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How to Save the Victims of the Student Loan Crisis

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There is only one way out of the student loan crisis - civil disobedience on a massive scale. Two reforms could bring a fair settlement to banks and borrowers alike. However, while fair, these reforms would cost the banks billions in receivables, which means they will use their considerable political influence to block them. That's why civil disobedience is the only way to succeed.

This is an emergency. In addition to the deepening distress experienced by millions of former students, the Federal Reserve, the Treasury Department, and several other governmental agencies have all warned that the $1.1 trillion in unsecured educational debt, much of which will never be repaid, creates a significant danger to the entire economy similar to that generated by housing debt in 2008.

This crisis is too big to sweep under the rug. Currently, close to ten million broke and under-employed former students are trapped in a debtors' prison without walls. Unable to maintain monthly payments, their loans have fallen into default, they are barred from obtaining ordinary consumer credit and prohibited from discharging their debts through bankruptcy. Tens of millions more struggle with excessive interest rates that limit their economic activity and add to their debt (some now owe two or even three times what they originally borrowed).

Civil disobedience would not be necessary if government was capable of functioning as a neutral arbitrator between the borrowers and the banks. Unfortunately, it cannot do that. From the beginning, government tilted the playing field to give unfair advantage to the banks, then, for decades, passed laws biased in their favor.

The Higher Education Act of 1965 established the federal student loan program, but this legislation allowed banks to fund the loans and collect the interest payments made, while the government pledged to back up the banks if the loans were not repaid. The banks got guaranteed profits while the students benefited from interest rates slightly below market. It seemed like a win-win arrangement. It wasn't.

The government should have lent the money directly from the Treasury. If the banks were unwilling to extend credit to young students, the government should have done so itself, subsidizing the risk to make the loans affordable, and simultaneously insuring that any profit came back to taxpayers.

Instead, with little notice, the federal government actually violated one of the most fundamental principles of a free-market economy. By creating a risk-free business for the banks, government compromised its essential impartiality.

Once started, government entanglement with the banks deepened. Decades later, when the cost of college dramatically rose, eventually at twelve times the overall rate of inflation, federal loan amounts had to increase in tandem. Because of the high interest rates, bank profits soared, but so did bankruptcies. To protect those profits, government intervened in the free market again, repealing in 1998 the ability to discharge federally-backed student loans through bankruptcy.

But college tuition kept increasing, eventually at too fast a pace for the federal student loan program to keep up. Because the federal loans were too little and too few, many students were forced to seek high-interest private loans from banks. These loans did not come with a federal guarantee, but in 2005, at the urging of the banks, the government repealed the ability to discharge these private loans in bankruptcy, as well.

Government had a financial interest in the federally backed loans, but it had none in these private bank loans. Its action was a straightforward gift to the banks and another egregious violation of the role of government in a free society. Ironically, it was conservatives, usually enthusiastic cheerleaders for the free market, who lead the effort to ensure that the risk-free business set up for the banks remained profitable.

Over the years, government abdicated its responsibility to protect vulnerable student borrowers and control the aggressive and at times rapacious marketing practices of the banks. Instead, it ignored that duty and used its authority to enable those practices. The results were staggering profits for the banks, profits higher than anyone had ever anticipated, and profits so great that the banks developed a huge vested interest in blocking meaningful relief for the borrowers.

Those profits are difficult to calculate precisely, but a recent report from the Congressional Budget Office (CBO) can be used to construct an approximation. Beginning in 2010, federal student loans were made directly from the Treasury, not the banks. That means the government rather than the banks now profits from the interest paid on the loans. In August 2013, the CBO predicted that over the ten years between 2013 and 2023, government profits from student loans would total an astonishing $184 billion.

It is hard to believe that the banks would have settled for anything less in past decades than the government expects to earn in the next decade. The CBO's anticipated differential between interest rates on future federal student loans and the Federal Reserve's discount rate (what big banks pay to borrow money), is roughly the same as it was for federal loans made prior to the 2008 recession. That difference is the profit on the loans, which should also be roughly the same.
But $184 billion only represents what the banks probably earned in a single decade from federally-backed student loans. It does not include profits from private bank loans. While there were fewer private loans than federally-backed loans, many millions of such loans were made and at interest rates much higher than the federal loans.

Adding to the massive profits realized from these private loans was a recent windfall likely to be worth tens of billions more. During the recession, while the "too big to fail" banks were getting bailout money, the Fed dropped its discount rate from 4.75% in December 2007 to 0.50% in December 2008 and 0.75% in February 2010. The banks gladly accepted these taxpayer-funded subsidies, but failed to pass the savings on to their student loan clients, who were forced to continue paying pre-recession interest rates, often as high as 8.5%.

