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Tackling the Student Loan Debt Crisis ft. Chicago Booth Asst. Prof of Finance, Constantine Yannelis

[00:00:00] Kriti: Hey guys! Welcome to WhyFI Matter$. I'm super excited to keep the conversation going from last week with Dr. Carlo Salerno. Just to remind you, we learned about income shared agreements and other policies to help, and the student loan debt crisis. And I'm excited to extend the conversation to this week. In today's episode we will dive a little bit deeper into actually what happened in the antitrust lawsuit accusing elite colleges of colluding to limit financial aid. And we're also going to learn about the effects of anti-competitive behavior, as well as income driven repayment as a solution to the student loan debt crisis. I am super excited to speak with Dr. Constantine Yannelis, who is the assistant professor of Finance and FMC faculty scholar at U Chicago Booth school of business. His research focuses on household finance, public finance, human capital, and of course, student loans. Dr. Yannelis, his academic research has been featured in many different journals and media such as the wall street journal, financial times, the New York Times, the Washington post, the economist, Bloomberg Forbes, and more. I hope you enjoy the interview!

Hi professor Yannelis! Thank you so much for coming on WhyFI Matter$ today. I'm super excited to have you here. It's my first time interviewing a U Chicago professor. And that's really exciting for me obviously, because I go to Lab. But thank you so much for coming on the podcast today. I'm super excited to get into student loan debt you're an expert in this field. So thank you so much for coming on the podcast today.

[00:02:05] Dr. Yannelis: Well, it's really a pleasure to be on the podcast.

[00:02:07] Kriti: So you are a U Chicago economist and how did you get to where you are? Can you give us a brief overview of your career path and what even sparked your interest in pursuing economics?

[00:02:23] Dr. Yannelis: Yeah I think the main thing that got me, where I am is a lot of hard work and studying. I've been interested in economics for quite some time. It was a little bit of a roundabout path. I've always been interested in policy. So I've always had a deep interest in history, economics, foreign affairs. I've always been quantitatively inclined as well. I really enjoyed doing research and I wanted to get more into many of these important issues. So I ended up applying for a Ph.D. and then I had a couple private sector offers and also academic offers. I ended up going the academic path. It just gave me the most flexibility in life in terms of thinking about the questions interest me and what I want to answer rather than working for somebody else. I think there are really two professions where you get to be your own boss and do what interests you that's being an academic or being an entrepreneur.

[00:03:25] Kriti: That really made me smile because I've never heard anyone say that before, but it's something that's so obvious in. I'm very entrepreneurial but I'm also really academic as well and I just realized that you're your own boss in those two situations. So.

[00:03:41] Dr. Yannelis: Exactly. I have some work in entrepreneurship as well as in student debt. And, it's really a similar problem. If you think about it, right? You have somebody, a student or an entrepreneur making a risky investment with uncertain payoffs and how to quantify that uncertainty, how to insure against these risks. So they're really similar, problems at the very base level.

[00:04:10] Kriti: Yeah, definitely. So one of the articles that I read you said that "education is the single highest-return investment most Americans will make. So getting our system of higher ed finance right, is fundamentally important for us household and the US economy." And I think specifically right now when people are looking at higher ed through the lens of having gone through and going through this pandemic, a lot of people are doubting the value of this investment. Does, what you said in your article, does that still hold true?

[00:04:47] Dr. Yannelis: I definitely still believe that's true. The biggest asset that any young person has, is themselves and their own ability to generate income, in the future and I say for most Americans education is the single highest-return investment that will make because that's what the data show. If you look at the returns to going to college, going to graduate school, they're very high over the lifetime. If we look at earnings premiums, they're not uniformly high for everyone. And there's a lot of across school type, across major type, not all of that as well understood, but on average the returns to education, are very high and people will earn much more over their lives, than the cost of going to college, even if you factor in the lost wages of working. And that's why I say that is the single highest-return investment that most Americans will make because the additional cash flows that they get just dwarf pretty much any other asset or return.

[00:06:04] Kriti: I think a lot of people, will take out loans. It's still hard to ignore this big, debt you've accumulated though. you would think that like universities would try to help as much with, financing your education, but it seems like there's been a lot of, issues in terms of the financial aid and student loan system within colleges. Most recently with the antitrust lawsuit filed against several top universities. So could you give us a brief overview of what happened in this lawsuit?

