Governments Shouldn’t Be In the Lending Business

The US Constitution includes carefully written rules for the government’s spending of money. Article I provides that Congress may appropriate money to be spent for certain objectives, and then only if the expenditure is for the general welfare, as opposed to the benefit of small groups or individuals. But neither Article I nor any other part of the Constitution deals with the government’s power to lend money. Was that merely an oversight on the part of the drafters that summer of 1787? Did they perhaps intend that the government should have carte blanche to lend money as officials thought best? Of course not. The right conclusion from the omission of a grant of power to lend is that no such power was contemplated.

Had one of the individuals at the Constitutional Convention said, “Should we write in a power for the government to lend money?” the reply from everyone else would have been “No.” The government they envisioned was one where the duties of the three branches were clearly defined and limited to just those functions essential for, as the Preamble says, “securing the blessings of liberty.” Lending out money was not necessary for that. Had the idea been debated, one of the delegates would no doubt have pointed out that politicians would be poor stewards of the nation’s limited capital, since they wouldn’t be lending their own funds and therefore not concerned about the prospect of losses.

Nevertheless, the government has gotten into lending in a big way. It lends money for people who want to give agriculture a try, to people who want to open up a business, to people who want to buy a house, and to students who want to go to college. The feds are eager to lend you money — just go to this website and see what you are eligible for.

The feds got into lending during the vast expansion of government during President Lyndon Johnson’s “Great Society.”  Johnson, a New Deal protégé of FDR, was certain that poverty and inequality could be conquered with enough federal action — regulation, spending, and lending.

Most conspicuously, he signed the Higher Education Act of 1965 that put the feds into the business of financing college education. At first, that was done by having the government back private college loans. If the student didn’t repay, the government covered the loss, but to qualify, the private lenders had to keep the interest rate low in order to get as many students as possible into college.

Unfortunately, during the heady days of LBJ’s Great Society, few people questioned the wisdom or the constitutionality of having the government underwrite college loans. In the 1960s, the Supreme Court was not the least bit interested in enforcing the Constitution’s limits on government power and any legal challenge to the Higher Education Act would have been fruitless. Years later, under President Obama, the federal government took over the college lending directly, supposedly to save money, but instead the costs have risen sharply.

The bad results of the government’s various lending programs underscore the wisdom of the Founders in not allowing it.  Many business and agriculture loans went bust and the housing bubble of 2007-08 was a result of federal meddling in the mortgage market. All loans have some risk, but when the lender stands to take a loss if the borrower can’t repay, he carefully balances the risks and rewards, often declining to accept the risk. But when government officials approve or guarantee loans, lenders don’t have to worry about taking the loss. They can be very generous, pursuing what they regard as socially beneficial goals, and never worrying about the losses the taxpayers will have to bear.

That has been especially striking in the case of college loans. Before the federal government decided to make college “accessible,” the cost of tuition was rather low and yet only a small fraction of the populace thought the cost was worth it. Our high schools did a pretty good job of preparing people for careers and there were few jobs for which a college degree was a requirement. Academic standards were generally high, maintained by scholars who cared about imparting the knowledge of their disciplines.

That began to change once federal student aid began flowing. More students decided to give college a try and many of them were less academically prepared for college-level work. The schools liked the new revenues that came with those students, so they started to incrementally make adjustments to accommodate them — grade inflation and curricular degradation. Professors were allowed or even encouraged to keep students happy with high grades. Courses that were easier and more fun started showing up in the catalogues. We also saw the beginning of courses aimed at specific identity groups where the emphasis was not on mastering a body of knowledge, but on absorbing the professor’s point of view about some social ill.

Another unforeseen consequence of federal student lending was escalating tuition and fees. As college officials realized that the government was putting lots of money in the pockets of students that could only be used to buy their product, they did the natural thing — they charged more. Thus, the cost of college was going up while the educational benefit from it was going down.

Also, employers started to insist that job applicants have college credentials, a phenomenon we call credential inflation. Why? The labor market was flooded with people sporting their college degrees and employers began to think, “Since we can fill our personnel needs with college grads, why bother interviewing mere high school grads?” Many jobs that had always been staffed with smart, trainable high school grads were now off limits to them. The “need” for a college degree almost never had anything to do with the high intellectual demands of the work, but simply with the mushrooming numbers of college graduates available.

After being lured into college with the prevalent notion that getting a degree was a great investment, lots of graduates were disappointed to discover that out in the labor market, their credentials did not ensure highly paid work.  Many, in fact, had to settle for jobs that they could have done while in high school, such as delivering pizza. The infamous Occupy Wall Street protest was largely driven by college-educated workers who were unhappy at having to pay off their student loans out of their meager earnings from jobs for which they were “overqualified.”

For the last several years, there has been a well-organized movement to have the government cancel the debts accumulated by students in their quest for college degrees. Inevitably, politicians saw a chance to win popularity by supporting that movement. Campaigning for the White House in 2020, Joe Biden made debt forgiveness a major promise. Once in office, his administration began to deliver on it by changing the repayment rules so that many students now pay far less than they borrowed. Even though the Supreme Court struck down one of his brazen loan forgiveness orders, he has continued his loan cancellation schemes anyway.

That’s why I say that the Founders were right in giving the federal government no power to lend money. It leads to wasted resources and huge burdens on the taxpayers. If we ever want to get our fiscal house in order, we’ll need to stop government lending.