Back-of-the-envelop calculations are dangerous. Nonetheless, given these facts, a conservative estimate of total bank profits from four decades in the student loan business, a business rigged for them by government, would probably be at least $500 billion and possibly as much as $800 billion or more. This vast transfer of wealth came from students and families with the greatest need. It was merely the profit on their loans, not part of the actual cost of sending a student to college.

Strangely enough, this enormous transfer of resources is rarely seen as a principal cause of the wealth and income inequality currently undermining the American economy. Yet, despite that lack of attention, the student loan crisis must have played a significant role in generating and perpetuating our current wealth inequality.

The government bias that helped the banks amass these profits creates an insurmountable obstacle to real reform. Lately, however, another obstacle has emerged, the mistaken impression that government has begun to address the problem. It hasn't, but this misperception is now undermining public demands for change.

In 2010, after ordering that all subsequent federally-backed student loans be made from the Treasury, President Obama also created a new repayment formula available on some of the new loans. In 2013, Congress passed a toothless and ineffective limit on the interest rate that could be charged. Noteworthy, however, was that both reforms only affected new federal loans made after those dates. Everyone with older debt was left out in the cold, mulling over minor changes that were miniscule or mere window-dressing.

Government has been in the pocket of the big banks all along and remains there today. That's why it would be foolhardy to wait for government to solve the student loan crisis. In the face of this rapidly metastasizing disaster, there isn't a single governmental body even considering meaningful relief for past borrowers.

When government has been corrupted to this extent, when avenues for seeking the redress of grievances are cut off, when so many are made to suffer with no prospect of relief, the requirement that citizens remain within legal constraints and refrain from acts of coercion no longer applies. Morality shifts from the established order to those protesting against it. That's why, in the case of the student loan crisis, it is both moral and necessary to force government to act through a campaign of civil disobedience.

Such a campaign could resolve the student loan crisis with two straightforward reforms: lower interest rates on all outstanding loans to non-profit levels, and reschedule payments on all such loans based on the borrower's discretionary income.

Banks have made enough money on student loans to last them for generations. Just as we commonly require public utilities to offer lifeline rates to senior citizens in exchange for the right to maintain their monopolies, banks should now be required to provide non-profit interest rates to students in exchange for the bailout and other support they regularly receive from government. That would cost them billions in receivables, but it would be an important step into the future. Global economic competition now requires that our public support for primary and secondary education be expanded to higher education. Non-profit loans would be a good way to begin.

The specific reform needed is for all interest rates on all student loans, federal and private, past, present and future, to be immediately lowered to non-profit levels. That means borrowers pay the same interest rate the lender pays to get the money being lent. For banks that's the Federal Reserve's discount rate, currently 0.75%. This reform would stop existing debt from rising so fast, make it easier to repay loans, and end the unconscionable profits made on the backs of the neediest college students.

Rescheduling repayment based on the borrower's discretionary income is the second necessary reform. Thanks to President Obama, a similar system is already in place for a portion of the post-2010 federal loans. It defines discretionary income as whatever remains after subtracting 150% of the federal poverty level from actual income. If actual income is less, no payment is necessary. If it is more, 10% of what remains is the required payment.

Borrowers who comply with this arrangement for twenty years have any remaining balance forgiven; the interval is reduced to ten years if the borrower works in a pubic interest capacity (fireman, soldier, charity worker, etc.). While current interest rates on these federal loans remain far too high, the repayment arrangement is a worthy model.

The specific reform needed is for all student loans, federal and private, past, present and future, to be made subject to this repayment arrangement, which accounts for the absence of bankruptcy protection. That would allow former students to remain creditworthy even if they are unable to make payments. Distressed borrowers would be protected from collections abuse, allowed to pay for the essentials of life, retain sufficient credit to rent apartments and start businesses, and be confident that their indebtedness will not be recycled to past generations or to the next one. (In 2012, roughly 119,000 social security recipients had part of their benefits garnished to pay for defaulted student loans, while hundreds of thousands of parents could not co-sign student loans for their children because they had yet to pay off their own student loans.)
Importantly, this repayment arrangement would also allow the banks to get some recovery. By requiring that borrowers pay at least a reasonable portion of everything they earn, it also prevents them from scamming the system by escaping the consequences for having spent the money they borrowed. That result would be grossly unfair to the banks and to the borrowers who have already sacrificed mightily to keep up with their existing payment schedules.

Despite the role government played in facilitating the student loan crisis, government must be forced to resolve it. The power of the banks can only be overcome through the force of law and the power of government. But does government actually have the authority to override existing loan contracts and force new interest rates and repayment schedules on the banks? Yes. Various emergency powers and precedents are available, even for reforms as radical as these. Government used such powers to close banks during the Great Depression, seize the entire steel industry in 1952, and impose national wage and price controls in 1971.

Such actions are rarely undertaken, and never on behalf of those without significant political power, like student loan borrowers. That's why it's necessary to both empower the borrowers and focus whatever power they can develop on Congress. Congress is the one part of government most vulnerable to public opinion, so if public opinion can be organized to give massive support to the borrowers, difficult as it may be to imagine, Congress is the best arena in which to mount this fight.

