T
HE
S
TUDENT
D
EBT
C
RISIS
By Alena Farber
I
NTRODUCTION
Many of today’s high school students plan on enrolling in college and often graduate school. But affording those long years of education requires most students to take out extensive student loans, which can affect people for years after they’ve finished their educations. Consider the case of Dr. Heather Ehmke. When she graduated college, her student loan debt was approximately $28,000 (slightly below the current national average loan amount). Fourteen years later, it had grown to $90,000. Her monthly payments grew from $230 to $816. And when she tried to file for bankruptcy to get her lenders to adjust the terms of her loan, she had to prove undue hardship. When Ehmke’s petition for undue hardship was dismissed, she was stuck with nearly a hundred thousand dollars of debt.
At a time when it is harder than ever to find a job, particularly without a college education, it seems almost a requirement to take on substantial debt. But that debt can follow you for the rest of your life—some are unable to pay off their student loans until as late as their 70s. So how can the government take steps to lessen the burden?
E
XPLANATION OF THE
P
ROBLEM
Historical Background
Throughout most of the 19th century, higher education was viewed as a right that should be provided even to low-income individuals in order to promote intellectual curiosity. In 1944, the Servicemen’s Readjustment Act (known as the GI Bill) provided for cash payments of tuition and living expenses to attend college for every veteran who had served during the war years. Over 2 million veterans had taken advantage of this opportunity by 1956, and an additional 5.6 million for training programs besides college or university. In 1965, as part of President Lyndon B. John’s Great Society agenda, the Higher Education Act increased the amount of federal funding given to universities. Under Title IV of the Act, that money was then used In recent years, the cost
of college has increased more than any other industry and now
represents a huge sum for four years.
Source: Forbes
Loans and grants for
education were first
introduced in the Higher
Education Act of 1965.
The turning point first came in 1966 when Ronald Reagan was elected governor of California. His campaign against the University of California at Berkeley involved cutting state funding for higher education and shifting to a tuition-based funding model. Reagan advocated for student tuition on the basis that higher education was essentially a private good: it gave people the ability to get hired for better-paying jobs. This idea that education was something that students should pay for (or, increasingly, pay back) caused the student loan industry to blossom in the 1970s and 1980s.
Guaranteed Student Loans
First introduced as the Guaranteed Student Loan Program in the Higher Education Act (HEA) of 1965 and renamed during its reauthorization in 1992, the Federal Family Education Loan (FFEL) program provides for low-interest loans from private lenders. These guaranteed loans were made available to all students regardless of family income in 1978, but once again restricted to those with family incomes below $30,000 in 1982. Over the past three decades, guaranteed student loans have become the chief source of financial assistance for students. In only 11 years, total loan volume increased threefold: from 48 million loans totaling $102 billion in 1989 to 110 million loans totaling $317 billion in 2000.
The guaranteed loan program’s success depends on the continued participation of private lenders, for whom issuing loans to students (traditionally risky candidates) poses a substantial hazard. By guaranteeing these loans, the government is able to strike a balance between the lender’s risks and their expected return on investment. But as early as 1983, the program was raising concerns about its high costs and surprising default rates. In 1980 (fifteen years into the program’s existence, and only two after it was opened to all students), the Department of Education had purchased a total $1.4 billion of loans, meaning the default rate was over 12%. Furthermore, the 1970s and 1980s saw the rise of another major expenditure for the FFEL: special allowance payments. The fact that some lenders were tied to the interest rate for Treasury bills meant that the government spent $1.5 billion on special allowances in 1981 alone.
To cope with rising expenditures, the government shifted focus from maximum lender participation to scrutinizing lenders’ default claims; any technical violation of program requirements would allow the government to deny guaranty coverage. This policy shifted the risk of loss back to the lenders (rather than the guaranty party), and encouraged lenders to opt out of the program. Lenders began liquidating their student loan portfolios, often by selling their FFEL debts to the Student Loan Marketing Association, more commonly known as Sallie Mae.
Special allowances – interest payments made
by the government when the stated interest rate on the FFEL loans provides less than prescribed rates of return
Reagan was a proponent
of the idea that
education was
something that students
should pay for.
