Subprime lending from housing to colleges backed by usa gov't

Poor job prospects, as well as mounting costs of basic needs such as health care and housing, mean many college graduates have not been earning enough to pay back their loans. Default rates on student loans have been climbing since 2003. By 2012, student loans registered the worst delinquency rates in consumer credit, worse than even mortgage debts and credit cards. Despite the uneasy relationship between the profitable student loan industry and growing student debt defaults, students continue to borrow to pay for college, and educational loans are the only form of consumer debt to increase markedly since 2008.

The industry has grown steadily over the past several decades in lockstep with rapidly rising tuition and fees—and with the government’s prioritization of loan-based funding over grants. To understand the growth of this risky business, we need to first grasp the basic alliance between government and finance in the profitable world of student debt.

THE SHIFT IN SUBPRIME LENDING FROM HOUSING TO COLLEGES

Aside from forging the 2007 College Cost Reduction and Access Act for holders of federal loans, under debtfarism the government has invoked consumer protection to deal with private loans. With rising concerns about mounting student debt, the Consumer Financial Protection Bureau (CFPB) and the U.S. Department of Education released a 2012 joint-report about the state of student loans in the United States, with a specific focus on private student loans.

The report argues that risky lending practices tied to private student loans have not only increased more rapidly than public student loans over the past decade, but have also come to share many similarities to the 2007 subprime mortgage crisis. Private lenders (banks) issued loans without considering whether borrowers would be able to repay, then securitized the loans and sold them to investors to avoid losses when students defaulted. According to the report, there have been more than 850,000 defaults in private loans since the 2007 crisis, exceeding a total value of $8.1 billion.

Debtors who default are then subject to disciplinary measures such as a downgrade in credit scoring, which could affect future employment opportunities due to the prevalence of employer credit checks. Defaulters are also doggedly pursued by collection agencies eager to cash in on commission and collection fees. Private student loans are a riskier form of credit for students than federal loans, because interest rates are far higher than for public loans. The report suggests two main reasons for the increase in private student loans and subsequent defaults.

The first is the lack of proper financial education for students and their families. Public student loans have lower interest rates and better consumer protection clauses than private loans, suggesting that people who are taking out private loans are unaware that better terms are available.

The second reason is greed, fuelled by institutional investor appetite for SLABS. Aggressive lending practices, which lie at the heart of this private lending growth, prompted the Secretary of Education to argue that subprime lending has moved from the housing market to colleges.

Sallie Mae and the Student Loan Industry
The student loan industry is made up of a wide array of overlapping public and private actors and institutions. There are two main categories of educational loans and lenders: public student loans, which are issued by the federal government and represent the largest category of loans (85%), and private student loans (15%), which are issued by a few large banks such as Wells Fargo and JPMorgan Chase.

By far the most powerful private actor in the industry is Sallie Mae, a former government-sponsored enterprise, or GSE (see glossary). Sallie Mae’s original role when it was founded in 1972 was to raise funds by selling student loans (also known as debt securities) on secondary markets, where investors buy securities from other investors. In this way, Sallie Mae could finance low-interest rate loans to increasingly more students by subsidizing and guaranteeing repayment to their private lenders. In 1996, Sallie Mae became the first GSE to be privatized and was subsequently renamed the SLM Corporation—although the moniker of Sallie Mae remains.

In 2010, the Federal Direct Loan Program (see glossary) assigned Sallie Mae and four other private educational lenders (FedLoan Servicing, Great Lakes Educational Loan Services, Nelnet, and Direct Loan Servicing Center) the role of federal loan servicers. These are companies that handle, for a fee, the billing and other services on federal student loans. By far the largest, Sallie Mae (or, more precisely, its offshoot company Navient), provides service to 3.6 million loan customers on behalf of the U.S. Department of Education. Sallie Mae has been growing at such a rapid pace that it has been diversifying into areas such as debt collection, insurance and consumer banking, and the issuing of credit cards to college students. Sallie Mae remains the main lender of private student loans and the largest issuer of SLABS.

Raising Funds, Reducing Risks—for Whom?
SLABS is often presented by economists and neoliberal policy makers as a highly efficient method of raising capital and reducing risk for lenders, including the risks of default and bankruptcy. This view of SLABS conveniently ignores the unequal relations of power in the educational loan business—and how the business generates revenue from commissions, fees, and interest.

Consider, for example, a first-year undergrad at UCLA who gets a four-year, $25,000 student loan from Sallie Mae. Depending on the repayment schedule and an interest rate based on creditworthiness, this student could end up paying Sallie Mae anywhere from $50,545.95 (based on a 145-month repayment plan) to $70,259.07 (based on a 193-month repayment plan) to even $74,126.61 (based on a 144-month deferred repayment plan). The deferred repayment option costs more because the student is not required to make payments during school or, according to the Sallie Mae website, is allowed to “pay as much as you’d like.” Sallie Mae’s rosy language leaves out why student borrowers might choose loan terms that are more expensive in the long run: they are worried about their ability to repay, because their families have no extra resources and they may end up unemployed or underemployed after graduating from college.

