In 1987, then-Secretary of Education William Bennett argued that "... increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase." This statement came to be known as the "Bennett Hypothesis." In July 2015 (revised in March 2016), a Staff Report was published by the Federal Reserve Bank of New York, the conclusions of which indicate that institutions more exposed to increases in student loan program maximums tend to respond with disproportionate raises in tuition prices:
In this paper, we use a Bartik-like approach to identify the effect of increased loan supply on tuition following large policy changes in federal aid program maximums available to undergraduate students that occurred between 2008 and 2010. We construct institution-specific changes in program maximums as the interaction of an institution exposure to the maximums in each aid program (the fraction of qualifying students) and the legislated program maximums. We find that institutions that were most exposed to these maximums ahead of the policy changes experienced disproportionate tuition increases around these changes, with effects of changes in institution-specific program maximums of Pell Grant, subsidized loan, and unsubsidized loan of about 40, 60, and 15 cents on the dollar, respectively.
The federal student loan program has been criticized for not adjusting interest rates according to the riskiness of factors that are under students' control, such as choice of academic major. Critics have contended that this lack of risk-based pricing contributes to inefficiency and misallocation of resources in higher education, and lower productivity in the labor market. However, recent research indicates that while high levels of student loan debt, coupled with high default rates, present a number of challenges for individual student loan borrowers and for the federal government (which must cover the defaults through taxes), they do not necessarily place a substantial burden on society at large.
After the passage of the bankruptcy reform bill of 2005, both federal and private student loans are not discharged during bankruptcy (prior to the passage of this bill, only federal student loans were unable to be discharged). This provided a credit risk free loan for the lender, averaging 7 percent a year. In January 2013, the "Fairness for Struggling Students Act" was unveiled. This bill, if passed, would once again allow private student loans to be discharged in bankruptcy. The bill was referred to the Senate Judiciary Committee where it died.
Some critics of financial aid claim that, because schools are assured of receiving their fees no matter what happens to their students, they have felt free to raise their fees to very high levels, to accept students of inadequate academic ability, and to produce too many graduates in some fields of study. About one-third of students, whether or not they graduate or find jobs that match their credentials, are financially burdened for much of their lives by their debt obligations, instead of being economically productive citizens. When those former students default on their obligations, the burdens are shifted to taxpayers. Lastly, the proportion of graduates who come from poor backgrounds has actually declined since 1970.
In 2007, the Attorney General of New York State, Andrew Cuomo, led an investigation into lending practices and anti-competitive relationships between student lenders and universities. Specifically, many universities steered student borrowers to "preferred lenders" that charged higher interest rates. Some of these "preferred lenders" allegedly rewarded university financial aid staff with kick backs. This led to changes in lending policy at many major American universities. Many universities have also rebated millions of dollars in fees back to affected borrowers.
The biggest lenders, Sallie Mae and Nelnet, are criticized by borrowers. They frequently find themselves embroiled in lawsuits, the most serious of which was filed in 2007. The False Claims Suit was filed on behalf of the federal government by former Department of Education researcher, Dr. Jon Oberg, against Sallie Mae, Nelnet, and other lenders. Oberg argued that the lenders overcharged the U.S. Government and defrauded taxpayers of over $22 million. In August 2010, Nelnet settled the lawsuit and paid $55 million.
In an effort to improve the student loan market, startups like LendKey, SoFi (Social Finance, Inc.), Konsolidate and CommonBond were founded to offer student loans and refinance loans at lower rates than traditional repayment systems using an alumni-funded model.
The New York Times published an editorial in 2011 in support of allowing private loans to again be discharged during bankruptcy.
In June 2010, the amount of student loan debt held by Americans exceeded the amount of credit card debt held by Americans. At that time, student loan debt totaled at least $830 billion, of which approximately 80% was federal student loan debt and 20% was private student loan debt. By the fourth quarter of 2015, total outstanding student loans owned and securitized had risen to, and surpassed, $1.3 trillion. This rising student debt is contributing to the expanding wealth gap.
With each passing year, student debt continues to rise. Nearly two-thirds of undergraduates are in debt. By graduation, their student loan debt averages around $26,600. One percent of graduates leave college with $100,000 or more of student loan debt. In 2013, the federal debt had grown to $16.7 trillion. Six percent of that debt comes directly from student loans making student loans only second to mortgages in consumer debt. The Consumer Financial Protection Bureau reported that as of May 2013, federal student loan debt had reached $1 trillion bringing the total number for outstanding student loan debt to $1.2 trillion. However, this amount does not include what students take from savings accounts, borrow from parents, or charge to their credit cards in order to pay for their education. In actuality, the burden of student debt is much greater than these numbers indicate.