Guaranteed loan – If the borrower defaults, the debt will be purchased by the guaranty party (usually a government agency), which will take on responsibility for the loan.
Sallie Mae
Sallie Mae was founded in 1973 as a Government-Sponsored Enterprise designed to serve as a major guaranty agency for the Guaranteed Student Loan Program. It was meant to encourage more investors to finance student lending—not to become the dominant student loan powerhouse that it is today. Sallie Mae purchased its first loan in 1975, and by 1979 its total assets exceeded one billion U.S. dollars. In 1991, it held a whopping 27% of federally guaranteed student loans. By contrast, its next competitor (Citibank) held 4%. The organization went from a government entity servicing federally guaranteed loans for two million accounts in 1987 to a fully privatized, publicly traded corporation which manages private student loans totaling more than $180.4 billion in debt for over 10 million accounts.
What does the privatization of Sallie Mae mean for borrowers? The major result seems to be higher interest rates. Sallie Mae alone represents almost one fifth of national student loan debt, and its higher interest rates mean that borrowers will default much more often. Rather than buying federally guaranteed loans, as it did originally, Sallie Mae now sells loans to the federal government. At a time when 71% of college students graduate with an average of $29,400 of debt (coupled with the infamous difficulty of finding a job after graduation), Sallie Mae’s net income in 2013 was $1.4 billion. The total wealth loss caused by America’s trillion dollar debt means that people are putting off buying homes, getting married, and saving for retirement. Meanwhile, lending agencies are focusing on increasing their portfolios and profits, rather than enabling borrowers to repay their loans in a timely and responsible way.
Recent Developments
One major issue facing students and their families was access to information about types of loans and repayment processes. While the government took steps towards remedying this in 2011, when the Department of Education released their financial aid “shopping sheet,” it is far from universally used. Discrepancies among different colleges and the lack of a nationally standardized financial aid system means that students are far too often taking on either too many loans or turning to higher-interest private loans before taking advantage of federal and state aid. But even setting aside the issue of informing borrowers, there is still the overwhelming problem of rising education costs and mounting debt.
In 2013, a bipartisan plan that pegged loan interest rates to Treasury rates served as an effective, but extremely temporary, solution to a serious debt problem. This was essentially a postponement; the interest rate may have been fixed for 2014, but it is predicted to rise as high as 7.25% within the next 5 years. Besides, while preventing interest rates from doubling quickly is undoubtedly a good thing, the major financial burden for student borrowers is not the interest but rather the principal on their loans: college
Sallie Mae holds almost
one fifth of national
student loan debt.
College costs have
increased by 538% over
the last 30 years.
costs have increased by 538% over the last 30 years with no signs of stopping. These rising costs means that more students than ever are going into default, and the associated fees and penalties cause debt to increase dramatically and destroy the borrower’s credit.
Despite these recent attempts at reforms, there is still a lot to be done. Student borrowers cannot even declare bankruptcy to escape their debts. Furthermore, Congress has made it very difficult for students to refinance their loans, essentially preventing borrowers from getting lower interest rates or more advantageous payment schedules. Student debtors are also denied many of the government’s traditional protections for borrowers. The Truth in Lending Act, which ordinarily would require lenders to disclose all future costs to their potential borrowers, doesn’t actually cover student loans. The rapidly growing cost of higher education and the lack of codified protections for borrowers mean there’s still a lot of work to be done if we are to eliminate the student debt problem.
Congressional Action
Up to 2010, the national student loan system relied heavily on privatized middlemen companies: students would take out loans from private companies, but in the event of default, those debts would be sold to the government. Sallie Mae was even more entangled in this system; its history as a Government-Sponsored Enterprise and the substantial overlap between Sallie Mae and government employees means that it receives much more favorable loan contracts and much lowers interest rates than its competitors.
