I hear that argument all of the time, but in reality the colleges aren't the ones giving out loans. What will probably happen is that loans will start being more difficult to get, which in turn will make getting into college even more difficult for people who already struggle to pay for it.
The argument is that the colleges are basically building their business model around those loans, because government regulations guarantee easy access to those loans, with no collateral and no barriers on obtaining one (http://www.collegescholarships.org/loans/guaranteed.htm). This means that anyone can get it, and that in turn makes it viable for college to demand that everyone does (by charging exorbitant amount of money).
From this it follows that if government gets out of the business of such loans, then a lot fewer people would be able to get them - which would mean that colleges would suddenly get a lot less applicants, sending their revenues plummeting. Which, in turn, would force them to lower the prices.
It's doubtful that it would bring them to the point where a loan wouldn't be necessary for most students, and it would still exclude quite a few who cannot afford such a loan, or wouldn't qualify for it. But one could argue that it's better to not be able to take such a loan in the first place, then to be able to take it only to be saddled with a mountain of debt with no hope of repaying it, and no ability to discharge it in bankruptcy.
IMO, if we want universal high education, the government needs to be in the game, but instead of providing traditional loans, or underwriting such from private parties, we should have a system whereby a loan is unconditionally provided in exchange for a share of future income, with a progressive bracket system (i.e. you don't pay anything below $X, including if you aren't working; and you pay a percentage off anything earned above $X). Percentage would be variable depending on how much income, on average, is expected to be earned by holder of a given degree, based on the current job market - this is to avoid subsidizing too many "worthless" degrees that never pay anything back.
Also, I would expect such system to emphasize trade schools over "real" college - and that is a good thing.
> Let people default on their student debt with 5 years of bad credit, and colleges will fix themselves.
How can the colleges fix themselves? They are not the one's giving out the loans. Maybe that's how it should be... It forces the colleges to have a vested interest in their students' future.
Sure, they're not the ones giving out loans. They're just the ones who artificially and astronomically inflated tuition to absorb all the available loan increases.
That is what needs to be corrected, by making the high loan-driven tuition levels no longer a reasonable offer in the marketplace, to force the prices back down to more service-oriented fees instead of a profit center.
Colleges will lower costs or give more scholarships when lenders can't give out arbitrary sums to anyone which must be paid back. That is, if colleges want the same attendance. It could be that they keep the same costs and only a few students can pay. That opens a lot of business potential for everyone else though.
The government interventino has been the problem, as you just exposed.
Let people default on their student debt with 5 years of bad credit, and colleges will fix themselves.