Monday, May 12, 2014

An Argument to Restore Consumer Protections to Federally Insured Student Loans & Put the Government Back into Direct Supervision of the Student Loan Business--What say you?

[Excerpted from]- 

Congress has removed bankruptcy protections, refinancing rights, statutes of limitations, truth in lending requirements, fair debt collection practice requirements (for state agencies) and  removed state usury laws from applicability to federally guaranteed student loans. Is the risk of higher default the problem? Even if there was a higher risk with regular consumer protection laws in place, is that bad? Why would we want to discriminate against our best and brightest?
Congress also gave unprecedented powers of collection to the industry, including wage, tax return, Social Security, and Disability income garnishment, suspension of state issued professional licenses, termination from public employment, and other unprecedented collection tools that are used against borrowers for the purpose of collecting defaulted student loan debt.  Punitive measures that make no sense and work against the very purpose of higher education it seems, even were it not for a poor job market created by sagging hiring quotas and flooding many professional manpower pools with liberally issued green cards.?
Concurrently, Congress established a fee system for defaulted loans that allows the holders of defaulted loans to keep 20% of all payments from borrowers before any portion of the payment is applied to principal and interest on the loan--in some economic models that is called skimming off the top.

In the absence of fundamental consumer protections the borrower's only available recourse is to submit to a hugely expensive "loan rehabilitation" process whereby they are forced to make extended payments (which are almost never applied to the principal or interest on the loan), and then sign for a new loan to which additional fees are attached.  This effectively obligates the borrower to a much larger debt than when the loan defaulted, often double, triple, or even more than the original loan amount, which seems insane...punishing our young men and women for getting an education because they are told by the college & our government that the job market will be there for them. 

This fee system and associated rehabilitation schemes have provided a massive revenue stream for a nationwide network of guarantors, servicers, and collection companies who have greatly enriched themselves at the expense of borrowers often creating unmanageable debt that debilitates, marginalizes, and ultimately relegates them to a lifetime of financial servitude and despondency in many cases, so it seems economic fuedalism is the grand plan of the banks and our government?

Analysis of IRS 990 filings of federal student loan guarantors proves without doubt that the income derived through this fee system is vast, as evidenced by not only the income of the guaranty agencies, but also by the salaries, bonuses, and perks taken by the executives who run them. This fee system is, indeed, the lifeblood of these organizations, who derive about 60% (on average) of their income through this legalized wealth extraction mechanism. Clearly, it is in the guarantors financial interest that students default on their loans. In fact, were there no student loan defaults, the guarantors would barely exist, so its' like the government has distorted the student loan law to create another type of long term bank bailout program?

Additionally, it is often in the financial interest of the lenders that students default. Large lenders derive income from not only lending and servicing operations, but also from collection assets (and even guarantor assets in the case of Sallie Mae) owned or controlled by the company. This leads to the common situation where a loan is defaulted by a lender, becomes vastly inflated with unverified and unchecked collection costs, and then becomes a revenue stream for the guarantor and collection company...all potentially owned (or controlled) by the very same lender! A defaulted loan clearly can produce far more revenue for the system. It is obvious that this structure gives the lender/guarantor/ collector entities a perverse incentive to default loans rather than providing customer service aimed at helping the borrower avoid default.

Indeed, Sallie Mae's own annual reports provide compelling evidence of dramatic profiteering from defaulted loans: In the 2003 annual report, The Sallie Mae CEO brags to shareholders in the opening remarks that the company's record earnings that year were attributable to collections on defaulted loans. The company's "fee income" increased by 228% between 2000-2005, while their managed loan portfolio grew by only 87% during the same time period.

It is a matter of record that lenders actually defaulted student loans without even attempting to collect on the debt! In 2000, Sallie Mae paid $3.4 million in fines as a result of the U.S. Attorney's office discovering that the company was invoicing for defaulted loans where the borrower was never contacted. Rather, records were fabricated to indicate that the borrower had been contacted. Similar cases were settled with Corus bank and Cybernetic Systems.

