The Irascible ProfessorSM
by Dr. Mark H. Shapiro
Commentary of the Day - May 2, 2012: What Congress Can do to Fix the Student Loan Crisis. Guest commentary by Alan Collinge.
At long last, the nation is beginning to address the issue of bankruptcy for those who are being crushed by student loan debt. The national dialogue has been noisy and confused on this point. To the astonishment of many, the banks have been successful in keeping in force laws preventing student loan debt from being discharged by bankruptcy for years. The fact that citizens are being forced to stand up and demand the right to do something as unpleasant, socially stigmatizing, and humiliating as filing for bankruptcy on this or any type of debt is astonishing in itself, if one thinks about it, but this is the unfortunate state of things. The cracks have begun to appear in the student loan system as college costs continue to soar, the total amount of student loan debt continues to grow to dangerous levels, default rates grow, and protests across the country become impossible to ignore. So one way or another, this problem will have to be solved soon.
Here's the big picture: The lending system supporting our higher education system is structurally predatory. It lacks fundamental, free-market consumer protections like bankruptcy, statutes of limitations, refinancing rights; and, at the same time the lenders have unprecedented collection powers that would make in the words of Elizabeth Warren "mobsters envious," we have a student loan system where the big lenders make significantly more money on defaulted loans than healthy loans (and what they make on healthy loans is not exactly chump change). And to make matters worse the guarantors (the government entities that are supposed to police the lenders) make, on average, 60% of their revenues from penalties and fees attached to defaulted loans. For example, the Department of Education (according to the President's Budget), gets back $1.22 for every dollar they pay out in default claims for Federal Family Education Loan Program (FFELP) loans. Even subtracting generous collection and other costs from this profit still leave them clearly in the black. If it was revealed that JP Morgan Chase, Fannie Mae, and even The Housing Department were making more money on defaulted sub-prime home mortgages than those which remained in good stead, bankers and politicians alike would be dragged bodily from their homes and thrashed, or something near to it. Yet, this is the reality for federal student loans.
In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act was passed. It included a change which removed bankruptcy protections from private student loans. The sheer brazenness of this action astounded the higher education community (given that these loans were essentially no different from credit cards, or any other unsecured loan). It was generally agreed that this legislation was more of a testament to the lobbying power of the lending industry than a solution to any real problem, and the general consensus was that it would be repealed quickly. The only argument cited by the lending industry in support of the measure was a promise that they would be able to lend to less creditworthy borrowers with bankruptcy protections gone, which was a questionable promise. It was generally thought that the Democrats would quickly undo what the republicans did when they won majorities in both the House and Senate in 2006, but enough "Blue Dog Democrats" sided with the banks and the Republicans to kill the reform legislation. Shame.
Financial motivation explains a wide and deep array of systemic defects, conflicts, and corruption in the system that involve the lenders, schools, and most importantly, the Department of Education. For example, Sallie Mae and others have been found to have defaulted student loans en masse - without even attempting to contact the borrowers! Another example: colleges routinely mislead students prior to taking out loans about their true default rates -- they instead doggedly promoted their reasonable sounding "cohort" default rates; and, the Department of Education never does anything to correct this false impression. (The true default rate across all schools is roughly 1 in 3, and has been for years; whereas, the cohort default rate typically lies between 4%-8%). Similarly, students usually aren't made aware that all the consumer protections mentioned above -- and more -- don't exist for student loans. These are only a few of many significant examples of false information, omissions, and outright deceptive behaviors that one could point to in this discussion.
So the question now is how to "fix what is broken," to borrow a phrase from President Obama, Secretary Geithner, and others. Gainful employment rules, dickering around with the Pell Grant, and similar activities do nothing here. Neither do the various repayment programs that are being marketed by the higher education crowd as viable substitutes for the consumer protections that were stripped from the system. Some young academics, like Jonathan Glater (UC Irvine) and G. Marcus Cole (Stanford), in fact, are pointing to these untested, unproven programs as a basis for dramatically increasing the federal loan limits, while retaining rules that prevent bankruptcy protection for student loan debtors. But, in my view, these are extremely, weak arguments that in the end virtually guarantee the national rejection of the student lending system. I've seen collection industry representatives almost drool at the prospect of a mass default, but I think the risk of social unrest that could follow vastly outweighs any profits the collection industry might make from mass default. This is not the direction we want to go, as we learned from the collapse of the mortgage market a few years ago.
Although there have been proposals such as the Student Loan Forgiveness Act of 2012 that would limit the maximum annual payment requirement for student loans to 10% of disposable income, and would forgive balances remaining after 10 years of payments at this level, I think that with nearly a trillion dollars in outstanding student debt it's too late for such tinkering around the edges of the problem. Thankfully a few smart people like Mark Kantrowitz and Anya Kamenetz have come forward to call for the return of the previous bankruptcy protections to all student loans, and some high-caliber columnists like David Brooks have done the same. These calls have, at long last, moved the debate forward.
Don't be distracted by the sophisticated, confusing rhetoric being forced into this debate by those who would maintain the status quo no matter what the cost, or those who would end public support for higher education altogether. Neither extreme has the interests of the citizens at heart. Remember only that after all, this is not a difficult problem. Congress created it by removing fundamental, free-market consumer protections from student loans. Congress can and must fix it by essentially undoing what they did. Quite simply, it begins by returning, at a minimum, the bankruptcy protections that were removed without rational basis (when the bankruptcy option was available for student loans as all other loans, far less than 1% of federally-guaranteed loans were discharged this way). With this fundamental, free market mechanism returned, the Department of Education will have a vested interest in compelling the schools to provide a high quality product at a low cost, and at reasonable debt levels.
© 2012, Alan Collinge.
Alan Collinge is the founder of StudentLoanJustice.org - he published The Student Loan Scam in 2009.
The Irascible Professor comments: Alan makes some excellent points. To be sure, the problem is enormous. The current student debt load of nearly a trillion dollars is a ticking time-bomb that threatens the economy in much the same way that the sub-prime mortgage debt crisis did a few years ago.
Prior to 2005 student loan debt could be discharged via bankruptcy after seven years. Returning to that standard would solve the problem for individual borrowers who are drowning in debt caused more by late fees and high interest rates on unpaid debt than on the original size of the loans. The flip side of the coin is that this could drive up interest rates for the private student loan market, which no longer is federally guaranteed. The IP thinks that bankruptcy should be a last resort but should be available after a reasonable period of time from graduation. But, there also should be other options available that would force lenders to negotiate repayment plans that allow borrowers -- including parents who are cosigners -- to pay a reasonable percentage of disposable income without incurring penalties and additional interest charges to allow for changed circumstances following graduation such as illness, underemployment, or unemployment.
Likewise, partial loan forgiveness should be available as an incentive to encourage graduates to enter less lucrative but critically-needed fields such as teaching, nursing, and primary medical care.
In addition, the lending rules should be strengthened for private, for-profit institutions. Many of these outfits have scammed students into huge debt with the promise of high-paying jobs that don't really exist. Lenders have failed in their responsibility to reasonably ascertain the likelihood that their loans are really increasing the human capital of the borrower in these situations, and they should be held accountable with the threat of bankruptcy without a waiting period for students who are unable to find the jobs promised.
Finally, some real attention needs to be paid to controlling college and university costs. Hyper-inflation in this area is driving the student loan crisis.
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