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An Unintended Consequence of Student Loans

June 24, 2008

My own institution, The University of Virginia (UVA), has undergone a transformation in funding that is not substantially dissimilar from the changes in funding at many public colleges and universities. The proportion of the annual operating budget that is derived from state funds has declined precipitously over the course of the last decade and now stands at only 8 or 9%  of the overall budget. UVA is one of the lucky ones as its ability to attract private dollars far exceeds that of most public institutions, but even from this relatively privileged vantage point the state budge cuts have produced real economic consequences for the School. As public monies have dried up for higher education tuition rates have moved up rapidly. Although many public universities have collected and allocated more private money for student aid, an increasing number of students leave college with a great deal student loan debt. 

What I have just written above is not news. Tamara Draut’s book “Strapped” examines the issue of the rise in student loan debt in detail and a recent  report published by Demos updates and extends that discussion.

But I think there is a side effect of this debt that is important to explore. One common psychological phenomenon that occurs when people make decisions about money is that they tend to compare the amount they are thinking of spending with other dollar figures that seem most salient to them at the time. They form ratios between these dollar figures as a way for them to decide if the amount they are thinking of spending is “a lot” or “a little.” For example, on most days spending $200 for car seat fabric protector might like a very bad idea, but on the day you just spent $25,000 on a car it might seem like a very reasonable idea. It is easy to convince yourself that $200 is “nothing” in the grand scheme of things even though that same amount that would have seemed large a week ago. 

I fear that student loan debt may work in a disturbingly similar way. Once a 22 year-old has $30,000 in debt it is easy to justify other kinds of debt because it “really is not that much money.” An extra $3,000 in credit card debt only moves the needle on overall debt from $30,000 to $33,000.  The large debt overhang also dampens the psychological pain associated with a new car loan. Am I sure this is true? No, I am not. To my knowledge no one has studied this phenomenon. But, my speculation is that it is true for many students and that the changes in funding for higher education have resulted in a self-reinforcing debt cycle among recent college graduates that is much more powerful than a strict economic analysis of student loans suggests.

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