President Obama’s Student Aid and Fiscal Responsibility Act of 2010 virtually eliminated private bank participation in the student loan process. The law eliminated government fees paid to these private banks, and planned to use the nearly $68 billion in savings (over 11 years) to expand federal Pell grants. The Pell grants will also increase in amount with inflation by 2017, and the law will provide almost one million more grants by 2020. It will also invest two billion dollars over the next four years in community college programs designed for workers dislocated from their industries. The passage of the law was seen as a major triumph over Sallie Mae, which was the largest lobbyist against the reform. However, critics of the law were quick to point out that ending private participation in student loans would cost jobs. Sallie Mae predicted that it would have to eliminate a third of its positions, and Sen. Lamar Alexander (R-TN) estimated a loss of 31,000 private sector jobs. He also raised the concern that tying student loans to the federal government would lead to overcharging borrowers in order to pay for expensive government projects (such as the infamous Affordable Care Act, passed the same week). There is also the question of whether this system of “reforming” student loans is fair to borrowers when the government stands to make a profit of an estimated $184 billion over the next 10 years.
The Truth in Lending
Act doesn’t cover
student loans: lenders
are not mandated to
disclose all future costs
to their potential
borrowers.
Pell grant – grant money provided by the federal government, limited to students with financial need, who have not earned their first bachelor’s degree
Congress has also attempted to put in place some protections for student borrowers. The Higher Education Opportunity Act of 2008 (HEOA), which reauthorized and amended the HEA of 1965, took the drastic step of requiring private lenders to give prospective borrowers interest and repayment information before borrowers agree to the loan. Yet despite the unquestionably necessary step of requiring initial disclosures, many argue that the law did not go far enough. When the Federal Reserve Board issued its rules for these disclosures, they did not require that lenders set maximums for their interest rates and fees, cancel debts in the event of death or disability, or provide an easy road to bankruptcy. And perhaps most importantly, while the law mandated that private lenders disclose their APR and interest rates, that mandate does not extend to government loans, which have been much more common since Obama’s Student Aid Act in 2010.
Most recently, Sen. Elizabeth Warren (D-MA) served as the driving force behind a publicly-applauded but ultimately failed bill that would have made loan refinancing considerably easier. Had it passed the Senate in June of 2014, it would have allowed an estimated 40 million people with federal and private loans issued prior to 2010 refinance at 3.86% (the interest rate that Congress set for federal student loans a year ago). The bill fell just four votes short of the 60 needed to pass, and was filibustered and then quashed by Senate Republicans because it required a minimum tax of 30% on Americans earning between one and two million dollars each year.
FOCUS OF THE DEBATE
Conservative View
While conservatives largely agree that student debt is a serious problem facing today’s youth, they don’t believe that restricting student loans is the best way to manage that. Rather than making loans inherently easier to pay off or using government tax dollars to subsidize those repayments, conservatives prefer to focus on giving recent college graduates the means to repay their already existing loans. To do this, they prioritize job creation, and choose to deal with the current difficulty of finding a job rather than the student loan industry.
That’s not to say that they are wholly unwilling to address student loans. Conservatives have been instrumental in legislation which fixes and lowers interest rates on federal loans. But they rarely support legislation which does more; more expansive projects normally require significant funding, which often comes from increasing taxes. While conservatives acknowledge the seriousness of the student loan problem, they prioritize maintaining current (or lower) tax rates.
Sen. Warren’s bill failed
in a 56-38 vote on June
11, 2014.
Annual Percentage Rate (APR) – a broader measure of the cost of borrowing money, reflecting not only the interest rate but also the points, broker fees, and certain other charges
Conservatives prioritize
maintaining current (or
lower) tax rates.
Liberal View
Liberals are staunch supporters of using legislation to reform and restructure the student loan process itself. In doing so, their primary goal is protecting the interests and financial futures of the student borrowers. They normally oppose bills which would tie interest rates to the market, because they see this as leaving too much ambiguity in the future finances of working-class debtors. Instead, they prefer fixed interest rates, which provide some much needed stability and concrete information for students. However, these beliefs are not set in stone; for the sake of getting bills passed with bipartisan support, liberals are willing to incorporate other ways of addressing student loans.
Liberals are also opposed to using student loan reform bills as ways for the government to profit. Many of their proposed changes would actually cost money, which would normally be obtained by raising taxes.
