Moneybeat: Canceling student debt

JENNY ROUGH, HOST: Next up on The World and Everything in It, the Monday Moneybeat.

NICK EICHER, HOST: It’s time to talk business, markets, and the economy with financial analyst and adviser David Bahnsen. He’s head of the wealth management firm The Bahnsen Group and he’s here now.

David, good morning!

DAVID BAHNSEN: Good morning, Nick, good to be with you.

EICHER: Let’s listen to President Biden last week in Culver City, California. He’s talking about his original $400-billion-dollar plan for student loan relief.

PRESIDENT BIDEN: My MAGA-Republican friends in the Congress, elected officials, and special interests stepped in and sued us. And the Supreme Court blocked it. They blocked it. But that didn’t stop me. I announced we were going to pursue alternative paths.

The Supreme Court blocked him, and he found alternative paths. So last week he went ahead with canceling an additional $1.2-billion-dollars in student loans owed.

That brings the total near to $140-billion-dollars canceled, again despite the Supreme Court. That’s a little better than a fourth of what he wanted to do. What do you think about the move?

BAHNSEN: Well, I think that a lot of people felt when he was trying to do the larger deal, the more wholesale just really explicitly illegal attempt at forgiving debt that the Supreme Court ended up stopping, there were a lot of people that felt it was a crass political move to generate support with younger voters. What he's done this time is basically say so.

They sent an email out, basically connecting the dots in targeting and outreach to 20-something-year-old voters. And I think it's a very dangerous precedent. There's a sense in which all politicians to some degree, oftentimes can be accused of trying to buy votes, and there's certain degrees of separation—you know, when people offer more benefits here, or more transfer payments, or I guess, in fairness, you can say more tax cuts. But this is really the first time I've seen a politician just explicitly say, out in the open, I'm trying to bribe you for your vote.

It's such bad policy. And it's so unfair to those who didn't take on student debt or didn't go to college, or this other camp of people that appear to be long forgotten, those who did take debt and paid it back. And so I remain really appalled on principle to this entire notion of wholesale forgiveness. And I also remain, as a matter of economic vitality, totally desperate for us to overhaul the student loan system going forward. Why they're trying to deal with those that already took money and got it and spent it and the college presidents got it and spent it - and on the margin, they're just trying to wipe away some of that debt - versus changing the system that is resulting in this massive higher education price inflation, and the degradation of the quality of product that is being delivered in higher education, it totally escapes me

EICHER: You say this student loan deal—basically now a subsidy—has the effect of contributing to tuition inflation. Explain how that works, how subsidies like loan “forgiveness” pushes up the price of tuition. Economically, how does that happen?

BAHNSEN: That's a great question. And it is very basic economics, but it's worth an overview. If you're going out of pocket to write a check, or you're going to have to go qualify at a bank for a loan and make an argument as to why you can afford to pay back this money, then you are going to be more price sensitive. All that analysis goes out the window and the universities know it. When you remove yourself from an economic buyer to a non-economic buyer. The government isn't interested in price competition between Oregon State University and Oregon University. They're going to foot the bill no matter what, and the person receiving it is not going to start paying for it ‘til years later. Now all of a sudden, Oregon State and Oregon know that there is a money good buyer, the federal government, who is paying. They're getting paid up front in full with no underwriting risk, no loan risk, no credit risk on the back end. So they have carte blanche to raise prices. So they can give a bad diploma, they can give a good diploma, the kids can party the whole time and learn nothing and go out in the marketplace as mediocrities into our society. It doesn't matter to the school, they got paid full boat upfront by the federal government.

So anytime you have a subsidy, it pushes prices higher because of the distortion into the market. What puts prices lower, what causes a market to work in every single other thing in society that isn't government subsidized? Competition. That's what moves prices - is I want to deliver a better product at a lower price. Someone else is trying to do the same. So we're fighting for customers who are price sensitive. So economic actors versus non-economic actors. That's what's happening here with the loans and higher education.

