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How a New Generation Can Avoid Getting Bankrupted by Student Loan Payments

The insanity of the private loan market is part of the excesses of the entire credit industry in the past few years. Understanding one means understanding the other.

On March 30, President Obama signed a historic student loan reform first attempted by President Clinton back in 1993. By cutting banks out of the lending program, he saved a projected $40 billion in subsidies that will be redirected to the Pell Grant, making college more affordable for millions of students. The bill also expands access to Income-Contingent Repayment, which allows graduates to limit their student loan payments to 10 percent of income, a standard rule in other countries.

The student loan beast is bloodied, certainly. But it’s not yet on its knees. More changes to the federal student-aid system are required to relieve thousands of people already saddled with unaffordable debt, to calm the growth of private loans, and to tame tuition increases.

The liftoff of college tuition into the stratosphere in the past thirty years, and especially the past decade, is concurrent with, first, the rise of student loans, and later the secondary market for loans that saw them repackaged into attractive, government-backed securities for investors. Student-loan volume more than doubled in the past ten years, from $44.6 billion to $94.5 billion annually. Student loans now make up the majority of all tuition aid. More than two-thirds of undergraduates take out student loans, and the ability to finance tuition through loans and home-equity lines of credit has made families less sensitive to tuition increases -- a vicious cycle that leads from rising tuition to increased debt loads back to rising tuition, and so on.

Just as the securitized mortgage market contributed to a historic run-up in the cost of housing over the past decade, the securitized student-loan market fed increases in tuition. Edmund Andrews wrote a riveting story in the spring of 2009 for the New York Times Magazine about the junk mortgage that nearly ruined him. He quoted his lender as saying “I am here to sell money.” When you have an army of money salesmen deployed to a particular economic sector, the result, as we have seen, is likely to be a quick run-up in prices.

Like any industry that exists by federal fiat, student lenders became a potent political force that lobbed great gobs of money onto the plates of influential lawmakers. Sallie Mae and another student lender, Nellie Mae, were the two largest contributors to the 2004 campaign of former House majority leader John Boehner. Their special interest was greater student indebtedness. Their nefarious deeds supplied me with plenty of red meat as a reporter between 2004 and 2007. The most important favor the lenders won, in 1998, was a broad exemption from bankruptcy protection, which traps students in an unrelenting obligation if they default.

College financial aid offices, the most important place for students to get help figuring out how to pay for college, were also the lenders’ most important marketing channels. Lenders were implicated in a major crackdown on for-profit colleges in the early 1990s. Student-loan defaults peaked in 1992 at 22 percent, and proprietary schools accounted for nearly half of all defaulters, although they were the source of just a fifth of all loans. Undaunted, lenders colluded with more reputable colleges as well. A sweeping nationwide investigation by New York State attorney general Andrew Cuomo found in 2007 and 2008 that lenders offered college financial aid offices special perks and kickbacks in exchange for marketing their loans more aggressively to students through “preferred lender lists.”

Not content with the profit margins offered by federally guaranteed student loans, lenders introduced a new product: the “private” or “alternative” student loan. These were not too different from putting tuition on your credit card: they carried rates as high as 18 percent, much higher than a federal student loan, and they didn’t have grace periods or other borrower-friendly policies. What’s worse, private student loans, just like federal student loans, came under bankruptcy exemption in 2005, becoming $50,000 unsecured lines of credit that you can never, ever walk away from.

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