Presidential View
President Obama has undoubtedly been a driving force behind student loan reforms throughout his terms. While he focuses on protecting student borrowers’ interests just as much as his party, he is somewhat less constrained by the need for bipartisan compromise, and has thereby enacted several drastic reform bills. Chief among these have been his move to eliminate private lenders from issuing new student loans (although there are many private loans still outstanding) and expanding government grants. Furthermore, in June of 2014, he proposed regulations which would limit student loan payments to 10% of borrowers’ incomes.
Obama has also been notable for his response to Republicans, who shy away from drastic student loan reforms which would require considerable tax increases. His administration has focused on supporting student borrowers, even if that means increasing government spending and taxes on America’s wealthiest citizens.
Interest Group Perspectives
Center for American Progress
Like most liberal organizations, the Center for American Progress (CAP) supports serious reforms of the student loan process. One of their major projects is increasing the protections for student borrowers, and allowing them more ways to deal with rapidly mounting debt. To that end, CAP advocates allowing students to refinance their loans more easily, and to declare bankruptcy as a way to discharge their student loans. They do support setting in place stricter regulations on which loans would be dischargeable this way; this would allow lenders to distinguish less risky loans and prevent the industry from collapsing due to lack of willing lenders. By distinguishing loans that are more likely to be repaid, CAP
President Obama he
proposed regulations
which would limit
student loan payments
to 10% of borrowers’
incomes.
Popular ideas for
student protections
include refinancing
loans and allowing
bankruptcy.
hopes to provide more borrower protections for the students who need it most.
The Heritage Foundation
The Heritage Foundation acknowledges that higher education needs reform, but doesn’t believe that increased government intervention is the best way to improve the situation. They believe that the problem lies in colleges and universities, which are raising costs at an unprecedented rate. Their goal is to reduce needless bureaucratic costs in order to help reduce tuition. For that reason, the Heritage Foundation disagrees with the Obama administration’s increase of Pell grants. Their belief is that increasing federal education subsidies via grants could actually increase tuition because universities would be charging the government rather than students. Increased grants would also provide no incentive to use resources more efficiently, and therefore would contribute to what Heritage perceives as the largest problem: financial mismanagement in the higher education system.
The Cato Institute
The Cato Institute notes the importance of reforming the way student loans are given and administered. But they don’t support giving too many loans at low interest rates because, in their opinion, it would encourage people to enroll in degree programs they aren’t able to compete or afford. And like the Heritage Foundation, Cato believes that giving too many loans will only lead to increased college tuitions, which will lead to a greater student loan problem down the road. They’re also opposed to decreasing interest loans overmuch out of fear that it will lead to taxpayers having to make up the difference; like most conservatives, Cato is opposed to increasing taxes to fund government projects.
POSSIBLE SOLUTIONS
It’s widely acknowledged that student loans pose a serious problems to the younger generation. The problem breaks down into two major aspects: the rapidly growing college tuitions which serve as the huge principals on the loans, and the student loans themselves which often come with high interest rates, are poorly explained to borrowers, and provide few protections for students who are unable to pay off their debts. Because there is almost nothing the federal government can do to manage the tuition costs directly, most proposed solutions focus on restructuring the way that student loans are managed.
Pell grants have increased drastically since 2008.
Source: Heritage Foundation
Rising college costs pose
just a large a problem,
but policymakers can do
little do deal with them.
More Protections for Student Borrowers
Most often, policy makers advocate allowing students to work with their loans after they have already entered into agreements. This comes mainly in two forms: loan refinancing and declaring bankruptcy. Both are currently fairly difficult to achieve; discharging student loans through bankruptcy requires showing some sort of undue hardship, and loan refinancing is poorly explained and rarely granted to students. While allowing loan refinancing is often widely popular in theory, to implement it would require substantial government funds, which is where passing such a bill becomes difficult. In the June 2014 bill proposed by Sen. Elizabeth Warren (D-MA), the required funding was to come from the so-called Buffett Rule, which would raise taxes for families and small businesses making more than $1 million. This provision of the bill caused considerable opposition from Republicans. If the required funding were to come from a different source, the bill would be much more likely to pass.
