Sen. Elizabeth Warren (D-MA) is definitely not an economist. Her recent student loan interest rate bill makes that clear.

Sen. Warren’s bill would lower the interest rate on Stafford federal student loans to .75%, the same rate the Federal Reserve gives to big banks. The argument given is, “If the banks can get it, so can the students.”

Look. We have student loans. They suck. We don’t look forward to paying them back. On paper, an interest rate of .75% sounds great. Sign us up! The economic implications, however, of an interest rate this low would be disastrous, and could in fact make college less affordable and attainable for needy students.

There are at least two forces that govern the world: gravity and prices. Interest rates (the price of loanable funds) contain information on how we should allocate our resources most efficiently. Creating artificially low rates (like the one Warren is proposing) will distort this information.

Consider a privatized economy with an excessive amount of college graduates. This flood of college graduates will, assuming everything else is equal, drive wages down for college graduates. The supply of college graduates will exceed demand, driving down their “price” (wage). This is not good for the recent college graduate, who needs to make money to pay back the loans they took out to receive their education.

Furthermore, because so many people have been taking out loans to go to college, loan rates will be excessively high. The high loan rates dissuade high school graduates from attending college. The interest rate effectively communicates the message that there are too many college graduates driving down wages in the market and, perhaps, college is not the best investment for the high school graduate. This means that fewer high school graduates will choose to continue schooling and, over time, the supply of college graduates diminishes, increasing wages back to normality. This is the market behaving, as it should.

Sen. Warren’s proposal to artificially lower interest rates would throw a wrench into the economy by removing the ability of a high interest rate to communicate the supply and wage information in the labor market to the prospective college student. More loans would be distributed to students who will then continue to feed into the flood of excess college graduates, continuing to lower wages in the market. These students, enticed by an extremely low interest rate on student loans, would enter into a spiral of debt that they will likely be unable to ever repay. This is not good.

If this theory is correct, we should see the following consequences in the data: higher unemployment rates for college graduates, lower wages, higher student loan amounts, and higher default rates. Indeed, this is already the case. Over 53% of recent college graduates were either underemployed or unemployed in the first quarter of 2012, and those who actually are employed have seen a 7.6% drop in pay over the last six years. The number of college graduates making minimum wage has increased 70%, which is another symptom of underemployment. There is rising outstanding student loan debat–up 12.5% since 2010, and up 300% in the last decade. Furthermore, student loan defaults have been increasing as well–in 2009, 8.8% of debtors who entered repayment defaulted within a year. In 2012, the number was up to 10%. These numbers will only continue to worsen if Sen. Warren’s bill actually results in lower interest rates.

Sen. Warren’s proposal may appear to be helpful for students, but the numbers just do not add up.

RousselleLong

Arman Oganisian | Providence College | @Arman_Oganisian

Christine Rousselle | Providence College | @crousselle