University endowments should be the main source of student loans

Here’s a modest proposal: Colleges and universities should tap into their own endowments to provide student loans before this obligation is imposed on taxpayers.

When President Obama federalized student loans in 2010, he promised the move would save taxpayers $68 billion. This does not happen.

If President Joe Biden’s unilateral decision to cancel student debt succeeds the constitutional challenges, which is doubtful, taxpayers could be owed more than $500 billion.

But while the federal government is doling out billions of dollars in student loans, many colleges and universities are sitting on endowments also worth billions.

Staffing officers at colleges and universities invest their funds in a variety of ways. So how about “investing” that money in students, essentially becoming the student lender of first resort rather than the government?

First some facts. According to the National Center for Education Statistics, a federal agency, “at the end of fiscal year 2020, the market value of college and university endowments was $691 billion.”

Harvard’s endowment leads the pack, with nearly $42 billion. Yale comes in second with $31.2 billion. And although both of these universities are private, the University of Texas system, a public university system, comes in third with $30.5 billion.

And it’s not just a few colleges and universities. By the end of 2018, about 75% of public and private universities had more than $10 million in their endowments.

How do universities invest this money? The American Council on Education (ACE) states that in 2020:

  • 71.8% was invested in stocks, bonds and traditional cash;
  • 21% was invested in private capital, such as hedge funds; and
  • 7.2% was invested in natural resources and other “real” assets.

But aren’t university endowments using some of those funds for student aid? Yes, but that money usually comes from endowment revenue, not principle.

Suppose Congress requires colleges and universities with large endowments to use a portion of those endowments – say up to 75% – to provide student loans. Once the endowment reached the set cap, the federal student loan program kicked in as a backup.

Colleges and universities invest their endowments to make a profit. Under this plan, student loan repayments would provide much of that profit.

Several benefits could flow from this policy. First, it is those who benefit most from student loans – the universities that receive the money and the students who take the courses – who would bear the cost and risk, not the taxpayers. Of course, the federal student loan program would still be available if a university reached its endowment cap or if the institution had little or no endowment.

Second, colleges and universities would have a financial interest in ensuring that their students get a good education and good degrees in fields that can get them a good job and pay the money back. This shift could also lead to a number of constructive changes to the less useful courses and study plans currently on offer.

Third, the change could encourage colleges and universities to better control their tuition fees.

Complaints about rampant tuition increases, well above the rate of inflation, are rife. But under the current federal student loan program, millions of students are largely protected from the real costs they incur. It almost feels like free money, and maybe it will be if Biden’s student debt forgiveness survives.

This cost isolation is a major factor in students’ willingness to borrow and spend thousands of dollars to earn a college degree. If colleges and universities were to turn to their endowments as their first line of student loans, they might decide to get their costs under control.

University endowments aim to earn 7.0% to 7.5% on their endowment funds. Could they do so many student loans? Probably not, but it might not be that far.

Here’s what Nerd Wallet says: “Interest rates for all new direct federal undergraduate student loans are 4.99%, down from 3.73% in 2021-22. Direct unsubsidized graduate student loan rates are 6.54%, down from 5.28% previously. Rates for PLUS loans, which are aimed at graduate students and parents, are 7.54%, down from 6.28% previously.

The best way to provide student loans is through private sector financial institutions. But Obama probably closed that door for good. The second best way is to let those who benefit bear the cost and risk. This is what would happen if endowments became the student lender of first resort.

Merrill Matthews is a Resident Scholar at the Institute for Policy Innovation in Dallas, Texas. Follow him on Twitter @MerrillMatthews.

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