Purchasing Power and Debt

Less financial stress and greater purchasing power is the premise behind the Income-Based Repayment (IBR) scheme the U.S. government has implemented for student loans.

(Not too long ago, I wrote a piece about the damage done to the purchasing power of the young and uneducated.)

Borrowers who enter the IBR program have to pay 10% of their income toward their student loan for 20 years if they’re in private employment, or only 10 years if they’re in public employment. After the repayment period ends, any remaining loan balance is forgiven.

Since the U.S. government guarantees the loans, this actually means we, the taxpayers, pay any remaining loan balance. It’s only forgiven from the standpoint of the borrower.

This program started in 2009. As expected, since that time, people have been trying to figure out how to milk it for all it’s worth. Graduate schools take the prize for squeezing out the most free money.

Some institutions realized they could have students borrow for all costs (living expenses, tuition, books, etc.) associated with getting a degree, go to work in the public sector, and then pay only 10% of their income toward the loans for just 10 years.

This in itself wasn’t new, but some graduate schools took it further. They raised tuition, and then told potential students that if they followed this program, the school would make their student loan payments for them… for the entire 10 years!

Essentially, the schools, through higher tuition that was paid for by loans, was banking the extra cash and then using it to make the loan payments!

This sort of abuse came to light over the past year, but seems to be subsiding. However, the point remains that when such a program as the IBR is introduced, people will scheme to get the most out of it, causing all sorts of unintended consequences.

And there’s a long-term consequence of the IBR that won’t go away. That is: increased competition for public jobs, and people sticking with them longer than they normally would.

In effect, IBR is replacing pensions.

Purchasing Power Over Pensions

For many years, the draw of public employment was the steadiness of the job and the benefits, which compensated for lower wages than could be had in the private sector.

The trajectory of wages in the private and public sector haven’t been exactly the same. The former saw wages flatten and fall during the 2000s, while it took the latter a while to adjust down after the financial crisis. But that still left pensions, which have been the cornerstone of public employment benefit packages for decades.

Now, pensions are also being reduced or eliminated in favor of 401(k)-type programs. This puts public employment on a more equal footing with private employment, and removes a perverse incentive for workers to stay in a job long after they would have normally moved on.

However, there will be an extraordinary number of graduates interested in public sector work going forward so they can make the most of the IBR program.

Sure, this program is available to graduates who enter either the public or the private sector, but the shorter repayment period in public employment has to be a major deciding factor. Who wouldn’t want to cut their debt payment schedule by a decade?

And, not only will new grads be looking for this type of work, but they’ll stay in such jobs longer, just to keep this incredible benefit, which will slow the normal turnover rate and keep these workers from whatever their normal progression would have been.

Interestingly, this should be a net positive for public employers, because it creates more competition for their open positions, and it’s the result of a benefit for which the employer doesn’t have to pay. Instead, we as national taxpayers get the “pleasure” of essentially subsidizing the employment of public workers across the nation, and we’ll do so for more than a decade.

I write to you about this today because the IBR is in the news right now. The administration wants to expand the program.

Currently, it has 1.63 million participants. New regulations will give the five million student loan borrowers who took out loans before 2007 eligibility to participate. And then, of course, we have all of the students who are currently enrolled, who are racking up debt at a record pace. They, too, will have a chance to hand off a chunk of their student loans to taxpayers, and use public employment to make the repayment period as short as possible.

So the next time you visit the Department of Motor Vehicles, if you encounter young workers who seem exceptionally bright, competent, and motivated, you don’t have to wonder why they’re there. It’s because they now have you paying for their student loans.

Rodney

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About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.