[00:06:44] Dr. Yannelis: Yeah. So I can talk about it a little bit. My understanding there is some colleges and universities were accused of essentially colluding in terms of financial aid. So I have no idea whether this allegation is true or not. It's good that we have a legal system and there'll be a lot of investigation and I don't think we should rush to judgment. But I will say that of course, anti-competitive behavior is very bad for a consumer. So if it's a proof that there was collusive behavior among colleges and universities, of course, action should be taken schools that engaged in this behavior, if they did should pay fines and mechanisms should be put in place to make sure that the schools don't do it again in the future and take a lot of the problems that we see at the high end of the, of the academic quality distribution. I mean, across elite institutions have to do with. There being too much market power of colleges and the universities. Most young people I'm on now just apply to most of the top schools or the schools that they think that we'll get into and just go to the best ranked school. And that's, that's the optimal thing to do. I tell my students to apply to all the top schools. I would tell my kids to apply to all the top schools, but the problem is that institutions aren't differentiating them themselves enough and students don't think enough about match quality. So I think that 20 years ago, Chicago was a very different place and had a very distinct undergraduate culture. It was a very, very, it's still is a very nerdy. And I say that in a very loving way. I'm a nerd. So I think that's a fantastic thing. And I really enjoy teaching my brilliant nerdy students, but I think Chicago has become more in chasing rankings. They become more like elite institutions. I think differentiation is a good thing. People are different. They have different interests also I think that schools doing different things is a good thing because some things will be successful. Or not successful and other institutions can copy that and improve their practices. So I think it's a, it's one of them, and I think this comes from the fact that people pay too much attention to rankings, and it's really, it's silly, to be honest. I mean, you should pay attention to some level, I mean, there are places that are in a different quality tier, but on the margin, if a place is ranked, you know, two or seven or, or something, you can get a great or a terrible education at any of these places and more will depend on individual efforts, what you do walk the from extent. Yeah. Do you know the right courses to take, I think these idiosyncratic factors on the margin matter much.

[00:09:54] Kriti: Exactly. And so you touched on well, you, you said the words anti-competitive behavior. So could you elaborate on what this exactly means?

[00:10:04] Dr. Yannelis: Oh absolutely. So the way a standard competitive market would work and in for most, almost every product we can, we can think of, you know, there's some exceptions in financial markets, but for almost every product we can think of competition lowers prices, right?

If there are two shops on the street and one is charging $10 for a coffee. Then the other coffee shop will want to charge $9. All the consumers will go to the cheaper one. And then if the cost of dollars to make the coffee, then those forces are going to drive the price of coffee down to a dollar, right?

Because the competition will force these coffee shops to just lower and lower prices until their pricing at at cost. And that's good for consumers because they pay less than. Anti competitive behavior means what collusion means. And the way this, these market forces could break down is one, if one of the coffee shops, clock closes, then the coffee shop, that's a monopoly. They can charge whatever price they want and if consumers want coffee, they have to go to that coffee shop. The other thing that can happen is collusion, which I believe is what some of these universities where essentially accused of what they can do is, you know, the coffee shop owner can call up the other coffee shop owner and say, Hey, why don't we both agree to charge 10, $10 for coffee? And then we can split all the surplus and we won't undercut each other. Each other that behavior, is illegal. And it should be because it's bad for consumers. Proving it is often very hard to do. And there's a lot of, the, these legal cases can often be a big, sometimes these anti-competitive forces are much more subtle. I think it's relatively rare that people are calling each other up and agreeing to fix prices. You know, the way that this breaks down is that in reality markets, aren't perfectly competitive. Because. Consumers just don't know the price of every item that's available or where where to go. Or I might be willing to. Go to the coffee shop near to me and pay because, my time is is valuable.

[00:12:26] Kriti: Interesting. So regardless of whether the colleges have had this sort of anti-competitive behavior, there is still a big student loan debt crisis in the U S. So I want to know some of your thoughts on. This higher education and this, the model of education here in the US and there's a few different things that I got different solutions to this problem.

[00:12:55] Dr. Yannelis: Yeah, so first I can give a broad overview of what's often called the student loan and an important point that I think needs to be made is that you asked and the loan balances are large. Around 1.7, close to $1.8 trillion. It's the second largest form of household debt in the United States and these are big balances, but this obscure that the average to loan borrower has no problem paying back these balances. Why? Because they went to college and they earn very good salaries. Now there's a significant fraction of borrowers who are really struggling. And these are disproportional.

People who have the for-profit colleges, which often engage in predatory behavior places like the university of Phoenix, Kaplan university and and the like graduates from those institutions. First of all, many students don't graduate from those institutions end up paying to flown and dropping out.