Adjusting Interest Rates
The largest factor affecting the way that student loans balloon out of control is the interest rate placed on the loan. Now that private lenders are now longer involved in the student loan process, the government is ultimately in charge of setting the interest rate for government loans. The rate can be controlled by correlating interest rates with Treasury rates: the rate would change according with the market. However, this approach is often criticized for being unpredictable. As the recession of 2008 showed, there is no way of knowing what turn the market will take, and giving student borrowers variable interest rates attached to that unpredictable entity would not help them significantly. For that reason, the government can also choose to put in place caps on the interest rate; even if the Treasury rate should change dramatically, there would be a provision that the interest rate would never rise above, say, 8.25%.
Adopt-a-Loan Programs
This solution, while fairly unusual, has been gaining a surprising amount of traction in the private sector. This would involve business taking on the responsibility of paying for at least one student loan for a current or prospective employee. The specifics to such a program haven’t been made clear, and would have to either be codified in the act or left up to the business itself. In order to facilitate such a program, the federal government could increase the limit on non-taxable gifting (currently $14,000) for businesses with the stipulation that the money be used to pay for student loan debt. Alternately, lessening taxes on transferring money (such as the inheritance or estate taxes) would allow regular Americans to help pay for a
The Buffett Rule would
raise taxes for families
and small businesses
making more than $1
million to 30%.
The cap on variable
interest rates is 8.25%
third party’s student loan, essentially allowing students to crowdfund their education.
This idea faces its most severe criticism because it would mean a huge cost for the companies. However, the companies could be incentivized to participate by stressing the recruitment and retention benefits and by giving participating companies some sort of tax break or tax credit.
Q
UESTIONS FOR
P
OLICYMAKERS
Fortunately, almost all policymakers agree that student loans are an issue that need to be addressed quickly. But the major problem will be passing bipartisan legislation that is effective enough. Reforms that will sufficiently ease the burden on students often require substantial government expenditure, and it is difficult to find a source of funding that is acceptable to both Republicans and Democrats. Yet with an issue that has such widespread voter support (particularly with young people), it’s especially important for representatives to set aside party differences and work on legislation that will help student borrowers.
CONCLUSION
In the past 30 years, the cost of college has grown by 538%: more than any other industry in the country. The cost of four years of college is, on average, enough to buy a 33 foot yacht. And more students than ever are relying on student loans to afford that exorbitant price tag. But those student loans prevent the borrowers from buying homes, starting families, or saving for retirement. Now that essentially all new student loans are issued by the government, it’s time for policymakers to take action and help students— both those about to take out loans, and those working to pay off prior loans to private companies.
G
UIDE TO
F
URTHER
R
ESEARCH
There are many suggested solutions to the student loan problem beyond those mentioned here. You can look into peer-to-peer loans, which involve student borrowing from private businesses or even other individuals, for an uncommon, but interesting idea. Overall, however, I suggest you focus on finding ways to finance and expand on ideas that have already proved popular, such as refinancing student loans, minimizing interest rates, or allowing debtors to file for bankruptcy. Finding bipartisan ways to fund these projects would bring them much closer to passing.
The cost of college is now almost $2 per minute.
Source: Forbes
The cost of college has risen more than five times as much as inflation.
APPENDIX
Dealing with student loans involves managing and minimizing many costs, particularly interest rates. Below are some recent and relevant figures. Interest Rate as of June 2014 (Undergrad) 4.66%
Interest Rate in 2013 3.86% Cap on Interest Rate 8.25% Average Debt for College Graduate $29,400 Percentage of Students Graduating with Debt 71% Average Cost of 4-year Degree $180,960 Current Total National Student Debt $1.2 trillion Percentage of Debt in Default or Forbearance 30%
Costs Associated with Sen. Warren’s Failed Bill to Refinance Student Loans:
Cost Over Next Decade $51 billion Tax Proposed on Those Earning >$1 million 30% Tax on Millionaires as of 2010 20.4% Expected Revenue From Increased Tax $72 billion
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