Canary in the Coal Mine: Student Loans

The Democrats are caught between the need to set up structures that will prevent future meltdowns and the pressures they face from well-heeled Wall Street-based interest groups. They are under cross-pressure to act in the public interest and to survive in the political system: those who displease groups with deep pockets face tough re-election campaigns, as their opponents will get the large amounts of funds needed these days to run for office. Hence, despite all the talk about new regulations, surprisingly little is happening.

Student loans serve as a sort of a canary in the dark recesses of Washington politics. If the Democrats cannot stand up to private sectors here, they are extremely unlikely to persevere elsewhere. The issue is very simple. If the Democrats cannot show the public that the existing arrangement constitutes an out-and-out raid of the public treasury by a few investment houses and banks -- and that anybody who opposes reform should be booed out of office -- do not expect them to be able to do so on the much more complicated issues of credit swap controls and regulations of derivatives.

Since 1965, the federal government has provided funds to private lenders through the federal Family Education Loan Program. The government gives loan money to private lenders and guarantees 97% of the loans, ensuring that the private lenders loan virtually without risk. Last year, these private lenders made $56 billion in loans to students. They pocketed huge profits without providing any service.

On February 26, President Obama proposed that instead of going through private lenders to borrow money, students should borrow money directly from the U.S. Department of Education, eliminating the role of the private lenders. By early July, the chairman of the House Education Committee had endorsed President Obama's plan, which, projects the Congressional Budget Office, would save up to $87 billion in the next ten years. On September 17, the House of Representatives voted 253 to 171 to put this plan into effect. It is eight months later but the Senate has not acted, while all the time it has been shedding tears about the mushrooming deficits.

As I said, if this bill cannot fly through a Democrat-controlled Congress, do not be surprised if little else opposed by large and well-endowed private interests will see the light of day. Even if the bill passes, it will be so diluted and further watered down after it is enacted that it will end up basically as a reform in name only. Watch the canary and see whether the toxic clouds are lifting or closing in.

Amitai Etzioni is a University Professor at The George Washington University and author of The Moral Dimension (Free Press, 1988). To contact him, write [e-mail].

http://www.gwu.edu/~ccps/securityfirst.html

 

 

Comments

[OneLiberalLady]

The only explanation for the foot-dragging of the Senate on this one has to be the donations received from the banking industry. They cannot claim that their constituents are demanding loans that subsidize banks, rather than direct education loans from the government.
The money saved, all $87 billion of it, could go to other pressing needs or to expand the educational loan program itself. The Senate has much to be ashamed of and to answer for here.

[dxnineone]

Part 2:

This is in addition to the services provided to anyone who actually borrows a loan - but borrowers must reach out to their lenders for a lot of the services provided by them. A student borrower is entitled to defer their payments in certain situations where they cannot make payments. But a student borrower must tell their lender. When's the last time you called your mortgage company and got a three month respite from paying your mortgage because you were dealing with a family emergency?

-Speaking of lies by the administration has propagated - the legislation passed by the House to end the FFELP, SAFRA, was estimated to save the federal government $87 billion. Slight problem - instead of lenders receiving what are called Special Allowance Payments (or SAP, where the government gives money to lenders to keep interest rates low, categorized as "subsidies"), most lenders are PAYING the federal government for the right to make loans (dubbed "negative SAP") because interest rates are so low. That fact, coupled with a market adjustment requested by Sen. Gregg of the CBO that closer reflects reality but isn't in the CBO rules, showed this bill actually saves the government $33B. OK, it still saves $33B, is that bad? Well, it is, because the rest of the bill still spends $77Band puts another $10B toward deficit reduction. In actual dollars, we'll need to come up with $54 billion just to break even. But I'm sure the Chinese will lend it to

[Hdaryl01]

Nice try.

1) The government guarantees 97% of the principal balance of student loans. Thus, on a $10,000 loan, the government guarantees the lender $9,700. Thus, a grand total of $300 of the lender's principal is at risk. Do you dispute this?

2) The only addition to the $300 (3%) a lender has at risk on a $10,000 student loan, the principal of which is 97% guaranteed by the government, is DEFERRED AND CAPITALIZED INTEREST.

3) LOW RATES?!? You have got to be smoking crack. The money center banks like Wells Fargo that make a lot of student loans currently borrow at 0-.25% from the Fed. They then turn around and loan this money at the "low" rate of +/- 9%. Of course all the principal they loan is 97% guaranteed by the government. In the example above, the lenders receive +/- 9% interest on the entire $10,000 from day 1.

[Hdaryl01]

(cont.)


