Biden’s student loan bailout and the death of skin in the game

President’s Biden’s forgiveness of up to $20,000 of the amounts owed on 45 million outstanding student loans represents the official death knell of any semblance of market discipline in America. Unfortunately, his administration has not been alone in giving away taxpayer money without attaching strings to ensure that everyone has some skin in the game.

Higher education is a good thing, and the more well-educated people we have, and the better educated they are, the better it is for the nation. But there are much better ways to achieve those goals than by using taxpayer money in undisciplined ways that distort the incentives underlying financial markets.

Government subsidies abound, and it may indeed be in the public interest from time to time to accept the moral hazard that accompanies a massive taxpayer-funded bailout when the benefit outweighs the moral hazard created. But this delicate balance increasingly seems to be relying on political expediency rather than financial reality.

The ultimate cost to U.S. taxpayers from student loan forgiveness may exceed $500 billion, or about one-third of the $1.6 trillion outstanding student debt. That is roughly equivalent to the time-adjusted price tag for the entire savings and loan crisis — a cost authorized by Congress, not just the president or a single political party.

Students can now freely walk away from $20,000 of their debt without committing to serve at a non-profit, in the military or in federal, state, tribal or local government office — factors that under current rules can be the basis for extraordinary student loan relief. The Treasury will simply write a check to the ultimate holders of the loan for most of the amount forgiven or write that amount off the federal ledgers, leaving the taxpayers to once again foot the bill. But consider the moral hazard created. If you had another $50,000 of student loans left, would you pay another dime?

This is only the tip of the financial iceberg that government largesse has constructed. Since 1980, the total cost of both four-year public and private college has nearly tripled, even after accounting for inflation. Because the federal government lends students the money to subsidize these skyrocketing fees, any sense of market discipline is completely obliterated, particularly when universities do not share in the loss. Unfortunately, it’s not just students and universities that the government has incentivized to disassociate themselves from reality.

The government has created so many financial safety nets that there is a national expectation that consumer and institutional markets will be bailed out when things get tough enough. In the Great Depression, taxpayer money was used to fund a wide array of job-creating activities, including the construction of the Hoover Dam, subsidization of farmers and the hiring of authors to write state guidebooks.

Since then, depositors of failed financial institutions, car manufacturers, insurance companies, airlines, small businesses, investment banks and mutual funds all have enjoyed some sort of bailout subject to varying degrees of financial pain. Rational fiscal policy would suggest that there be rules that condition government largesse and that they include meaningful commitments and limitations if we are serious about not distorting the incentives and risks that make markets work.

In the 1980s, when the failure of Continental Illinois and 3,000 financial institutions threatened the national economy, significant costs were imposed on senior management, directors and stockholders in return for the use of government money.

The authors of the 2020 book “The Rise of Carry” suggest that when the government continuously bails out financial markets without significant strings attached, it is actually incentivizing large financial entities to take excessive risk to maximize short-term profits (and annual compensation packages), expecting that the government will come forward with a taxpayer-funded bailout when the bubble explodes.  

The Founders would be appalled to see taxpayers subsidizing financial companies that take massive risks, student borrowers that walk away from their loan commitments when the vast majority of our youth do not attend or graduate college and wealthy educational institutions that increasingly charge unbelievable sums to support their unrestrained infrastructures. 

The more we forget about the importance of skin in the game, the more we ensure that taxpayer-funded bailouts will beget even more taxpayer-funded bailouts. We should care about that, even if politicians no longer seem to.

Thomas P. Vartanian is executive director of the Financial Technology & Cybersecurity Center and a former general counsel of the FSLIC.  He is the author of “200 Years of American Financial Panics: Crashes, Recessions, Depressions and the Technology that Will Change it All.” William M. Isaac is former chairman of the FDIC and Fifth Third Bancorp and is chairman of the Secura|Isaac Group and Blue SaaS Solutions.