States Act on Student Loan Abuse

Michael Gentile, Editor-in-Chief, JHU:


In January, the Consumer Financial Protection Bureau as well as the attorney generals of both Illinois and Washington filed lawsuits against Navient, the world’s largest student lender. In response, Navient issued formal guidance to the Department of Education to bar state probes, arguing that they merely trace over federal efforts and expand unneeded regulations.

Luckily, even unwanted regulations aren’t thrown away when broken, but reinforced. Of the hundreds of millions of dollars that state probes have returned to borrowers, Navient’s $4B infraction will make a self-assuring centerpiece.

The plaintiffs allege that Navient misled its struggling borrowers to postpone their payments, despite the Higher Education Act’s mandate to switch delinquents into payment plans based on income rather than outstanding debt. These programs cap payments at 10% of income.

During these postponements, Navient’s $4B accrued in interest. The CFPB claims that “inadequate email notices” failed to inform hundreds of thousands of borrowers of these terms. Moreover, in instances when Navient did switch borrowers into “income-based repayment plans,” Navient did not make clear when they ended and resumed charging the higher postponed rates; these plans are recertified annually to adjust for income changes.

In 2014, Sallie Mae’s loan management business privatized and split into Navient, though the Department of Education still originates its federal loans, about $1.5B worth. Comparatively, Navient manages $300B of the US’s $1.4 trillion in total education debt. Last year alone, 1.1 million former students missed their first payments and America’s total balance in default broke $144B.

That said, debt growth has far outpaced federal contributions, not to mention both credit card and auto loans. Today, the average student balance tallies over $34,000, outsized only by housing mortgages and their infamous history of predatory lending.

As the debt balloons, so do the opportunities for abuse. Leading up to 2008, the American Dream sold its romantics white picket fences and promises of financial freedom; in 2008, real estate foreclosures rose 81%. Ever-appreciating home values were supposed to free up lines of credit and pioneer small business, to enfranchise families without assets, and allow the middle class to partake in the growth of the world’s greatest economy. But once the experiment fattened up enough, financial engineers stretched middle class benefits into personal and risk-free fortunes known as mortgage-backed securities.

In short, mortgage lenders sold Wall Street banks their borrowers’ contracts and streams of interest payments, thousands of which banks then combined into income-bearing assets, known as collateralized debt obligations. Every time mom and pop sent a payment, the investor who bought the security containing their mortgage would receive the money. While both lenders and banks earned fees for selling mortgages and CDOs, they reassigned their risks to the households paying off their homes and also receiving mortgages of others. So playing with house money, both lenders and banks offered and sold loans they shouldn’t have—to those with only the American dream to own a home but no financial means to do so.

Student lenders aren’t afraid of free money either and have followed suit with Student Loan Asset-Backed Securities, or SLABs. Unlike collateralized debt obligations, education debt is rarely collateralized, allowing companies like Navient to charge higher interest rates and investors to earn more generous payments. Otherwise, SLABs mirror the products that brought down overpriced picket fences across the country; but not ivory towers, right?

As long as promises are kept, college graduates will enter the labor force with sought-after and valuable skills and earn salaries far in excess of what they otherwise would have; houses prices would have kept rising too. Thus far, over 7 million students have broken their own promises to pay. According to a Citizen Bank survey, 36% of graduates wouldn’t have gone to college if they had understood the burden that debt would become. Though both sides have fallen short of expectations, only Universities reserve the right to blame their counterparties’ lack of ambition or the national labor market.

For colleges to collect over $600B in annual revenues and still fail 36% of their clients, either premier salesmanship or utter depravity is required. Jason Stanley’s book How Propaganda Works contends that both play roles in undermining propaganda.

According to Stanley, certain propaganda appeals to values in order to undermine them. In the case of voter-fraud, those who speak out against the integrity of a ballot deter others from voting and, in doing so, damage the integrity of the vote whether their allegations are true or not. In the case of higher education, colleges appeal to the financial freedom that a college degree provides but ball-and-chain that freedom with student debt.

