Student loans have been decried by progressives for saddling an entire generation with debt in ways that are exploitative and fail to maximize welfare. They’ve got a point. The level of college debt has contributed to many millennials’ struggle to invest in productive businesses or start families. At the same time, students continue to be incentivized to take out loans they would otherwise not take, and prevents competitive markets from adjusting rates to risk.

breathless defenses of student loan cancellation is regressive,

Understanding the economic concepts of the principal-agent problem and moral hazard may help us find tools to align incentives and bringing debt down to sustainable levels. Under the current system, manyof the student loans being offered are owned by large quasi-governmental agencies such as Sallie Mae, or a third-party loan servicing company. An estimated 92% of student loans are federal, so discussions about student loans should primarily be concerned about the actions of institutions and their functions. Federal student loans are set at interest levels below market rates, are not subject to credit checks, and are not adjusted based on school attended, grades, or major. Guaranteeing loans for universities via government loans to students is a subsidy to universities, and taxpayers foot the bill. These subsidies are not offset by responsibility on behalf of the university; after all, the university does not have skin in the game.

This combination of ingredients creates a situation with considerable moral hazard. First, if student loan limits are raised, ostensibly to increase opportunity for people of lower incomes, colleges absorb much of this money by increasing their rates. Second, since interest rates do not depend on the major of students, low-time-horizon students are more willing to opt for easier yet ultimately lower paying majors. One way to determine whether this is true is to look at student activities and time taken to graduate. The Heritage Foundation examined how college students use their time and found that students spend only a few hours per day on studies. Similarly, students are taking longer to graduate, suggesting that the easy money of student loans is something students are receptive to. This third-party payment system creates moral hazard and discourages an efficient use of resources. For instance, if the money given to value-neutral majors was instead allocated to business capital, our society would likely grow more than under the current system.

Making college “free” would make this even worse. Everyone getting more educated sounds desirable until you realize that this further creates credential creep, disproportionately affecting those with less time and financial stability to devote to education. In this sense, education becomes more of an arms race that we all pay for, with a decreasing relationship to efficient provision of the goods.

Addressing the principal-agent problem could repair this system.  Ideally, there should be incentive for universities to care more about student loans. Shifting the damages of nonpayment from taxpayers to colleges and universities would do just that. Making colleges liable for failed student loans encourages schools to accept more highly paying majors and to offer better career services. Schools have more information about students than loan agencies, and shifting the responsibility and cost towards them is one step towards encouraging more economically rewarding majors. Furthermore, this would give them a stronger interest in making sure that students are diligent and hardworking.

Colleges already have intimate knowledge of student’s financial situation, grades, majors, and other important aspects. Having them service or be liable for student loans provides a stronger financial incentive than alumni donations. Doing so would solve the principal-agent problem and result in a more efficient use of resources.

Isadore Johnson is a campus free speech advocate, an economics and philosophy student, and regional coordinator for Students for Liberty.