The Ethics & Immorality of the Federal Student Loan System

Is it possible for something to be ethical but immoral at the same time?

Like most people, my students—to whom I ask this question every semester—don’t believe so, because they use the words interchangeably. That is, until my query inspires them to think about it on a deeper level.

An action is ethical if it is both legally permissible and a generally accepted practice. That same action is moral as long as it’s consistent with one’s personal set of values.

The individual meanings of the two words are often conflated because we’re inclined to believe that the two philosophical concepts are compatible: if it’s not against the law and everyone is doing it, it must be OK.

Not necessarily, as the federal student loan program illustrates.

Consider the credit underwriting process—or, rather, the absence of one. Although lending without regard for a borrower’s financial ability to repay his or her loan may be a legal and generally accepted practice (because that’s the way the student loan program was established long ago, and certain other financial products are similarly structured as well), one may also argue that it’s immoral too because that disregard has the potential to entrap as easily as it entices.

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The program’s fundamental pricing methodology is equally at odds with itself.

When Congress passed the Bipartisan Student Loan Certainty Act of 2013, it pegged a hierarchy of interest rate markups for the various student loan programs (e.g., Federal Direct and PLUS) to a particular financial instrument (10-year Treasury Notes, in this instance). Yet the government funds its program with much lower-cost, shorter-term Treasury Notes—perhaps as short as one and three months in duration—and pockets the difference. And Congress widened that disparity by mandating an added hierarchy of upfront fees, whose values are a multiple of the cost of originating and administering these loans.

Legal? Sure. After all, the bill was passed by overwhelming bipartisan majority and signed into law by the President. A generally accepted practice? Yup. One needn’t look any further than your local bank for that. But is it moral?

Only if you’re OK with turning a profit on the backs of your own children.

Then there is the matter of loan structure. The various government repayment plans all span 10 years. Although that too is legally permissible and a generally accepted practice among higher-education lenders, an argument could be made that the standard term is immoral because it disregards a borrower’s financial capacity to meet his or her obligation in the time allotted.

In fact, after taking into account the current average size of these debts, the plain truth is that more borrowers would be helped if the repayment durations on all outstanding loans were doubled (to a maximum 20-year term) than if the interest rates were reduced—even to 0%.

Last, there is the inability to discharge these loans in bankruptcy court. In the mid-1970s, Congress exempted federal student loans from this consumer protection to safeguard taxpayers from egregious abuses that were making news at that time—reports that were later discredited. In 2005, the same consideration was extended to private student lenders, which lobbied for parity with the government program.

Although a borrower’s inability to evade this category of debt (except under extreme circumstances) is now both legal and generally accepted, if the basis for the enabling legislation is flawed and if a borrower is consequentially prevented from seeking the same protection from the courts as he may for any other consumer loan (which puts him at a serious disadvantage with his creditors), it’s hard not to conclude that the inability to discharge student loan debts in bankruptcy is immoral.

The federal loan program presents a classic example of how morality is sidelined when the two concepts collide and money is at stake.

Consider how the profits that are generated by the various government loan programs flow into the general fund: The surplus dollars end up offsetting an equal portion of the national debt.

Think of how untethered borrowing limits facilitate the continued expansion of a higher education industry that many believe to be overbuilt. And how the intensive administrative work that is a direct result of the program’s unreasonably short repayment term and indefensibly high pricing scheme support a multi-billion dollar, private sector loan-servicing industry.

There’s not a lot of talk about much of this. Nor is there about how the federal loan program’s deficiencies have set up debtors to be victimized by lending institutions in other sectors.

Take, for instance, those who are struggling to make ends meet—which constitutes nearly half of all higher-education borrowers whose loans are either delinquent, in forbearance or are otherwise being accommodated by some sort of relief arrangement. They are increasingly turning to online lending solutions to tide them over until the next paycheck. But because of the exceedingly short duration of their payday, account-advance or bill-pay loan, borrowers with chronic cash flow problems are often compelled by circumstance to rollover that same high-priced debt over and over again.

The proliferation of these so-called alternative financial products represents yet another example of something that is legally permissible, generally accepted and, at the same time, disturbingly immoral.

We often hear those whose professional or personal actions end up challenged in the court of public opinion attempt to defend the decisions they’ve made by pleading, “I didn’t do anything illegal!”

The follow up question to that should be, “But was it the right thing to do?”

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.