Student Loan Crisis - New York Times Catching Up With My Guest Posters

Originally published on forbes.com.

  I started following the student loan crisis when I noted that student loans seemed to be neck and neck with health care as the primary grievances on the We Are The 99% site.  I was very lucky to get two pretty regular guest posters Alan Collinge and Tim Smith, who have written on the issue from different angles.  I was astonished to get a call from Sallie Mae asking me how they could get their side of the story onto Forbes.com.  At the risk of being prosecuted for impersonating a journalist, I did a brief interview with John Remondi, President and COO of Sallie Mae.  I'm still hoping for some guest posts from Sallie Mae, but nothing has come through yet.  Sunday, I heard from Tim Smith, who let me know that the New York Times was picking up on the issue with this piece.  I invited him to share his reaction.  Here it is.

The Education Bubble Won’t Create A Disaster, Right?

“Looking back, anyone could have predicted the housing bubble.”  This sentiment has been echoed many times, and graphs of the past housing bubble almost make it seem obvious before the bubble burst.  The education bubble?  While many acknowledge the soaring cost – especially those in the education fields – fewer agree that we’re about to see the education bubble pop and create a bigger mess than the housing bubble.  Education may have its critics, but it also has major defenders.

However, the chorus seems to be changing.  Even the New York Times recently joined with an article that compared the education bubble to the housing bubble (this analogy has been used multiple times, but like the above graph shows, under predicts the mess that the education bubble will cause).  Even while other media players have finally seen this bubble, the warning signs were spelled out on this blog :

These warning signs would be favorable laws toward discharging student loans in bankruptcy (making it more challenging for students to receive money for education); a societal zeitgeist toward education changing (for instance, businesses preferring certification or a degree from something similar to the Khan Academy over traditional colleges); a major recession coming back to the United States, taking away more employment (making it more difficult for student with loans to pay back their loans); students becoming discouraged by negative news toward education (causing many to drop out or to avoid college).

Of course, some readers might wonder if all four signs must appear for the education bubble to pop, and the answer is "No".

Even though the education bubble has received attention, few expect the consequences to be bad.  In fact, the Times’ article mentions that economists don’t see the consequences being similar to the housing bubble – in other words, the education bubble pops, and everything is fine.  Consider the potential reality:

1.      High student loan balances discourage future and current demand for other products and services (consider the attitude, for instance, of Natalia Antonova, who faced a debt crisis with her student loans).  This subtracts money flow from the economy to provide jobs in other areas.  Even without the bubble popping, this is the current situation.

2.      If the demand for education drops, the consequences will affect those in the education system – schools will need fewer professors, advisors and others in the education field.  This will create a terrible job hunting situation, where graduates will be placed against high-credentialed people (some of whom may have been their professors).  Remember that in order to keep these people employed, the demand for education must remain the same or rise.

3.      If the demand for education declines, the demand for educational products will decline also – textbooks, construction, and many of the expenditures that some colleges think are necessary to provide a good education.  This drop in demand will cause business, which sell products and services to educational institutions, to cut back on their staff to offset their losses.

There is one way in which economists might be right – if wages began to soar.  Like the housing bubble, Americans felt the mess because the decline in housing prices meant that debt was owed on something that had little value.  If education continues to rise, while wages stagnate or slowly rise, a college degree will be like a home, which has lost its value.  If wages soar, however, a college degree will still mean the path to prosperity.

Tim Smith blogs on the “Echo Boom”, also known as Generation Y (Americans born between 1980 – 1995). Tim has previously appeared here discussing his generation’s attitude towards homeownership and education.

I'm beginning to think that the "bubble" metaphor may not work that well for education.  In the case of the stock market and real estate people own assets that they think they can sell at any time for some minimum price.  Then something happens and everybody heads for the door at once.  At that point the seeds of the next bubble are sown, because the assets have some level of intrinsic value and somebody will buy them for something and may get rich on the next turn of the wheel.  Educational credentials, on the other hand, are not at all fungible.  They can only be cash flowed, not liquidated.  If they are not used when fairly fresh, their value erodes rather quickly.  The actual economic value of the credential will often be quickly replaced by the experience which the credential enables.  

You can follow me on twitter @peterreillycpa.

Does Sallie Mae Want Students To Default ?

Originally published on forbes.com.