There is also some evidence that suggest this tendency to default borrowers is by design rather than a mere result of circumstance.  In 2007, an employee of the Kentucky Higher Education Assistance Authority, KHEAA, contacted StudentLoanJustice.Org by email, and submitted that the agency managers had purposely marketed loans to poor, disadvantaged communities in the expectation that these citizens would default on their loans, thus be "on the hook" for the fees and penalties that would result-extractable through garnishment of the income sources mentioned previously. This  raises serious concerns, as it clearly implicates KHEAA in engaging in predatory lending.  The text of these communications was forwarded to the Department of Education, and it is unknown what, if anything, resulted).

Obviously, collection companies prefer that loans default.  Guarantors clearly share this preference.  That lenders and collection companies also share this financial motivation is sufficient, to characterize the lending system as predatory, since the lending system clearly has both motive and means to act in such a way as to encourage default, rather than being motivated to act in a way that avoids default.  

An unbiased observer should rightly object here, and point out that there is governmental oversight that should prevent this sort of activity.  After all, at the end of the day, these defaults must certainly be a drain on the taxpayer...right?  

Wrong.  It was reported in January 2004 by John Hechinger (WSJ) that for every dollar paid out in default claims, the Department of Education would recover every dollar in principal, plus almost 20% in interest and fees.  Further, supplemental materials in the president's 2010 budget show a recovery rate for defaulted FFELP loans of about 122 %.  This is the amount recovered compared to the amount of the loan at the time of default.
 Compare this recovery rate to that for defaulted credit cards, which is usually about 25 cents on the dollar, and one can see that defaulted loans are clearly not costing the Department of Education money.  In fact, simple, comparative analysis shows clearly that the reverse is indeed the case.  In other words: The Department of Education is making more money on defaulted loans than loans which remain in good stead.

Therefore, all entities involved: The lenders, the guarantors, the collection companies, and even the Department of Education  and its agents have a financial incentive for student loans to default...and this all is a direct result of the lack of consumer protections and the draconian collection powers that exists uniquely for federal student loans as described above.

Another reasonable objection, here :  The student loan default rate, as advertised by the schools, lenders, and even the Department of Education  are not inordinately high...they have stayed well within reasonable levels, at between  4% and there must be something keeping the system well behaved, right?

WRONG. Despite repeated claims by the Department of Education, the student lending industry (andtheir army of lobbyists), and the universities that default rates are relatively low (ie 4%-7%), is a default rate that almost has no equal.  A 2003 IG report estimated that between 19% and 31% of 1st and 2nd year students would be put into default during the life of their loans. For community colleges, the range was between 30% and 42%, and for for-profit schools, was between 38% and 51% .  Simple averaging gives a default rate of more than 1-in-three.  Completely ignoring for-profit schools gives a 4-year university/ community college average of about 30%...These are perhaps high estimates, given the IG's predilection towards conservative estimates for budgeting purposes, but if even close (ie within 10 percent), paint a far different picture than what has been portrayed.

More recently, the Chronicle of Higher Education reported that of borrowers leaving school in 1995, fully 20% had defaulted on their loans as of 2010.  This guarantees a "lifetime" (i.e. 20 year) default rate of something higher than that, and this is for borrowers who left school with a far smaller debt load, adjusting for inflation, and also describes borrowers entering the workforce during a far better economy.  Therefore, to say that the true, lifetime default rate is currently 25% is almost certainly a significant understatement.

In fact, given these data, one could argue with justification that perhaps 1 In 3 undergraduate student loan borrowers leaving school in recent years will default, or have defaulted on their loans. This is an extremely high rate that the Department of Education, lenders, and universities are loathe to acknowledge.  By way of comparison, this default rate is higher, likely, than the subprime home mortgage default rate, and has been for years.

That the Department of Education, the Schools, and the lenders all failed to inform the general public about the actual default rate for federal student loans is troubling, and provides further evidence that it was not in any of these entities interests to disclose this information, although at least for the Department of Education, there is a clear public benefit mission that should compel the loud, and unambiguous disclosure of this information.  That the public was not warned of the true likelihood of default for these loans cries out for explanation.  In the absence of any explanation from the Department for this omission, and in view of the financial return on these loans,  one can make a compelling case that this information was concealed from the public due to Institutional concerns that trumped the public interest...and one can only imagine the harm this caused unwitting borrowers and their families who made very significant borrowing decisions unaware of the true risks they were entering into.