4) 97% guarantee doesn't mean virtually no risk?!? Again, Crack? So the lender risks $300 (3%) in principal on a $10,000 loan. And, the lender's risk is increased by the amount of deferred capitalized interest that accumulates. Take 9% as the rate. $900 in deferred interest is accrued in the first year. Thus, at the end of year one, the government guarantees $9700, and the lender has at risk $1,200, on the $10,900 balance (11% at risk). Carry this forward for the average four years and you get $11,881 at the end of year 2, $2,181 at risk for the lender (18.357% at risk). Year 3, $12,950.29, $3250.29, (25.098% at risk). Year 4, $14,115.81, $4,415.81, (31.28% at risk). This IS virtually no risk. the lender's risk never even reaches 1/3 (33%), and this risk is entirely based on accumulated deferred interest on the entire principal balance, 97% of which is guaranteed by the government, save for the token $300 in principal the lender has in the game.

Student loans, like SBA, like USDA, like Fannie Mae, and Freddie Mac are all examples of the bank lobby's efforts that have resulted in risk free scams and unlimited profit centers, with VIRTUALLY NO RISK. As Dire Straits says "money for nothin'...checks for free..."

[Hdaryl01]

(cont.)

5) Then we need to consider the fees. According to the Sallie Mae website, there is a (drum roll...) 3% DISBURSEMENT FEE!!!!! Paid UPON DISBURSEMENT TO THE LENDER WHICH IS CAPITALIZED!!!!! So the lender puts up 3% of the money, the government guarantees 97% of the money, and when the lender disburses the money, it gets to capitalize a 3% fee, which of course generates interest. So, in the final analysis, the lender puts up NO MONEY!!!!! And, the lender is never at risk for any principal, ever. The lender's only risk is the interest which accrues on the principal that is guaranteed by the government (97%). The lender is given the exclusive right to generate massive interest income out of thin air, on OUR MONEY (guarantee). On $10,000 as per above over 4 years, the lender creates $4,415.81 in interest income out of thin air, with no skin in the game.

6) Bankruptcy. The bank lobby got an exemption to discharge on student loan debts under the 2005 Bankruptcy law. Consumers can discharge mortgages, car payments, but not student loans.

7) It is astounding how absolutely little the parasitic lenders do to earn so much. How little (none) risk they take to earn such returns (massive). That are 97% guaranteed by the government. And, non-dischargeable in bankruptcy.

[dxnineone]

Part 1
1) I do not dispute that $9700 is 97% of a $10,000 loan. What will dispute later, is what the amount of a default claim that gets returned to a lender. Which brings me to:

2) Deferred and capitalized interest doesn’t get added to the guaranteed amount - it doesn’t go higher than $9700, regardless of what gets capitalized. Lenders get an amount guaranteed by a GA, it doesn’t go up, but, reasonably, does go down when the loan is paid off.

3) I’m talking about the lender’s retention of the interest rate through a process called Special Allowance Payment or SAP. Lenders get to retain a portion of the interest that’s earned on the principal amount and remits the rest of it to the Feds. Lenders retain a portion that’s equal to the Commercial Paper Rate plus 1.19%. That’s great for lenders when the CP rates are high, but that hasn’t happened in over a decade. Let’s look at an example - a reasonable recent CP rate is .28 (not looking up current number for this exercise), add 1.19% gives you 1.47%, that’s what the lender can keep (there can be other factors of the lender that shift that .25%, but we’ll just use this one…).

[dxnineone]

Part 2
A lender charges 6.8% for an unsub Stafford loan, per the federal regulations. 6.8% minus 1.47% equals 5.33% - that’s what gets remitted to the feds. If you do the math out, lenders remit a little over 78% of the interest accrued to the feds. That means for every $100 of accrued interest, the lender gets to keep $22.

4) Again, your math is correct - the lender will never get more than $9700 in your example, and in fact, would get less if the student borrower actually made payments (again, based on original principal, not accrued interest that gets capped). And 31.28% risk, is still risk, as little as you think it is. If you’re OK with taking 31.28% of the amount owed to you for your work done, please let your employer know, they’ll be happy to save the money. And wait until you see WHERE the money comes from that gets paid to the lender for defaults (we’ll get to that next…)

[dxnineone]

5) Valid attempt, I’ll even give you credit for going to Sallie Mae’s website, but the 3% disbursement fees you’re looking at are for Sallie Mae’s Signature loan - private loans not associated with the FFEL Program and have no government guarantee. You’ll be happy to know that the risk for the lender is 100%. There are, however, some fees associated with FFEL Program loans. One is the origination fee, which is somewhere between .5% and 2% of the principal of every loan, and that can be charged to the borrower and remitted to the government. (Say it’s at 1%, the lender could take $100 of the $10,000.) Some lenders, especially small banks or nonprofits, pay these on behalf of the borrower. The second is a 1% default fee, generally collected from the proceeds of every loan (again the $100 of the $10,000) that is remitted to the government to be placed in a fund. That fund is used to then reimburse the lender for loans that default. That’s right - the 97% guarantee is funded by money previously supplied by the lender themselves. So it’s not coming off the feds’ books. (In fact, when they take over the loan after default, they can do some pretty awful things, like wage garnishment and tax return offsets, to get their money. The loans aren’t just eaten by the feds, they collect with methods only dreamed off by Tommy Two Thumbs…)

