While student loan forgiveness is undoubtedly expensive, research suggests that individuals whose debt is forgiven get better jobs, experience higher mobility, and are ultimately more productive.
A crisis in the US student loan market has been looming over the economy due to an explosion in recent graduates’ indebtedness since the Great Recession. As of 2020, student loan debt has surpassed $1.5 trillion. About 44 million graduates shoulder more than $30,000 in student loans.
This rise, accompanied with high delinquency rate of over 11 percent, has created a student debt crisis that can potentially adversely affect millions of borrowers. Many of these borrowers might never earn enough to repay their debt. The risk is that student loan debt is not only crippling Americans financially, it is holding them back from pursuing better opportunities. This has ignited a policy debate about whether and how to intervene in the student debt market—e.g., should student debt be forgiven? Sen. Elizabeth Warren (D-MA) has proposed forgiving student loan debt for millions of borrowers on a sliding scale based on income, but the evidence about what the effects of this forgiveness might be is, at best, scarce.
In a joint paper with Ankit Kalda and Vincent Yao, we investigate whether the rise of student debt in the US has significantly curtailed the financial and labor market prospects of the younger generations. Our paper exploits a plausibly random debt relief shock experienced by thousands of borrowers due to the inability of the creditor to prove chain of title.
National Collegiate is one of the largest holders of private student loan debt, with over 800,000 private student loans totaling over $12 billion as of 2018. Over the years, it bought student loans from a series of banks and other financial institutions. However, judges throughout the country have tossed out collection lawsuits by National Collegiate against the borrowers it was attempting to collect from because it lost important paperwork and wasn’t able to prove that it owned this debt in the first place. This meant that thousands of borrowers saw their student loans disappear. This provides an ideal setting to explore the effects of relieving student debt as the loss of documentation is not correlated to borrowers’ outcomes and the judges’ decision mirror the effect of implementing a student debt forgiveness policy. We pair this setting with detailed data providing information on both borrowers’ balance sheets, income and employment history provided by Equifax, one of the three main credit bureau.
We find that, on average, debt relief leads to a decline in student loan balance by $7,901, not too far from the $10,000 proposed by the incoming Biden’s administration. This decline is substantial, as the borrowers in our sample had an average monthly income of about $2,000. It is important to notice that this forgiveness does not lead to an increase in the borrowers’ disposable income post relief, because they were not paying the loan before the discharge and are not paying it afterward. So this initial shock of $7,901 affects their net wealth and alleviates the psychological burden associated with being delinquent, but it does not have an immediate cash-flow effect.
One of the issues related to debt forgiveness is the fear that it would incentivize a less responsible behavior by the borrowers. In contrast with that view, we find that without student debt, borrowers were better able to manage their finances. In fact, they reduced their total debts by 26 percent, which was partly due to people increasing repayment amounts by shelling out more than the minimum amounts due. Overall, we find that people unburdened by student loans exhibit a lower demand for credit in general. What is more, these borrowers were significantly less likely to default on other credit accounts, particularly credit cards and mortgages, suggesting a more responsible use of credit. Overall, these results show that there are important externalities: forgiving student debt benefits borrowers but also their creditors as these borrowers become less financially fragile.
We then analyze the extent to which student debt distorts borrowers’ job market choices. We find that when borrowers were relieved of student loans, they were more likely to pursue new opportunities. Their mobility increases—we see them moving to a different state. More importantly, this mobility is accompanied by a 30 percent higher likelihood to change jobs—and the people who did make a switch landed higher-paying jobs in new industries. We are able to quantify the resulting increase in income and found that it is roughly equivalent to two months’ salary.
Why do we observe an increase in social mobility? Student debt reduces the borrowers’ willingness to take risks and work harder. The reason is that since student loans are not dischargeable in bankruptcy, borrowers know that sooner or later collectors will catch up to them and garnish their wages. This means that out of every $1 of additional income, up to $.25 will go to the collectors. This makes them less keen on looking for higher-paying work just to pay collectors more. Furthermore, borrowers are likely to pick safer jobs that pay steady income in order to meet their debt obligations, rather than riskier but potentially more appealing jobs, e.g. starting their own business.
All of these results show that policy interventions in the student loan market should not be considered a zero-sum game between lenders (or taxpayers) and borrowers alone, since there are important broader effects on the economy. That is, we compute a multiplier effect greater than one: for every dollar spent on forgiveness more than one dollar is generated and reinvested in the economy. While loan forgiveness is undoubtedly expensive and introduces moral hazard issues, our research suggests that individuals not constrained by such debt get better jobs and are ultimately more productive.