Shortly after issuing the loan to the UCLA student, Sallie Mae securitizes the debt, packaging it with a bundle of other similar student loans. It then sells this debt bundle to an outside investor, like a pension or hedge fund, pocketing the total amount of the original loans plus fees and commissions. In doing so, Sallie Mae receives payment on its student loans immediately, as opposed to receiving small monthly payments for twelve to 16 years from students and bearing the risk that these students might default. Revenue is extracted in student debt collection, too. Thanks to amendments to the Higher Education Act in 1991, debt collectors that specialize in student debt are permitted to tack on hefty collection (25%) and commission fees (28%) to the outstanding loan, making debt collection a highly lucrative business.

Private lenders are not the only ones benefiting from the educational loan business. The Department of Education, which also securitizes its loans, is believed to have generated $101.8 billion in revenue from student loans from 2008 to 2013. It does so largely by exploiting a spread between the low interest rates it pays to borrow money (e.g., 2.52% based on the 10-year Treasury bond rate in 2013) and what it charges students (e.g., 6.8% for Stafford Loans (see glossary below)).

The basic premise driving SLABS is that powerful financial actors and institutions are able, through regulatory and legal sanctioning by the government, to transform a debt obligation (student loan) into a financial asset (SLABS) that can be traded on the secondary markets. This can be understood as the “commodification of debt.” The underlying assets for SLABS are student loans that have been sliced and diced to create packages of debt obligations that are then sold to investors such as pension funds. SLABS has proven to be a lucrative device to hedge risk for investors, raise capital, and even to generate income when student loan debtors default (through derivative contracts such as credit default swaps, which pay off in the event of default).

Once we peel away the complexities of SLABS, we are left with the basic problem: the success of the “investment” ultimately depends on the ability of the debtor to earn enough money to pay the principal of the loan, plus interest and fees. The alchemy of finance cannot erase the risk of how hard it may be for the student to ever repay the loan because the student will struggle to find gainful employment after graduation. From this angle, SLABS—like all forms of credit—rests on the ability of the state to ensure that debtors (students) will repay the loan—no matter what their incomes may be.

For the student loan industry to continue to expand and remain lucrative in the face of increasing rates of delinquency and default, the state must discipline the debtors. In my recent book, Debtfare States and the Poverty Industry (2014), I refer to this new feature of neoliberal governance—emerging alongside the rollback of the welfare state, dereliction of labor laws, and increased levels of precarity among working- and middle-class Americans—as “debtfarism.” Debtfarism represents a set of institutional and ideological practices aimed at regulating and normalizing the growing dependence on expensive consumer credit to meet basic needs, such as education. Personal bankruptcy law is a core regulatory feature of debtfarism, as it acts to deal with defaults in the student loan industry and to ensure the legal and moral obligation of debt—regardless of the borrower’s ability to repay.

For many students, the draconian changes to the bankruptcy code with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 represented a major turning point. Among its notable features, the BAPCPA was designed to keep student debtors out of bankruptcy in three ways.

First, BAPCPA made relief under Chapter 7 (under which most debts are immediately cancelled) more difficult to access. Granted, federal student loans have long been exempt from discharge (the release of a borrower from the obligation to repay her/his student debt through bankruptcy) under Chapter 7, but some legal loopholes were available to highly distressed debtors, particularly holders of private student loans. The passage of BAPCPA makes it nearly impossible to pursue debt relief under Chapter 7.

Second, BAPCA made it more difficult for highly indebted students to qualify for the other remaining option for bankruptcy relief—Chapter 13 (adjustment of debts). Student debtors filing under Chapter 13 can only be granted bankruptcy protection if they prove “undue hardship.” Undue hardship is determined through means-tested procedures making human suffering reducible to algebraic equations. (Congress refused to provide a clear and transparent definition of “undue hardship,” opting instead to transfer responsibility for interpretation to the courts.) Chapter 13 also requires debtors to jump through more hoops, such as mandatory pre-bankruptcy credit counselling and a rigorous repayment plan for three to five years before the courts discharge “some” debt. Despite these obstacles, desperate student debtors continue to file under Chapter 13 to seek relief from dischargeable types of consumer credit, such as credit cards, medical debt, and auto loans.

Third, BAPCPA added private student loans to the types of educational loans that cannot be discharged without adequate proof of undue hardship. This means that private lenders such as Sallie Mae now enjoy the same state protection from debtor bankruptcy as the federal government. Moreover, private educational lenders such as Sallie Mae have been granted powers to garnish the wages, tax refunds, and even Social Security benefits of delinquent debtors with no statute of limitations.

http://www.dollarsandsense.org/archives/2015/0515soederberg.html

 

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