After accepting a few guest posts from Alan Collinge, I heard from Sallie Mae. At the risk of being confused with a journalist, I had an interview with John Remondi, Chief Operating Officer. The Sallie Mae people indicated that Alan is not always factually accurate, although they indicated they are not opposed to bankruptcy protection for student loans. Probably the biggest difference they have with Alan is on his assertion that they profit from defaults. Mr. Remondi made a pretty convincing case to me that they would rather that the loans performed. They convinced me, but not Alan, who is back with another guest post on the subject.

Two weeks ago, [It was actually in April.  Time flies when you are having fun.]Peter Reilly (noted accountant, and courageous Forbes contributor) was invited by the top brass at Sallie Mae to meet to discuss my contributions to this column, and comments I made regarding the company in particular.  While it was a bit difficult to extract any specific criticism they had about my claims, they did make it clear that they felt I was wrong about my assertions that the company makes more money from defaulted student loans than loans that remain in good stead.  In response, I would like to lay out the facts about defaulted student loans.  They are well proven, not controversial, and unambiguous.

Lenders are paid full book value on defaulted loans (principal plus interest).  For defaulted loan collections, collectors get to keep 18 cents out of every dollar before anything is applied to principal or interest.  If the loan is rehabilitated, the new, much larger, loan is sold, and the guarantors get paid (in addition to 10 months of payments that go straight into their pockets) something like 18%  of the inflated balance. 

For lenders who only lend to students (and don't guaranty, or collect on defaulted loans), they lose no money on a default. The money they are reimbursed can (and is) immediately used to fund another loan.  Therefore, these lenders, fiscally, have a neutral outlook about defaults (i.e. they don't care one way or another if a loan defaults). [I think Alan is ignoring administrative costs, which might be significant.]

If a company both loans, and also owns collection subsidiaries, then as long as collection of defaulted student loans is profitable (and it is extremely profitable), then this company clearly and unambiguously has a financial interest that loans default rather than remain in good stead.

If a company not only lends, and collects, but also owns a guarantor company (guarantor's lifeblood is penalties and fees attached to defaulted loans), then this incentive is increased significantly.

Sallie Mae went on an acquisitions tear in the late 1990's, acquiring some of the largest collection companies, and also multiple guaranty agencies, including the largest, USA Funds .  Therefore it is impossible for Sallie Mae to claim that they would rather loans remain in good stead than default.

I think I'm going to remain agnostic on this issue.  I am waiting to hear back from Sallie Mae.  I also might take another crack at Sallie's 10-K, but if you want to beat me to it, jump right in and comment.

You can follow me on twitter @peterreillycpa.

Could Refinancing All Student Loans Be A Free Lunch For The Taxpayers ?

Originally published on forbes.com on May 2, 2012

Before I met with John Remondi, President and COO of Sallie Mae, I combed through Sallie's 10-K to see what they were worried about. One thing they say they are worried about is that the cost of college will go down. That would be bad for their business. When I asked Mr. Remondi about that he kind of smiled and said that was the type of thing they had to mention to their shareholders, but he didn't really think it was all that likely. Then there is this other thing they are worried about:

For instance, during the fourth-quarter 2011, the Administration announced a Special Direct Consolidation Loan Initiative that provides a temporary incentive to borrowers who have at least one student loan owned by ED and at least one held by a FFELP lender to consolidate the FFELP lender’s loans into the DSLP program by providing a 0.25 percentage point interest rate reduction on the FFELP loans that are eligible for consolidation. We currently do not foresee the initiative having a significant impact on our FFELP Loans segment. However, the initiative is an example of how the Administration and Congress could detrimentally affect future estimated cash flows and profitability from our FFELP Loan portfolios through their actions.

The FFELP program was one of those public private partnerships. The federal government guaranteed most of the interest and principal, but it was financial institutions making the loans. President Obama thought that the piece going to the financial institutions was really a waste of money, since they were not taking any risk. There are no new FFELP loans being made, but the exisiting loans will be around for a long time. Sallie Mae is transitioning to making non-guaranteed loans, but they expect to be making money off the FFELP loans for the next 20 years.

They are even buying more of them from other institutions.  It does not require a lot of capital for them to do that.  The federal guaranty makes the portfolios gilt edged.  Sallie can securitize the loans with instituional investors getting something like LIBOR +1, while Salle gets LIBOR +2.  Doesn't seem like that much of a spread but it can add up.