EICHER: So here’s an argument for student debt relief, got this on NPR, and I’ll quote it: “People whose payments are cut or eliminated should have more money to spend elsewhere—maybe to buy a car, put a down payment on a house, or even put money aside for their own kids’ college savings plan. So the debt forgiveness has the potential to raise the living standard for tens of millions of people.”

In other words, economic stimulus. How do you respond to that?

BAHNSEN: Frederic Bastiat in the mid-19th century, and repeated by Henry Hazlitt in the mid-20th century, termed the notion of the “broken window fallacy,” which is the basic fallacy of all bad economics, that focuses on the visible and not the invisible, the short term and not the long term, and the effect on some parties, but not all parties. And the example was people looking at a brick going through a window and thinking it was a good thing for a community because now they'd have to pay someone to repair the glass, ignoring what the shop owner wanted to spend the money on - buying a new suit, buying new shoes. So they ignore what they don't see - the shoes not bought - and focus on what they do see, the sub optimal nonproductive repair of a window. That's all that argument is, is classic broken window fallacy. And it's infuriating.

First of all, if it were true, that you could give out a trillion dollars, and then forgive it, and it would cause people to go buy houses and cars, and everybody would be doing well. Why don't we do it tomorrow with $10 trillion? What's the limiting principle? If just making up money out of thin air and giving it to people to spend as a way to stimulate the economy, why stop at college loans? Why not forgive everyone's credit card debt? The reason you don't do it is because that money has to be paid for. So you still are replacing money that was spent under certain legal terms and conditions, and now we're replacing it with money that will have to be paid back in the future. We're not eliminating what happened; the money was already spent.

So sure Johnny right now who doesn't make a student loan payment, and has a few extra bucks to go out with it helps Johnny today, but it's taking from the economic growth of society. We're just simply replacing who's going to pay it back with the people who got the money. And now instead, your kids and grandkids, my kids and grandkids, they pay it back - and that takes away from future economic growth. We can't escape this idea. It's moral hazard at its finest.

EICHER: All right. Defining terms. You just mentioned it, “moral hazard.” Last week, we defined a Bahnsenism, but this week, let’s do a known and much-used term we find in economics textbooks: moral hazard.

BAHNSEN: Yeah, there's so many different examples. But it's essentially when a policy or decision takes away an incentive in the future to do the right thing. So an example is if you forgive, if you bail out a company that did a bad thing, then there's a moral hazard that a company in the future might think, “I may as well do a bad thing again, because if it works, then it's good for my business. And if it doesn't work, we already know I'll get bailed out.” So it incentivizes bad behavior. And a better way of saying it is it takes away an incentive to do good behavior. It takes away the incentive to be prudent, because the precedent has been set, which is what we mean by moral hazard, a precedent that there will be some sort of cover for you, even if you do something bad.

And to me, the great example here with the student loan issue is once they forgive some amount of student loans wholesale, if they were to do that, I don't know why anyone would believe that it won't happen in the future, that I may as well take more student debt. I may as well go and get this extra degree I wasn't really going to think about doing. And oh, by the way, why not assume that one day they're gonna bail out the credit card debts as well? That's a far bigger, more expensive, higher interest cost.

And student loans very candidly, are mostly applied to people that have higher income. Most people that went to college and have degrees, especially graduate degrees, where a lot of student debt lies. Statistically it's unavoidable that they're in a higher income bracket. So why don't we just go ahead and wipe out the credit card debt of lower income people? All of this is moral hazard, Nick.

EICHER: Ok, David Bahnsen is founder, managing partner, and chief investment officer of The Bahnsen Group.

Two key websites: Bahnsen.com for all things David, DividendCafe.com for his weekly musings on markets and the economy.

Thank you, David!

BAHNSEN: Thanks so much, Nick.

WORLD Radio transcripts are created on a rush deadline. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of WORLD Radio programming is the audio record.