But even if they do graduate, typically outcomes are not. But not good. They've gotten better over, over time as there's been more pressure, but there's still, these outcomes are still pretty bad. A lot of students also take out loans and don't finish. So when we think about a crisis in student loans, what we're really thinking about is.

The average borrower. It's not like the people often their heads, they think of the student loan crisis. They think of people who went to Harvard or Stanford or Chicago. That's not the case. I mean, almost nobody. It takes out loans and defaults and these elite private institutions the people who are really struggling tip on average, went to places like for-profit schools or a lower tier institutions.

So when we think about policy responses, what we want to think about is providing relief to these people who are really struggling. And I know it's a lot of the policy solutions are taking to blunt and an approach, right? If there's a if there's a rat in my house, the solution is not to burn the house down or to use a use a bazooka. So they get rid of the rat. What you want to do is trap the rat and get it get it out. So a lot of these policies that are suggested things like student loan, cancellation, that's universal, or very broad based, it's going to spend a lot of money to make transfers to people who are, who are going to be very rich over their lives.

[00:15:42] Kriti: It's not like targeting. It's not targeting the right group of people.

[00:15:48] Dr. Yannelis: Exactly. So, if you do a simple correlation of student loan balances and earnings it's very positive. So people who have more student loan debt earn more, that's often surprising to people, but then when you explain. It makes sense,

[00:16:02] Kriti: getting a bunch of degrees and

[00:16:06] Dr. Yannelis: who has $150,000 in student loan debt. I mean, you can, some people just have bad circumstances and unfortunate events of a typical person with a lot of student loan debt. They're a doctor, they're a lawyer, they're an MBA. And , my MBAs they're fantastic people. I really like them. They're. And on some level I be happy if the government gives them a bunch of money because I, because I like them, but I'm not going to argue that it's good policy to spend a lot of money for very, for doctors, lawyers. And so what we really want to do is target these people who are struggling. And one thing that often gets missed in the policy debate is that we already have a very generous student loan forgiveness program, that's called income driven repayment. The way that income driven repayment plans work is that they link borrower's payments to their income. So for example, some plans, borrowers pay 10% of their income above 150% of the poverty line. And after say 20 or 25 years then balances are forgiven. So these are ways to provide relief to struggling borrowers, without giving a bunch of money to people who are going to earn a ton of over there over their lives.

And then also, you know, we could make, if we want to give more forgiveness as a society, one way of doing that and really targeting it is I'm making income driven. More, more generous. A lot of these things that are proposed, there's still like, there's still like going after the rat with a w with a bazooka things like $50,000 or $10,000 of forgiveness, most of that money is going to go to high high-income people and also it's not going to relieve a lot of low-income people who have a lot of debt who probably need the most relief, whereas income, different or payment would

[00:18:17] Kriti: it's like targeted. And I actually interviewed somebody who basically gave me a similar solution, which was called income share agreement. Maybe they're just different names for the same exact thing,

[00:18:33] Dr. Yannelis: they're a little bit different. So, and the main difference is that income direct payment, is capped. Whereas income share agreements are uncapped. So an income share agreement means I pay a portion of my income. Up to a certain amount of time. Whereas income driven repayment means that I pay a portion of my income until the loan is paid off.

[00:18:57] Kriti: Interesting. So if you go to some of these top like 50 universities, it would seem that they have a big enough large enough endowment that they could pay everyone who attend. Why don't schools make use of this endowment? What is endowment doing really? Is it just like sitting there?

[00:19:20] Dr. Yannelis: If it is sitting there and I'm growing? I mean, so the. Universities are spending their endowments at a rate of typically around five, 4% a year. You're there for some schools they probably could.

Eliminate tuition has only a handful of schools that would be able to to that would be able to do this. But even this. Your Chicago for and for example, the endowment is not large enough to eliminate tuition, not even close with with gains and even places with very large endowments.

I was talking to somebody from Harvard business school a couple of months ago, and they were saying that even Harvard, they have a structured. Deficit in the long, in the longterm, I don't know the details of that, but this was a very smart finance professor. So I trust their, they did the calculations correctly.

So, and then down the, yeah, you could spend it all and eliminate tuition for a couple of years, but then what is the university going to do? It'll be in. Position in a couple of years and then it would require very massive hike. So it's not really it's not really a sustainable solution. Yeah.

They, the endowments are meant to be more or less permanent, which means you can spend around 5% of them a year risk tolerance, a place that is okay. I see.

[00:20:49] Kriti: I was wondering what your thoughts were on like the European model of education, because I have, I know people who, you know, are in France Germany, and they don't pay a single dollar for their secondary education. And I was wondering if you thought that a value of going to a school in the U S is going to am paying all that money is, is actually that much more. Impactful to a person then attending a university in Germany or France. Why is Europe able to make it free? But are they sacrificing something necessarily?