How the lack of consumer protections causes inflation

There are too many bad outcomes that result from the Department of Education having their financial motivations misdirected to describe here, but one very significant result is that during the legislative process, when the schools, lenders, and their lobbyists pressure Congress to raise the allowable loan limits, the Department of Education is the only entity able, and obligated to act in the interest of the students by voicing objection to raising these limits based on defaults, indebtedness, and other feedback from borrowers that only they have access to, and mastery of.  Instead of voicing concern, much less objection to such proposals,however,  the Department of Education instead remains largely silent, despite their knowledge about the true default rates, etc.  This, again, is a key failure in oversight that effectively causes Congress to make decisions without the interests of the borrowers being represented (Of course the lenders and schools claim to have the interests of the students at heart, but their obvious financial motivations obviously discount their credibility on this claim).   Therefore, Congress continues to rubberstamp these legislative efforts, and the schools quickly raise their tuitions to reach the new lending ceilings.

If the Department of Education were seeing a material, financial loss with loan defaults, they likely would be far more assertive about the reasons NOT to raise the loan limits...and this would provide a critical check on the process.  But they have been largely absent from these debates, and their  misaligned interest is certainly the reason why.

So it must be agreed that lack of Department oversight contributes directly to Congress' repeated decisions to raise the loan limits, and we've already established the link between this poor oversight, and the removal of consumer protections. So undoubtedley, the removal of standard consumer protections has effectively allowed the schools and lenders to have their way with Congress on this issue.

Critics could argue that the established student advocacy groups should have stepped in to fill this role...and this is obviously a true statement...but the advocates will argue (disingenously, but nonetheless) that they did not know that defaults were as high as they were, therefore any objections from them (assuming they did object) were not strong.   And in fact the advocates have, as a matter of record, supported raises in the loan limits, repeatedly, citing the spectre of predatory, private loans as a reason.

Of course, the loud debate on the cost issue results in fingerpointing in all directions..."like a scarecrow in the wind" between lenders, schools, the Department of Education, the student advocates, and Congress.  But of these five entities, four were behaving as expected (i,e, schools pushing for raising the limits, advocates wringing their hands in the absence of defensible proof that things were going awry, lenders playing their part as the selfish, amoral entities they are understood to be, Congress debating what they are told, and ultimately voting based upon this debate).

The Department of Education, however, failed to fullfil its role, and did not disclose to the group the true magnitude of the default problem, as one would expect it to both during the legislative process and to the public generally.  Therefore they are clearly the party whose behavior can ultimately be questioned with strong justification.  Of course citizens have every right to be seethingly resentful and angered by the collective failure to point out that the students were being saddled with outrageous increases in student loan debt, but strictly speaking, the Department's failure is the only one with zero defense.  

This is a critical, unambiguous link that is never pointed out, but which is key- probablythe  key-  to explaining the rampant inflation we have seen in academia over the years.

There are related failures in oversight  at the Department of Education, as well, that collectively  indicate that the Federal student Aid office is for all intents a captured agency.. 


Congress, and the President,  should maybe assume the  immediate responsibility of fixing this systemically predatory system by returning the standard consumer protections that should have never been taken away in the first place & making the government the loan issuers and managers. Insodoing, The federal government will, once again, have a financial interest that student loans not default.

This environment will, ultimately compel the government to use its considerable influence to encourage the universities- in a serious and meaningful way- to both provide a quality education that gives the student the best chance for success, and also to do this at a reasonable cost.   Instead of looking the other way as Congress deliberates on whether to raise the loan limits yet again, the Department of Education will be compelled to object.  The Department will certainly discover the creativity to come up with meaningful tools for ensuring academic excellence, low cost, and ultimately, student success,..and these tools will work because the Department will want them to work., and  employ its soft and hard resources to that end.  

What say you??

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