argue that the federal government should automatically pick up a larger share of the tab for Medicaid when a state’s unemployment rate is high. This would let states directly use the federal government as a recession piggy bank rather than relying on the indirect mechanism of tuition hikes and student loans.

Claudia Sahm calls for the government to send direct cash payments to households when unemployment is rising, and then automatically turn them off when unemployment is falling. This would stabilize demand without overshooting the mark the way we did in 2021.

Gabriel Chodorow-Reich and John Coglianese call for expanding Unemployment Insurance to cover a larger share of the workforce and to create a provision to make the benefits more generous during periods of very high unemployment.

These ideas were influential — versions of them featured in the Covid response, but they were implemented on a discretionary rather than automatic basis. Ironically, this was because Congress underestimated how strong the recovery would be and therefore believed (incorrectly) that automatic stabilizers would be more costly. This actually led them to appropriate more stimulus funding than we needed.

We could absolutely improve higher education and higher education finance. In particular, I think the student loan system’s treatment of graduate school is somewhat bizarre in its lack of differentiation between different kinds of programs. But the college debt pileup of 10 years ago was a macroeconomic policy disaster much more than an education policy disaster. And if we want to avoid its recurrence, we need better recession-fighting policies, not more arguments about student loans.