[00:21:30] Dr. Yannelis: It's not, it's not free. Somebody else pays for it's a, it's a fallacy to say university is, is free in Europe, right? A European professor doesn't work for for free the bill themselves paid through taxes. And this is actually a very regressive way of financing, higher education relative to the way that it's done in the US the UK or Australia.

Why? For the exact reason we were talking about earlier, people who go to college earn more. The people that don't go to college, people who go to graduate school earn more than people who only get a bachelor's degree or only an associates degree. So this is another thing that a lot of people find surprising, but it often usually clicks once. This is explain the European model of higher education financing is actually much more regressive then the American and British model, because you're raising taxes for everybody to pay for something that really only the wealthier part of society enjoys.

Now that doesn't mean that I'm, I'm definitely not against subsidies for education, because I think a higher education has a lot of what we call externalities in economics, meaning that if people are more educated, that creates good things for other people that aren't internalized. They might come up with new innovations that save people's lives. They may be better citizens and voters. So I do think there's a role for government subsidies in education. The US has some, has a lot of problems, but designing an optimal higher education system would probably be closer to the U S and Australia than France or Germany.

[00:23:19] Kriti: I totally see what you're saying now. No one explained to me this whole concept of how the policies should target the people who need it the most. And in fact, it's being like counterproductive in that sense. You did say that there are certain negative aspects of what's happening. And one of them would definitely be the racial wealth gap. So I was wondering if you can elaborate a little bit on how student loan debt affects the racial wealth gap.

[00:23:52] Dr. Yannelis: Yeah, so the, the racial wealth gap is a huge problem in the United States. It's been a huge problem for for a long time. Often proponents of student loan cancellation bring closing the racial wealth gap as a reason to forgive student debt. And it's true that according to some surveys that I've used by the federal reserve and other sources, black households have more student loan debt. This is not one of the primary drivers of the racial wealth gap.

So I did some calculations on this and if you eliminated all student loan debt, you would shrink the racial wealth gap by about 3%. And, shrinking it by 3%, is a good thing. But, that's just not enough, right? I'm very disappointed if in my lifetime, The racial wealth gap only shrinks by 3% and it would cost 1.7 trillion dollars to shrink it by 3%. So if you invest 1.7 trillion and the goal is to close the racial wealth gap, they're much bigger impact ways of doing that. Keep in mind a lot of very poor people didn't go to college at all, and student loan forgiveness would not benefit them by by 1 cent. So, you know, there are a lot of roots of the racial wealth gap, but in order to close that it would make more sense to focus on one the racial income gap and two gaps in housing, because housing is the biggest non-human capital asset that most households own and blacks have a much lower housing wealth than so I think money was better there is the goal is to close the racial wealth gap.

[00:25:40] Kriti: It's interesting that you bring up housing especially right now with what's going on in Hyde park with the library that's being built. I know that it's going to raise the average cost of a house in Hyde park by a lot. So what are your thoughts on it?

[00:25:57] Dr. Yannelis: Yeah. Hyde park has an interesting history. It used to be a very wealthy neighborhood. You can tell from all the historic Woodlawn, it was probably the wealthiest or one of the wealthiest neighborhoods in the city one of the reasons Rockefeller put the university and then the area is around Hyde park, deteriorated with white flight in terms of gentrification and housing prices. I personally think investment in south side is, is a good thing. I don't think the problems of south side Chicago face are there too many jobs or employers or investment there? I think that the Obama presidential library is going to employ people in the local community. So I think it's certainly going to be a good thing for it'll bring in tourists to local businesses. So, I personally think that it's a good, a good thing for most people there might, almost anything, there are winners and losers. But I think there will be far more winners in terms of the community in south side Chicago. And I think that the people in charge of the project are very cognizant . But again, I haven't looked deeply into the into the issue. So take my, opinion on zoning in Hyde park with a very big grain grain of salt, salt.

[00:27:14] Kriti: So going back to student loan, are there any other kind of positive solutions other than income driven repayment or income shared agreement that you think will help tackle this issue?

[00:27:32] Dr. Yannelis: I think the core of the issue is really a misalignment of incentives between some predatory schools and students and those bad incentives come from these government loan program. So unlike in other private loans, let's say a bank makes student loans are made by the federal government. The students pay tuition money to schools and then if the student doesn't get a job or they end up defaulting on their loan taxpayers, pick up the tab, it doesn't hurt the school's bottom line. So a lot of predatory institutions take advantage of this. I wouldn't hesitate to call them diploma mills because I'm most students sign up, pay their tuition and don't actually graduate. They drop, they drop out. She call them dropout factories almost that are, that are financed by the federal the federal government.