[dxnineone]

Part 5

6) I actually have no bone to pick with bankruptcy rules. The original thought behind exempting student loans was to prevent someone from deciding on bankruptcy to rid themselves solely of student loan debt, but was hijacked by some greedy lenders. Bankruptcy needs reform from top to bottom and I don’t disagree that student loans should be part of some sort of financial restructuring for those truly in need. Again, truly in need.

7) Have a discussion with anyone who services student loans, or someone who tries to obtain the financing to back student loans in today’s market and see what little they do compared to the “massive” profits they receive. Are there the Albert Lord’s of the world who make ungodly amounts of cash with student loans as their primary business? Absolutely. But for every Alex Rodriguez and his obscene contract (and I very much equate Al Lord and A-Rod, both overpaid cheaters…) there are thousands of major and minor league ballplayers who don’t make as much as what A-Rod accrues in interest every month. (More minor league ballplayers make in the range of $10,000 - $15,000 than there are major league players that make +$1million…). Doesn’t mean we should outlaw baseball as a career path - but that’s a different discussion.

[dxnineone]

A couple of points that I'm ashamed a professor at my alma mater missed and/or posted misleading info --

-97% guarantee does not mean "virtually no risk". First, it's 97% of the current principal of the loan, without any interest that accrues - and interest is how 90% of lenders and servicers stay in business, that's their operating margin. The federal government can, and will, deny claim payment for a host of reasons, and if you're interested in figuring out exactly what rules a lender or servicer has to adhere to, take a look at 34 CFR 682. I'll be here in a few years when you have that section down.

-That brings me to "huge profits without providing any service". This could not be further from the truth - and downright irresponsible to pass off as fact. It's a bold-faced lie propagated by this administration and latched onto and repeated by anyone with even a moderate left-lean. Guaranty Agencies, lenders and services provide billions of dollars each year in outreach services, some required by the aforementioned 34 CFR 382 and some as genuine public service. From financial aid awareness nights in high schools around the country to college exit counselling to financial literacy courses for adults, GAs, lenders and services spend their own money providing these services.

[bobo5]

Pick a practical path.

[Hdaryl01]

Indentured servitude. Everywhere in the U.S.. Americans have become profit centers that are kept perpetually hungry so they stay on the treadmill.

The U.S. feels like it is a strange oppressive foreign country when I visit. I feel more at home in my wife's native country, where we have reverse migrated with our two children for better opportunity, and a better quality of life in a much more civilized environment. My wife had lived in the U.S. since she was 3 years old. Thankfully we had the option to escape the lunacy.

I am one of the very last of the baby boomer generation. In my lifetime, the values, principles, social contract, rules, and all other written or unwritten, spoken or unspoken societal conventions have been completely abrogated.

It is absolutely shocking how unabashedly oblivious politicians are to the plight of the American individual. It is equally shocking how uniformed many Americans are about how things are done, and how people are treated in other countries. And, how so many Americans can be conned into voting against their best interests, and advocating similar causes.

The Netherlands. Max tax rate 52%. Cradle to grave single payer health care. Free education all the way through as far as you want to go, with housing and food stipend. Over funded public pensions. No stress at all about healthcare-non issue. No stress about education-non issue. No stress about safety net or retirement-non issue....

Wake up America....it's insane....

[Pearlswan]

This article reveals that my student loan for $5,000 that was taken out in 1974 and guaranteed by the US government, and that was in default in the 1990s because I was abandoned with 5 children under age 7, had to have been paid to the lender by the gov't through the guarantee program.

Yet, when I returned to the workforce in the mid 90s, I was told I owed $22,000 on that student loan. I paid it down until it is now at $5,000 again. How can I have paid $17,000 back on a $5,000 loan that at one time was in default and now, in 2009, 35 years later, I still owe $5,000 and growing?

I put my own life at risk and protected my children from domestic abuse from their father and, as a result, suffered a decade on public assistance and lost my professional certification. I was subsequently injured on the job and am disabled yet I can get no hardship discharge for this loan nor can I get them to reduce the last $5,000 owed even though I've paid them $17,000 on the loan to date. That is $12,000 more than I borrowed! I suspect the government already paid off the lender and then the loan went up for sale and winds up back with Sallie Mae once again. What a racket!

