How a New Generation Can Avoid Getting Bankrupted by Student Loan Payments
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.
In the days of loose and easy credit, private student loans were much easier to get than federal student loans because students didn’t have to fill out the long, confusing FAFSA form and share personal information. Over the past decade, student loans soared from 7 percent to a quarter of all student loans. While federal student-loan volume was increasing at 7 percent per year, private student-loan volume was increasing at 27 percent each year!
Most students who take out private loans have better options to pay for college. Private student loans are marketed directly to students, and disproportionately used by those at for-profit community or technical schools -- students who probably would be eligible for income-based grants and subsidized federal student loans if they could get through all the paperwork. In the fall of 2006, Barnard College tried a simple experiment. For any applicant who wanted to take out private loans, they required her and her parents to have a single conversation with a financial aid officer. That one change led to a drastic 73 percent drop in private-loan volume. Ninety-eight students took out a total of $1,559,385 in private loans in 2005–6, while thirty-nine students took out just $414,889 in private loans in 2006–7. There was only a moderate increase in parents borrowing PLUS loans to make up for it; most parents probably also dug deeper into their savings or resolved to tighten expenses instead, collectively saving over a million dollars in debt and what would have been nearly another million dollars in interest at typical rates over the life of the loans. This is at a prestigious private university where parents are probably educated and relatively financially savvy, but they still needed the disadvantages of private loans to be spelled out to them.
The insanity of the private loan market is part of the excesses of the entire credit industry in the past few years. Think about it: Large banks falling all over themselves to offer $50,000 unsecured lines of credit to seventeen-year-olds who merely enroll in any accredited college, anywhere. Student loans formed their own credit bubble that looks something like a smaller version of the mortgage bubble. In the 2008 credit crunch, nearly two hundred lenders pulled out of the federal student-loan program, often abandoning the very community college students who have the greatest need for funding. The Treasury Department made a $260-billion line of credit available to prevent greater disruption in funds to students.
A March 2008 report by the National Consumer Law Center found ten significant parallels between the growth of the private loan market and the mortgage crisis. “The question is whether a similar crisis [to the mortgage crisis] is on the horizon for student loan borrowers.”
The student-loan bubble probably doesn’t have the potential to create the kind of global meltdown that the mortgage bubble did, because student-loan backed securities weren’t as widely traded throughout the global economy, and because the overall market is smaller. But for a decade or more to come, outsized student-loan burdens will continue to impair millions of individuals’ ability to establish strong economic futures, and to do their part to pull the economy into recovery. The effects of inflated tuition, just like the effects of inflated house prices, will be felt for decades as well. And now that lenders are forced out of the federal student loan program, they may redouble their efforts to make money from the private student loan market.
Today about $598 billion of federal education loans and about $132 billion of private student loans are outstanding, for a total of roughly $730 billion. In the most recent economic downturn, more borrowers are falling behind on their loan payments. The percentage of school leavers who defaulted in the first year their loans were due edged up from 5.2 percent to 6.7 percent in the 2008 fiscal year. Several years out of school the default rate gets worse.
Without bankruptcy as a last resort, those with unmanageable student-loan debt have few options. Alan Collinge of Student Loan Justice http://studentloanjustice.org/ pointed me to a Department of Education audit published in 2003, well before the financial crisis. For loans taken out in 2000, the Department of Education estimated a 19 percent default rate for all four-year students, a 30 percent rate for all two-year students, and a shocking 44 percent rate for for-profit college students. Millions of student-loan borrowers in default means millions of people with ruined credit, difficulty saving, and little forward economic momentum.
The new reforms are important. But they don’t address the bankruptcy exclusion, nor the excesses of the private loan market, not to mention the underlying dynamics of bureaucratic inertia that keep costs headed up, up, up. Federal student-loan borrowing jumped by an unexpected and dramatic 25 percent in the 2008–9 academic year as other sources of funding, like parents’ home equity loans, dried up. As tuition and fees keep rising, public university students can typically face gaps of $10,000 a year between what their families can afford and their cost of attending school. There has been some tightening of credit standards, and some private lenders have stopped lending, but students are still looking to borrow. Without addressing college affordability issues directly, we will just be putting off the problem for another generation.