Audits and Fraud Insurance: Optimizing Borrower Defense to Repayment

• In Event: Issues in Higher Education

Abstract

Should a social planner provide insurance against fraud in a market where private insurance is unlikely and the planner audits potentially fraudulent firms? I investigate this question in the context of the U.S. borrower defense to repayment regulation, which allows students who have been defrauded by their colleges to have their loans discharged in full or in part. In a model of student choices across universities with endogenous fraud rates, I demonstrate that moral hazard induces a tradeoff between the welfare benefits of insurance and the costs of riskier school choices by students. If moral hazard is low, fraud insurance is beneficial for welfare. Using variation in insurance levels across U.S. presidential administrations, I present evidence that moral hazard in this context is minimal.

Author

• Jo Ellery, joellery@fas.harvard.edu