As I noted, the consolidation program outlined above worries them a little.  Well, here is what I am thinking.  Maybe we the taxpayers need to encourage our President and his likely opponent to propose a program that would worry Sallie a lot.  It is our guaranty that makes the debts of those kids (and many of them are not kids anymore) a valuable financial asset, that the capital markets can play with for the next 20 years.  Why don't we just offer to refinance the whole lot at a reasonable rate ?  That includes the loans that are not performing that well.  We are already stuck with the downside on them because of the guaranty.  If we want to be nice guys, we could do things like put in bankruptcy protection for the really desperate.  But even, if we want to be hardnosed about, it is the taxpayers who are at risk that should be making the profits on the loans for the next twenty years.

It is too bad that we don't have a Presidential candidate that can think like a venture capitalist and make that kind of move on behalf of the American people.

Should Student Loans be Dischargeable in Bankruptcy ?

Originally published on forbes.com on December 29, 2011, this is my first guest post from Allan Collinge.  The student loan struggle is still ongoing making this as timely now as it was two and a half years ago.
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What Congress can do to Solve the Student Loan Crisis

At long last, the nation is beginning to acknowledge the very large problem that student debt has become.  The national dialogue has been noisy and confused to this point, however, and the few legislative attempts to address the issue, while pleasant sounding, will do little to ease the debt burdens of the vast majority of borrowers, and do nothing to address escalating college prices and the associated debt loads being imposed upon the citizenry. Ultimately, this distracted dialogue and feeble legislation serve no one well, and the protests we are seeing now across the country echo this point.  In order to understand and solve the student loan crisis we now face, it is critical to understand the unique fiscal dynamics that govern the student lending system, and the institutional and political behaviors that results.  Forget about the for-profit college scandal for a moment.  Put the public vs. private student loan debate on hold.   The following must be addressed if these debates, or others, are to be productive.

First, it must be acknowledged that the lending system supporting our higher education system is structurally predatory.  In the absence of fundamental, free-market consumer protections like bankruptcy, statutes of limitations, refinancing rights, and others), and in the presence of unprecedented collection powers that would make "mobsters envious" (Elizabeth Warren's words), we have a student loan system where the big lenders make significantly more money on defaulted loans than healthy loans.  What is worse:  The guarantors (the entities that are supposed to police the lenders) make, on average, 60% of their revenues from penalties and fees attached to defaulted loans. What is almost unbelievable:  Even 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.  Imagine if it turned out 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.  This is the reality for student loans- a reality that demands very careful consideration.

A few common-sense questions are compelled here:  Would you want to take a loan from someone who wanted you to fail in your endeavor?  Doesn't this put the lending system in a position of bad faith?  Is this not a defining characteristic of a predatory lending system?   Adam Smith, Milton Friedman, and every other western economist would answer yes on all counts (Ironically, Republican members of Congress were, by all accounts, more responsible for the legislation that caused this than members from the other party, but that is a topic for another discussion).

These financial motivations explain a wide and deep array of systemic defects, conflicts, and corruptions in the system that involve the lenders, schools, and most importantly, the Department of Education.  One example, Sallie Mae and others have been found to have defaulted student loans en masse- without even attempting to contact the borrowers!  Another example:  all colleges routinely mislead students prior to taking out loans about  their true default rates- they instead doggedly promote 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 the hundreds of significant examples of false information, omissions, and outright deceptive behaviors that one could point to in this discussion.  The readers can imagine the multitude of other dishonorable activities that might result from the anti-borrower financial motivations that have taken hold of this lending system, and more than likely they will find these to be happening, in fact, on the ground.

Those who claim that the new, improved  “Direct Lending” system is cured of these predatory underpinnings are wrong.  Defaulted loans still carry all the same penalties and fees as before, and Sallie Mae and the other big player are still both servicing healthy loans, and collecting on defaulted loans in the same conflicted manner as before.  The collection frenzy around massively inflated, defaulted loans may even be exacerbated under the new system, where interest income is no longer a possibility for these contractors.  In any event, the new system clearly doesn't curb the predatory nature of the debt instrument.

The most troubling outcome resulting from this lending environment, however, is the massive tuition inflation that the schools are imposing at will upon the students.  Congress enables this, year after year, by repeatedly increasing the lending limits, in the absence of protest from the Department of Education, which has known about the astonishingly high default rates for years, but has promoted this pollyannish view of higher education, instead of telling the hard truth.   And of course this affects all students, not just those who borrow.  Wealthy and moderately wealthy families who must pay out of pocket for kids to go to college feel this, and feel it more sharply, arguably, than those who borrow.

