Student loan borrowers need financial literacy, not more regulation

Yesterday’s Consumer Financial Protection Bureau (CFPB) field hearing in Wisconsin was designed to address how student loan servicers could better serve millions of struggling borrowers. But instead of mandating that servicers provide more after-the-fact counseling, the CFPB could better help borrowers through reforms aimed at enhancing their financial literacy on the front end.

{mosads}The CFPB is right to be concerned about growing burden of student debt both on the borrowers and the broader economy. Total outstanding debt, and the share of loans in default, are at historic highs. And although countless studies show that a college degree is still worth the investment, the majority of loan defaults are wracked up by students who don’t complete college. They therefore don’t enjoy the wage premium that comes with a four-year degree.

But in its quest to hold loan servicers accountable for the student debt problem, the CFPB is overlooking the behavior of borrowers. It should also be thinking about ways to enable the students to make better borrowing choices.

The harsh reality is that most young borrowers have little to no financial literacy (I can say this with confidence as a millennial). As elaborated upon in the field hearing, too many borrowers don’t understand how their loans work, what the repayment terms are, or even if they are private or federal. This shouldn’t come as a big surprise, since many young people struggle with basic numeracy (see this eye-opening ETS study).

If our generation knew more about how finance works — not as a concept associated with the words “Wall Street” and “crooks” — there would be less need for regulatory-mandated hand-holding from the loan servicers. We also wouldn’t need special treatment, such as eliminating interest rates because they are supposedly too complicated, like the New America Foundation recently proposed.

Special treatment to counteract financial illiteracy may help borrowers in the short run, by giving them a free pass to attend college anyway, but it undermines another important function of college: preparing young people for the real world. Maybe if we knew more, we would make better choices about investing and building wealth for retirement. We wouldn’t be the most conservative generation for investing on record, in an economy defined by increasing returns to capital over labor. We could actually be on our way to long-term financial security.

True, loan repayment programs as defined by Congress and the Department of Education are unnecessarily complicated and duplicative, and should be consolidated. Not even the financially savvy can easily navigate through them.

And it is also true that falling real earnings of young college graduates are exacerbating the student loan problem. As a new Progressive Policy Institute (PPI) report shows, reforms to our higher education system to encourage alternative pathways into the workforce, along with incentives for more employers to create better jobs, would also go a long way in helping struggling college graduates.

Still, the mandated financial counseling that is currently required for student loans isn’t cutting it. Instead of targeting loan servicers, the CFPB should focus on new ways schools can help students to be informed, responsible consumers.

For example, the CFPB could work with the Department of Education to take advantage of innovations in educational technology to provide more customized loan counseling before students take out their loans. The agencies could also work with schools to ensure borrowers remain engaged and informed about their loans, and any changes to them. Perhaps there could even be a reward for schools that implement exceptional programs with demonstrated outcomes. Finally, providing students, parents and career counselors with better data on college majors and outcomes would go a long way to making informed choices.

Targeting loan servicers may fix some problems with the student loan system, but it still misses addressing how student loans became so problematic in the first place. That’s why the CFPB should seize this as an opportunity to implement reforms that will more effectively help the ones the agency is charged to protect: borrowers.

Carew is an economist and director of the Young American Prosperity Project for the Progressive Policy Institute.