Loan Forgiveness = Dem Victory in 2012?

If the volume of traffic that made its way to our recent posting on loan forgiveness is any indication, it is clearly a very hot topic right now. Based on the comments and feedback we received, it is also one that evokes very strong opinions in people. Most notably, some of our readers shared stories about how they have taken decades to dig out from under heavy loan burdens. Some of these readers indicated their belief that the government should step in and do something about these burdens, with outright forgiveness, debt ceilings and maximum payback periods all being mooted as possibilities.

Though loan forgiveness is not something that I would typically advocate for, some of our commenters provided numbers suggesting potential forgiveness programs could be cheaper in real dollar terms than the stimulus plans were (or indeed potential future stimulus plans would likely be). The current state of affairs which sees the federal government owning much of the outstanding student debt also ensures that write-offs wouldn't directly hurt lenders, many of whose balance sheets are just recovering from the financial crisis.

Even many detractors would have to agree that there would be undoubted economic benefits from forgiveness, at least at the individual level. Our original reason for posting about this topic was Professor Wolfers' assertion that any multiplier effect from loan forgiveness would be negligible, a statement we heartily disagreed with (while agreeing with his larger premise that forgiveness wouldn't be a good idea no less!). Many of our readers agreed through personal anecdotes that the multiplier would be much higher than Wolfers believes. Paraphrasing one reader, there is a lot that many of us could do with an extra $800 every month, and I am not referring to putting it in a savings account with a 1% APY.

Though some (including yours truly) believe that loan forgiveness is wrong on moral responsibility grounds the potential economic benefits that could be realized by some substantial percentage of the population simply being able to spend more are compelling. And, to be honest, this moral high ground feels a lot less steady after it was unceremoniously eroded by the actions that the US government has already taken in bailing out banks and corporate interests.

After all, if American citizens, albeit through their elected officials, are collectively willing to bail out bankers who took unnecessary risks, why not lend a hand to those who have tried to better themselves through higher education only to find life getting in the way of their ability to pay the price. At least that is the logic of some in the pro-forgiveness crowd.

Of course, there is a downside. In broader terms, it would increase an American debt burden which has already led to a credit rating cut. This is unlikely to appeal to a very vocal group of Americans who are against government spending in any form. Though the burgeoning debt is an incredibly sensitive and highly debated topic on both the political and economic fronts, it is almost impossible to know what adding a few hundred billion to the national debt would do. Some people believe that it would be bad. It also seems likely that it would set an unwelcome precedent for future loan takers in the inevitable event of another recession down the line. This moral hazard argument was noted by Mr. Wolfers as well, and we feel that it is more compelling than his multiplier-underpinned macro analysis.

However, while loan forgiveness is debatable as sound economic strategy, it is almost undeniable that for one group, it could be a good political strategy come 2012. As noted in the original forgiveness post, most advocates for loan forgiveness tend to be connected to the Democratic party. With President Obama's flagging approval ratings and claims that he has abandoned his liberal ideals running roughshod over reelection hopes, there are worse things that he could do than advocate for loan forgiveness.

While it would hardly be a slam-dunk to get such a plan through Congress, loan forgiveness in some form might be more palatable to Republicans than another straight stimulus plan, especially with Tea Partiers breathing down their necks. A plan developed with Republicans might be a little more heavy on total debt caps or maximum payback periods than straight forgiveness, but this would nonetheless have an immediate and measurable impact on the monthly take-home of many Americans, and that can't do anything but help Mr. Obama's reelection bid.

Whether or not loan forgiveness is sound economic strategy, moral or even possible is almost irrelevant. If President Obama's team believes that proposing a forgiveness plan will energize the base, and perhaps even the economy itself, heading into next fall you can expect it to be an increasingly hot topic of conversation whether you like it or not.


  1. Anonymous25/9/11 18:30

    If what we really want is short-term stimulus, we don't need to forgive loans. The government could "forgive" one year of loan payments for those not already in default, or those previously in default who become current for at least, say, three straight months (or three straight payment periods, whichever is shorter). That gets the multiplier effect into the economy, without writing off future income.

    College and graduate degrees have a multiplier effect many years beyond first jobs. Recent grads struggling to stay current now will find repayment easier years from now--forgiving the debt entirely writes off more than necessary to help them. And because only a portion of debt is forgiven, for purposes of broad stimulus, the moral argument is at least reduced. Really, morally, how is forgiving payments on a loan from Uncle Sam (or a portion of them) for one year different from a one-year tax reduction?

    After all, what makes loan forgiveness a too-expensive form of stimulus is that even for the neediest grads, those who number amongst the "50 poor people" from Wolfer's example, only a fraction of the forgiven loan makes it into the economy NOW. This year's payments might be spent, but the next ten or twenty years of payments on a forgiven loan won't make it into the economy now. There's not really a good reason to write that money off.

    Finally, let me voice my support for the Dept. of Ed's direct lending program. The expense is far less than guaranteeing loans. Guaranteeing a loan (with interest) that goes bad is more expensive than buying the loan now and, should it go bad, either reducing payments or forgiving them. As important, it gives the government a chance to enhance the treasury from the program when loans are repaid. By buying old loans and making new ones directly, the government ensures it doesn't have to actually shell out more than the original principal. The difference between mere lost income and actual expenses, come budget-balancing time, is significant.

  2. Josh Sturtevant26/9/11 11:14

    Thanks for the comment.

    Your plan strikes me as completely reasonable and economically viable with little chance of creating a moral hazard. I also think that it could prove to be an effective stimulus tool in the short run.

    In other words, I don't think that anyone in Congress would be able to both come up with it and gain enough support to get it through a vote.

    More likely loanees will be inundated with ideas, battered with rhetoric and threatened with government shutdowns.

    Maybe cynical, but a quick rundown of the headlines today has left me as bearish on the political process as I am on the stock market...

    In any case, thanks for reading and thanks for the suggesting an elegant solution to this current problem.