Some perspective is needed here.  If there is an infectious disease outbreak, the CDC is pretty snappy about warning the public.  Similarly for the USGS and earthquakes, NOAA and tsunamis, etc. Should we not expect the same type of response from the Education Department in the face of exponentially increasing student loan debt and astonishingly high default rates?   When we were looking at a Trillion dollars in national student loan indebtedness, and the default rate was north of 1 in 4, why wasn't the Department of Education sounding the alarm?    These questions have yet to be posed to those in charge at the Department, but need to be.  By Congress.   Department staff who should have warned congress and the public but didn't should be held accountable. This isn't a question of good government. Rather it would seem that is a question about minimally adequate government.

So the question now is how to “fix what is broken”, to borrow a phrase from President Obama, Secretary Geithner, and others following the most recent State of the Union Address.  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 ed crowd as viable substitutes for the consumer protections that were stripped from the system. Some policy “thought leaders”, in fact, are pointing to these untested, unproven programs as a basis for dramatically increasing the federal loan limits!  This is not the direction we want to go. We cannot afford it, and to claim otherwise is hugely irresponsible.

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 reall, 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 bankruptcy was the same for student loans as all other loans, far less than 1% of federal 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.

With financial motivations aligned with the interests of the students, instead of against them, we should expect the Education Department to take its job seriously, crack the whip on the schools, lenders, and ultimately compel not only a significant decrease in college prices, but also an end to a myriad of corruptions and conflicts that have taken root across higher education and are too numerous to mention, here.

Until Congress does what is right and the Department of Education has skin in the game for students, the invisible hand will not operate like it does for all other lending systems, and no fix (like gainful employment, for example)  will have any meaningful effect.  Prices, debt, and defaults will increase to the point where the American public will reject the entire lending system and all it supports. The related social consequences of this are not clear, but it is clear that we don't need to go there.  And as the American Street demonstrates, this is likely something that Congress must do sooner rather than later, and in a non-partisan manner.
Alan Collinge is founder of StudentLoanJustice.Org and author of The Student Loan Scam: The Most Oppressive Debt in U.S. History - and How We Can Fight Back (Beacon Press, 2009).

Occupy Wall Street - Let's Have a Student Loan Bailout - But We Need to March on the Colleges

This was originally published on forbes.com on October 7, 2011.  It was the beginning of my following the student loan debacle.
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I'm probably going to aggravate some friends with this one so I should preface it with the overall philosophy that I have on social issues.  My favorite summary of it is this quote by Brendan Beehan:

I have a total irreverence for anything connected with society except that which makes the roads safer, the beer stronger, the food cheaper and the old men and old women warmer in the winter and happier in the summer.

The irreverence extends far and wide and includes many aspects of my own profession and "Wall Street".  For the moment I am going to talk about the education system.  What is aggravating me about the education system is some of the things that I am reading in We Are The 99 Percent.  We Are The 99 Percent puts a human face on the issues that have people out in the streets.  The format is a series of pictures of individuals holding up a hand written note telling their story.  Some of them are heart rending:

22 year old divorced single mom with a two year old daughter. Neither of us can go to the doctor, we can’t afford to get sick. Especially mommy. Mommy works full-time and is considered “lucky” to have a full time job. Mommy makes 7.25/hr and right now her bank account is in the hole -12.00 with a week left til payday… Mommy doesn’t feel lucky. Mommy has lost a lot of weight because she can’t afford to eat more than once a day, but she makes sure I have everything I need. I lose a lot of time with her because she is always gone to try to take of me the best she can. I love my Mommy….. WE ARE THE 99%

Now I sometimes consort with a curmudgeonly bunch of aging tax accountants. I probably make up the left wing of that group.  (When I am with my human rights activist friends, I'm the right wing).  The elderly accountants, including myself, all think there is something out of whack with "Wall Street".  We have clients in hedge funds, which based on the tax reporting headaches they create seem to invest in everything everywhere.  We are puzzled as to why it is that traders are feeling constrained by the speed of light.  Having worked with actually applying the ever changing tax law for 30 or more years, we have no excpectation of it ever making a lot of sense and recognize that it caters to special interest. I'm the most enthusiastic about Occupy Wall Street but I have to part company with it on one of the major grievances.  Student loans.  I agree that you have been ripped off, but I don't think you should be pinning that particular grievance on finance capitalism.  I think the blame for that one falls strongly on the education system.

