Nobel winner: Cut student loan rates

John Waggoner | USA TODAY

A proposal by Sen. Elizabeth Warren, D-Mass., to reduce interest rates on student loans has one big economic backer: Nobel Prize laureate Joseph Stiglitz.

Warren's proposal would tie the interest rate on Stafford student loans to the Federal Reserve's discount rate, currently, 0.75%. Government-subsidized Stafford loans have a 3.4% interest rate, and are scheduled to rise to 6.8% this summer, unless Congress decrees otherwise.

College graduation has become a big factor in whether students succeed later in life, Stiglitz says. "The life chances of a young American are more dependent on the income and education of their parents than in other industrial countries."

While the national unemployment rate was 7.5% in April, the unemployment rate for college graduates was 3.9%, according to the Bureau of Labor Statistics. High-school grads with no college have an unemployment rate of 9%.

"Students are being squeezed," says Stiglitz, who won the 2001 Nobel Prize in economics. "Incomes are down, and tuition is going up." Those who go to public colleges are getting hit the hardest, he says, because of state budget cuts.

Most other industrialized nations make paying for college easier, Stiglitz says. For example, Australia's loan program caps payments as a percentage of income, essentially enabling most people to pay for college without going bankrupt. Many European countries directly subsidize college, although those subsidies have fallen due to the financial crisis.

But saddling students with payments they can't make -- or limiting their ability to attend college at all -- means the U.S. could fall behind foreign competitors. "There is a real risk that this will impede long-term economic growth," Stiglitz says.

Students in the lower middle class are having the hardest time affording college, Stiglitz says. "They don't qualify for Pell Grants, and their parents really have no way to pay tuition at most schools."

At $1.1 trillion, student loan debt has exceeded credit card debt for the first time. As debt has risen, so has the default rate -- now about 11.7%, according to the Federal Reserve. But students who default are still on the hook for the money. "Bankruptcy law treats student loans differently from any other kind of loan; it can't be discharged in bankruptcy," Stiglitz says.

Lowering rates would at least give students some relief from interest, which continues to compound while students aren't required to make payments.

Congress will take up the issue of student loan interest rates this week, and there are a number of proposals to consider. President Obama's 2013 budget, for example, proposes that rates be based on a market-based formula, rather than by Congressional action. The rate would be fixed for life, and payments couldn't be more than 10% of the borrowers' discretionary income.

While Stiglitz wouldn't predict that Warren's bill would pass, he says the main goal should be to ensure that loan rates won't rise next month. "Congress goes year by year to stave off a crisis," he says. "That's no way to run a country."