[Jannsmoor]

You have been badly treated. I am sorry my government sold you out. It seems inconceivable you have spent so many years under this cloud.

One would think if we have over $100 billion of AIG, we would have enough to end this nightmare.

[dxnineone]

First, if you borrowed one single loan in 1974, and it was $5000, it wasn't a federally guaranteed loan. Lenders were not allowed to lend that much money in one shots at that point in time.

Second, if you borrowed $5000 and hadn't paid it off by the mid-90's, it's because you weren't making payments in full, or sporadically making payments and interest was accruing. Don't get me wrong, I don't agree with the relatively high interest rates that are charged by higher lenders, but Congress sets those limits, and most lenders have some incentive plans to reduce those interest rates, but your federal government set those rates, not your lender.

There are options available to any borrower who cannot temporarily make their payments, but you're required to talk to your lenders, you can't just ignore the problem and then be shocked and appalled when your loan doubles or triples. You're inherently entitled to most of these options - don't run away from your debt. And don't forget, you decided to borrow the money - it wasn't a gift, it was money you borrowed and are required to pay it back.

[Pavane]

The way I see it, the lender got their money and more. She borrowed only 5,000 but, to date, has paid back 17,000. Who cares how she paid it. The lender is, in fact, paid. And that is what I would tell them.

[IUAlumna]

You can request a break in paying back your student loan because of financial hardship (aka a forbearance), but you continue to accrue interest and will owe far more than the original debt, and your payments will increase when the forbearance ends. Not the most helpful program, since most people do not end a period of financial hardship by suddenly being able to afford high payments. The new higher payments make borrowers MORE likely to need another forbearance, which will further increase payments ... and so it goes, until you've paid a lot more money than originally planned, all without ignoring the problem or your lendor.

Not everyone in debt is irresponsible. Not everyone in debt is dumb. Sometimes people in debt are just ... poor.

[schatsie]

Again, 97% guaranteed by the US government­,,,,Social­ize the Risk, and Privatize the Profits.... Where in the sam hilll in the constitution does it say this should be the way it is...As long as the government is taking the risk, then all the interest should be returned to the government instead of the BLOOD SUCKERS..... I am appalled that in this time of unemployment, these students will be acruing more and more in interest charges that are totally out of touch with Reality...­.Inflation is 0% and the banks are making out like bandits....

[Jannsmoor]

Don't forget, banks can borrow money from the Fed at 1/4% at the discount window. So we're not only guaranteeing their loans, we're supplying the money.

[Hdaryl01]

Yep. While the Fed sells T-Bills and T-Bonds that PAY alot more interest than the 0-.25%......

[jimbrick]

Nothing will change until 10 million enraged homeless middle-class unemployed workers march to Washington and camp in front of the Capitol.

Or, a few riots in which Wall Street banker's cars are turned over and burned.

or, a populist party which gets 10% or more of the vote, which threatens to impose jail time on every CEO of every major bank in the US, and to enact massive punitive taxes on anybody with a net work of 10 million or more.

Only then, when you scare the beejeezus out of people, will you see some movement.

Read a little deeper into the history of the US. Only popular uprisings prod Congress out of this level of corruption. Every major reform was right after a series of riots.

[LordMoon]

Student loans are one of those phrases that sound real nice, like saving children, or kissing babies.

But really it's not, nor has it ever really been about student loans at all. Instead the industry should be called the student debt industry. Because that's what it's all about, getting students into debt, that they will have to work almost a life time to pay off.

Many times in that life time, they will wonder aloud to themselves, why they ever got a degree, because with student loan payments, they will only make as much as they would have, if they never went to college and instead went straight to a minimum wage job.

That's exactly how perverse the economics of this country is, thanks to corporate control of our government. The corporattions would rather put someone in debt for their entire life time, so that their debt can be leveraged and sold as derivatives to overseas investors, than help those who want to make something out of their lives succeed. And in doing so help our country succeed.

They have turned this country into little more than a work house, for working people. And they expect to keep it that way, despite any high falutin notions of reform, their against it, let the students be dammed to debt slavery, they need to make a buck.

[nicholasfromWA]

No mention of the exorbitant (and ever-increasing) tuition fees? THAT's the problem, not the institutions who provided us a means to pay them.

[Pearlswan]

Wrong. The government could fund those institutions directly and lower the tuition costs instead of loaning out money to the students, individually. The only reason they do it this way is to put the students in debt because workers in debt are a lot easier to control than workers who are free of long-term debt obligations.

[maryloo]

The US has become basically ungovernable in the public interest.

[GordonDR]

Sad but true. Paul Krugman admitted in a recent column that this thought had crossed his mind. Nothing will change until campaign finance changes.