A typical, although on the extreme end, grievance is from someone who went $150,000 in debt to obtain a masters degree in Minority Womens  Studies.  She received an excellent education and is now extemely frustrated that no one is willing to hire her based on the important things that she has learned.  Now some even among the 99ers, who have posted, would put the blame for that squarely on her shoulders:

Nobody has ever held a gun to my head and said “here sign this student loan” nobody has ever told me I would ever be rich once I get my degree. We are responsible for our own actions and the decisions we make.

That particular fellow is 42.  In his youth, he decided not to go to college and learned a trade instead.

I don't blame her, because I fell into a similar trap in my youth.  It was not nearly as bad back then and actually looking back over my whole life I don't regret it, but it was still a trap.  Here is the trap.  If you are a first generation college graduate there is a good chance that you were heavily influenced and inspired by your teachers.  I remember being inspired by my English teacher (If you can read this thank a teacher.  If it is any good at all,  thank Mr. Moroney).  So I started out majoring in English.  In my sophomore year one professor convinced me I was ill suited for that.  There was something about the whole field that I just didn't get.  For example, I thought that Moby Dick was a story about a bunch of guys working in the whaling industry.  History suited me much better and I had some really inspiring professors including David O'Brien, one of the leading scholars in the history of American Catholicism.  I also had good math skills so I was thinking of a career in the then relatively new field of applying quantitative methods to historical problems.  After a year in VISTA, I went to the University of Chicago.  I bailed out after a year without completing my master degree for some personal reasons but also from becoming discouraged from meeting too many people in their thirties who were still not quite finished with their dissertations and the discouraging job prospects of those that did finish.

So there I was at the age of 24 with no saleable skills and student debt.  I forget how much.   Probably around 5 grand, which was worth a lot more in 1976 than it is now.  When I was a teenager, my mother and I had been techincally living in poverty.  How is it that my circumstances in 1976 were not nearly as desparate and discouraging as today's debt encumbered graduates ?  A couple of things.  I had gotten some scholarships, but there was a little bit of bait and switch.  As tution and room and board rose, the scholarship didn't.  Nonetheless, three summers I worked a union job in the shipping department of a valve factory.  Lots of overtime.  One summer I made 2 grand which was nearly a years tuition.  I received social security survivors benefits until I was 22.  As I understand it social security survivors benefits now cut off at eighteen regardless of whether you go to college.  What the hell can a kid do to make say 20 grand in a summer nowadays ?  Never mind, I don't want to know unless it is avatar levelling.
My mother thought sending me to an all male high school, with an almost all male faculty would be good since I needed male influence.  She was right.  There were really inspiring men there.  Jesuit priests, Jesuit scholastics, career Catholic high school teachers, retired and active duty Army guys who taught military science and drilled the regiment.  I'm glad I went.  There was not one of them there though with the sense to tell me that maybe I should consider something like public accounting, which at the time was in my opinion the absolutely best deal for a first generation college graduate.  Nobody told me to think about being an actuary - I guess I'm lucky I dodged that bullet.  The academic world has an undue influence on first generation college students.  It did not abuse my generation that badly, but it has done a serious number on this one.  And this is one travesty that you cannot lay at the feet of finance capitalism.

So here is my proposal.  Anyone with a student loan should be allowed to have an appraisal done on the monetary economic value of whatever credential they have received.  They should have their debt written down to that amount or alternatively be permitted to surrender the credential in exchange for total debt forgiveness.  The woman with the degree in Minority Womens studies would still have the education just not the credential and the associated debt.  

We have laws to protect unsophisticated investors from certain types of investments.  In order to invest in them you have to show you have net worth to spare.  There should be similar protections for unsophisticated 18 year olds being encouraged to go into debt that they will have no prospect of getting out of.  Will this mean that all the degrees in Gender Studies might end up being gobbled up by the children of the wealthy?  Maybe.  So lets require the professors to publish the reading lists since  that's where most of the real education will come from.  Should we stick the banks with this bailout or the taxpayers ?  No.  It should be funded by an excise tax on university endowments.  There is probably a lot to blame "Wall Street" for, but this part of the mess, I don't think so.