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How The U.S. Credit Crisis Will Lead To An Overhaul Of The U.S. Student Loan System
By Money Morning on March 5, 2009 | More Posts By Money Morning | Author's Website
The costs of the ongoing credit crisis have been well chronicled. But there’s a bright spot, too.
In a crushing blow to lobbyists, bankers, and loan intermediaries, the credit crisis and the accompanying collapse of the securitization market may actually force a top-to-bottom overhaul of this country’s much-maligned student loan system.
If that happens, prospective student borrowers may no longer have to face a lifetime of indentured financial servitude, and the U.S. higher education system may finally get a long-overdue makeover.
When it comes to the ongoing financial crisis - of which the frozen credit markets are a primary casualty - one of the only positives to date has been a total bypassing of the bankers and loan facilitators that had been pushing student loans for college and graduate-level studies. In the new era, the federal government itself plans to take over the bulk of the lending duties.
While the prospect of fewer private lenders lowers the total pool of available student loans, U.S. President Barack Obama’s new budget proposes to fill the void by having the federal government take over most student lending. The proposal is not a budget-buster, because the government already finances or guarantees most student loans. A “Student Loan Bill of Rights” may even emerge from this credit conflagration.
A Lot of Anger
From a financing standpoint, the greatest impact of the credit crisis has been on the securitization market. Student loans are originated by private bankers and government-sponsored intermediaries, and are packaged into “asset-backed securities.” The government guarantees repayment of the underlying loans in many of the security pools.
Securitized student-loan pools are sold to investors and the proceeds of those sales go back to the originators, who then have more money to make more loans. The credit crisis brought the securitization markets to a complete standstill.
The 2007-2008 school year was the most difficult year on record for student borrowers. The Massachusetts Educational Financing Authority was unable to meet loan commitments, forcing 32,000 students to seek alternate funding sources. Another non-profit lender, the Michigan Higher Education Student Loan Authority, stopped making loans. Major banks including: Bank of America Corp. (BAC). Wachovia Corp., and Citigroup Inc. (C) subsidiary Student Loan Corp. (STU) exited the student loan business altogether. So did Northstar Education Finance Inc. and CIT Group Inc. (CIT), two other active student loan lenders.
More than 100 student-loan lenders withdrew or ceased operations from 2007 through 2008, according to Finaid.org, a financial aid Web site catering to student borrowers.
Then there’s the giant of them all, SLM Corp. (SLM), commonly known as Sallie Mae. This onetime government-sponsored enterprise (GSE) was privatized in 2004 and manages more than $130 billion in student loans for more than 10 million borrowers. Like many student loan providers, SLM originates federally guaranteed loans under the Federal Family Education Loan Program. And like many other student loan lenders, SLM has experienced its share of controversy.
In 2005 , a former Sallie Mae employee alleged in a federal lawsuit that the company engaged in “a pattern and practice of granting forbearance in a purposeful effort to increase total student loan debt.” The particularly onerous practice - by Sallie Mae and many other loan management and servicing companies - of extending and consolidating loans for borrowers for substantial fees and at higher interest rates has gained national attention. A year later, CBS News’ “60 Minutes” profiled Sallie Mae and its controversial business practices.
But when it comes to the ire of student borrowers, as well as watchdog groups, Sallie Mae is certainly not the only target. In 2007, New York Attorney General Andrew Cuomo launched an investigation against Citibank, The College Board, EduCap and Nelnet - alleging deceptive lending practices. Sallie Mae eventually agreed to a new code of conduct and donated $2 million to a fund to educate borrowers about student loan options.
The pain inflicted on student loan borrowers and their families is chronicled at www.studentloanjustice.org. Alan Michael Collinge, the founder of Student Loan Justice and the author of the book, “The Student Loan Scam,” says many borrowers come to realize that they’ve been essentially condemned to indentured servitude. Lenders and servicers have paid enormous sums to their lobbying armies to generate legislation that disallows refinancing of student loans, provides for the garnishment of wages, social security and even disability benefits, and worse.
The Overhaul Game Plan
In May 2006, then-U.S. Sen. Hillary R. Clinton, D-N.Y., with substantial input from Student Loan Justice, introduced a Student Borrower Bill of Rights (Senate Bill 511). The bill was reintroduced the following year but was overcome again by lender lobbying. Perhaps the Obama administration will embrace wholesale changes in how student borrowers are treated and offer them a way out of debtor slavery.
Financial aid to students is different from other types of consumer debt, which can facilitate - or even encourage - overconsumption. And the fallout from the tight-credit environment has a substantial long-term social cost.
For instance, some of the hardest-hit for-profit schools offer vocational training in such potentially valuable areas such as nursing and computer-technology. And these schools typically cater to lower-income students with lower FICO credit scores and higher default prospects. Providing affordable loans to students and a realistic timetable and payback arrangements will further the education agenda the United States needs to make a priority in an increasingly competitive job market.
While the credit crisis is to blame for our deep and devastating recession, the one silver lining may be an opportunity to permanently sideline profiteering banks and student loan intermediaries from feeding at the federal trough even as they stand on the backs of indentured-student borrowers.
The Obama administration’s budget proposes to eliminate private lenders from the market and to have the federal government provide direct loans to students. By eliminating the subsidies to well-heeled intermediaries, the government can reconstitute the U.S. Department of Education, fulfill its promises to promote - and actually facilitate - higher education and not disadvantage workers who too often pay dearly for skills they desperately need.
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This student loan budget proposal is crazy. Why add $1 trillion to the national when you don’t have to? If you’re going to nationalize an entire industry, at least do it to one that’s broken!
Student loans are the only form of consumer debt lacking standard consumer protections. In 1997, student loan companies such as Sallie Mae successfully lobbied Congress to amend the Higher Education Act and remove consumer protections, making defaulted student loans among the most lucrative and easy debts to collect.
The loan companies actually have a vested interest in debtors defaulting on their loans and have great leeway to collect on those loans.
Harvard Professor Elizabeth Warren was quoted in a Wall Street Journal article as saying that “student loan debt collectors have power that would make a mobster envious.”
The student loan companies can garnish or seize Social Security and disability payments, and even raid personal bank accounts without a court order. A number of people have actually been driven to suicide by their collection tactics. Others have fled the country, rather than become destitute and homeless in the United States.
Since I have dual citizenship, American and Irish, I could choose that option as well, but I see no reason why I should have to live in exile. Over the last 7 years I’ve paid $106,000 on the original loan amount of nearly $65,000, and I still owe over $98,000 to Sallie Mae. I’ve paid my debt and made great sacrifices to do so.
The only people benefiting from this situation are the CEOs and corporate officers of companies like Sallie Mae. The outrageous profits they make would be better off circulating in local economies. Reform is badly needed.