So, one thing to do is to align the incentives between the school. And the students Brazil, for example, instituted a recent policy that I'm studying in which they made schools on the hook for dollars charged off and in default. So that's one option. Now. Weren't careful doing that kind of stuff because you know what we would want if contract what we'd want to write it on is the value added of the school, basically how much more you earn because of going to that school? We don't observe that, right? Because students are not assigned randomly to schools, I did my undergrad at the university of Illinois and the average student at the university of Illinois earns less than the average students university of of Chicago. And I would like to say of all of that is because we do such great teaching at Chicago. But a lot of that is just the students on average at are stronger in terms of academic background and the ability and earn. Otherwise, so that the danger, with those policies is that it could disincentivize schools from taking more challenging students who might benefit the most.

So we want to be very careful in designing those policies and, I think we'd want to, move slowly. And think hard about what kind of metrics we would look at. They might differ for different types of institutions. Another one is providing some direct relief through something, like bankruptcy. So student loans, unlike other consumer loans that can't be discharged in bankruptcy. and it's not completely crazy that they have these restrictions or the concern is 22 year old kids. When they graduate, they have no assets and a bunch of debt, so they could declare bankruptcy. And then seven years later, when they want to buy a house and start a family, in some cases their bankruptcy flags are removed and it could very costly.

So the rule in the past was that student loans can be discharged in bankruptcy after five or seven years. And that effect to some extent it was a sensible. Policy in my view. And then by the time students are, I don't want to take a strong stance on whether they're five or seven or 10 years is the right number or three years. But after a certain number of years after they finished school then you can separate and other ones who are doing really well and earning a lot of money are not going to want to file for bankruptcy and the ones who are just really struggling because of, bad luck or other circumstances who would benefit from this relief. And now , maybe we wouldn't want to involve the bankruptcy system. Maybe we would want some kind of administrative discharge. Run by the department of education or or the treasury perhaps, and then, because that, there are problems with bankruptcy too, and it might not make sense to go through the court system. But I think that's something that could provide a lot of. The people in a targeted way so that we're not, we, that the people who need relief get it exactly.

[00:31:21] Kriti: I think like one of the biggest takeaways is definitely aligning this student loan, forgiveness policy with the people who need it the most. I have one final question for you, which is what would be your advice to your 17 year old self? And it can be in terms of anything.

[00:31:39] Dr. Yannelis: This is an easy one. What I always tell young people, and, I'm getting older, but I'm not that old by yet is always think about option value. Think about keeping your options open, develop the skillset necessary to do different things and to follow different paths. when I was 17, I was a totally different person from what I was 27. And when my 27 year old self is pretty different from who I am today. I remember when the first iPad came out, I thought this thing was completely absurd and who's going to, who's going to buy this. And they're they're ubiquitous. it's hard to predict industries are going to grow. I mean, something like the COVID pandemic, it's something that was always on radar a pandemic, but not in, I never thought in my life that I've experienced something like this. So you are, you can't predict the future. And it's also hard to predict who you'll be. And. In the future, because you may learn different things. You may want to do different different things. So now when people have all of this, think about keeping about options and that means working hard and developing skills. Can be used in different things and just setting yourself up so that you can quickly acquire skills like they're trying to acquire broad skills, not narrow skills.

[00:33:12] Kriti: I think that's great advice. I definitely learned a lot during this interview, so thank you so much for taking time to do this. And I had a lot of fun talking to you and learning more about the student loan debt crisis and also what it's like, being an economist.

[00:33:29] Dr. Yannelis: Great. Thanks very much it was really a pleasure.

[00:33:32] Kriti: So that's the end of the interview. And I really loved talking with Dr. Yannelis. Today we learned about actual economic terms, such as anti-competitive behavior, which was pretty cool. And we also learned about two more solutions to end the student loan debt crisis, which was income driven repayment and also bankruptcy protection for student loan borrowers. So that's definitely cool. And. How economists and policy makers experiment with these various solutions and see how it plays out in the future.

We also definitely touched on important things in this episode, such as the racial wealth gap. And if you want to learn more about the racial wealth gap, you should listen to my episode that I did two summers ago on it. So we'll have that linked in the episode description. Also go check out some more of Dr. Yannelis, his research. I'll have his information in the episode description. Thanks for listening. And I can't wait to talk to you next time.


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