Though enrollment rates have tapered in recognition of this propaganda, especially among low- and middle-income families, abstinence hardly constitutes choice. Rather, Universities have become monopolistic by definition, increasing their prices based on the amount of customers they deny.

From 1980-2007, both public and private real tuitions rose 171% on average; average income rose by 100% less. The year 1980 is significant for the stage that the 60’s and 70’s set.

In the 60’s, the Cold War swelled government spending and the need for private financing, growing the defense and finance sectors and thus the demand for college-educated workers. As a result, a diploma’s rate of return skyrocketed for baby-boomers in the 70s. But due to their demographic size, the supply of graduates soon outstripped the labor force’s demand for them and watered down that rate of return. In response, the federal government cut its subsidies to Universities, which began hiking tuition to clear the surplus and reassure their value.

It worked. The technology era soon reflated the worth of college-training but, this time, without a resurgence of governmental contribution. Today, college graduates can expect to earn about 16% more each year than Americans with only high school diplomas. Considering the higher income tax brackets that graduates earn themselves into, the federal government collects even more than 16% extra while shelling out less assistance than ever.

In this sense, your University and government stand to gain the most from your education; startup culture has told you so for years. Peter Thiel, Facebook’s first external investor and a Stanford JD, has even begun a fellowship to grant young entrepreneurs $100,000 to not attend college. He has since seeded 60 companies worth $1.1B combined.

That said, these successes owe much to Thiel’s exceptional network of investors and resources; Thiel, himself, is worth $2.6B. In the larger US, however, three of four startups bust before clearing a profit, doubling the collegiate fail rate indicated by Citizen Bank’s survey.

In showcasing the bright side of the moon, Thiel and other college naysayers counter undermining propaganda with some of their own. By appealing to American values of entrepreneurship, startup culture often conceals its disregard for market demand.

In the past, entrepreneurs didn’t engineer products based on their innovativeness, like many apps developed today, but exploited consumer needs and corrected inefficiencies in the economy. Today’s inverse pursuit of demand and the outright goal to be acquired by larger firms result in the “high burn rate of cash by startups” and the propensity of players to hop to and from projects. As such, startups centered on short-term booms have become an industry in itself and haven’t contributed to sustainable job and productivity growth, but rather income inequality for the few that succeed. Unsurprisingly, those few distribute the bulk of undermining propaganda. Albeit, there are fewer tech billionaires than $50,000 a year colleges.

Navient’s prosecution is the United States’ second step toward setting the record of financial freedom straight. Our first came in 2008 and ended in collapse, though we’ve matured a great deal in our use of credit since. Even if tuition prices remain rigid, programs to educate students on their obligations post-graduation will help to reduce the numbers of those in regret.

Further, if students can better rationalize their choice to attend college, less will and market mechanisms will respond. Particularly, if the labor force’s demand remains the same but the supply of college graduates falls, Universities will grow more inclined to drop costs or the government to subsidize more admissions. Only when propaganda stops outcasting those who lack education will citizens retake college as a product for their consumption. Only then will students regain the sense and power to invest in their future based on costs and benefits.

25 states, in addition to Washington and Illinois, have contested Navient’s motion against the relevance of state oversight. Clearly, enough money is on the line to check student lenders twice, especially given Navient’s connections with the Department of Education.

Many pundits have warned against moral hazards in the event that student lenders take on widespread defaults. Others have wagered that subprime lenders would enjoy a taxpayer backstop most likely in the form of a bailout. Bear in mind, taxpayer means college graduate; those who manage not to default would pay the student loans of others. Though Bernie Sanders’ campaign for universal education did not pan out, votes for paying again will be even farther in between. Not to mention, such votes most often come during economic downturns when options are most limited and recent graduates are unemployed with bills.

Aside from the sheer size of mortgages relative to education debt, today’s threats benefit from early recognition. Whereas Dodd-Frank and sweeping financial regulation came in the aftermath of 2008, revisions to the Higher Education Act calling for heightened transparency can occur now. That said, there are lots of highly educated people who care deeply about this issue. Surely, we can figure it out.


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