Certainly, it is a disadvantage that the banks already have enormous influence over Congress. That's why a strategy is needed capable of overcoming the relative weakness of the borrowers just as it limits the overwhelming strength of the banks. There is only one way to do that: a massive campaign of civil disobedience. Here's how it can be organized.

Think of the classic rent strike. A negligent landlord refuses to undertake necessary repairs. The tenants refuse to pay rent until he does. If the tenants can hold out long enough, the landlord runs into cash flow problems: mortgage payments, property tax, maintenance, utility bills. It is often easier to comply with tenant demands than evict them and find new ones.

Banks have cash flow problems like landlords. They have great wealth but their assets are tied up in investments in the same way that a landlord's wealth is tied up in property. The banks cover their ongoing expenses with monthly income from loan repayments just as landlords cover theirs with rent. If that monthly cash flow stops, the banks are in trouble.

This vulnerability can be exploited. The Internet and social media present an opportunity to do so on a massive scale. Instead of a rent strike, it would be a payment strike, and it could be organized through a website. There people with outstanding student debt could pledge to stop making payments if and when they are joined by five million others who agree to simultaneously stop making theirs - unless Congress implements the two necessary reforms.

Five million participants is a huge goal, but with 37 million in debt for outstanding federally-backed loans made before 2010, and millions more in debt for private bank loans, it is doable. Of this total, millions of borrowers are already in default. They no longer make payments, so they are unable to provide any leverage. But twelve million more are chronically late with their payments, a rich field from which to recruit, along with the many millions more who struggle to keep up.

Making such a pledge is not as risky as it seems. There is no legal or other jeopardy involved in making a pledge. It is only when payments are actually withheld that jeopardy begins. Many will make the pledge as a protest only, not yet ready to actually commit. This creates a powerful potential not present in a rent strike where the threshold act is to actually stop paying rent. In a payment strike requiring only a pledge, the total can build to a point where those who had intended only to protest come to see the potential power inherent in their numbers and deepen their commitment.

The website must be highly organized, able to produce frequent communications that provide the information and education necessary to reinforce motivation. Websites currently exist that give victims of the student loan crisis a chance to protest. Through them a large number of disgruntled borrowers can quickly be reached. Public curiosity about the student loan debacle will generate further interest. Then, when the number of pledges becomes newsworthy and the mass media gets involved, interest will explode.

Conservative pundits, corporate spokespeople and politicians will all condemn the threatened strike, but labor unions, progressives and grassroots activists will applaud it. A fight between millions of grassroots Americans and the nation's most powerful banks will be a compelling story, as well as a fight that others not involved with student loans will want to join. The resulting political firestorm will provide the free publicity needed to expand the effort and inspire deeper commitment.

Once the number of pledgers passes a few million and attention to the story intensifies, resistance from the banks will mount and pressure on Congress to resolve the conflict will grow. That is part of the plan, and if at that point the potential payment strikers have prevailed in the court of public opinion, Congress will find it more and more difficult to side with the banks.

Do not underestimate the possibility that Congress would actually be forced to grant the strikers' demands before an actual strike has to be launched. Government will want to avoid a conflict of this magnitude since enforcement actions would overwhelm its resources and continued defiance would undermine its authority.

Even cooler heads within the banking industry are likely to realize they might have more to gain by using their wealth and a compliant government to earn future profit than risk consumer boycotts, public hostility, and the cash flow problems created by an actual payment strike. They might remember, as well, that when pushed to do so by the Great Depression, Congress, however reluctantly, threw the banks under the bus.

If the pledgers' demands are not met when their numbers reach five million, they will have to stop making payments. Many who first signed on only to protest will have become sufficiently inspired to act. Others will not. If the actual strike begins, the government will single out some for legal reprisals and the banks will sue others for nonpayment. But if close to five million participate, the chance that any one will suffer is diminishingly small since neither the banks nor the government have the resources to discipline so many people simultaneously.

Like any strike, battles like these are lost or won based on determination. The power strikers have to openly defy the government and deprive the banks of billions in critical cash flow is greater than the power of the sanctions either can effectively bring against them. If the strikers understand this, hold out long enough, remain united, and learn to give each other strength, they will inevitably win. Once their victory is achieved, any legal actions or financial punishments brought against participants can be dismissed or undone as part of the overall settlement, a common occurrence in any successful strike.

Civil disobedience like this is an old strategy wrapped in new technology. That strategy has a rich history of success in past struggles for civil rights and economic justice. A detailed description of the student loan crisis and how the Internet can be used to build and execute a massive payment strike appears in the e-book mentioned below. It argues that civil disobedience is the only way to disentangle the government from its pro-banking bias and right a wrong that is undermining the lives of tens of millions of Americans.

Bill Zimmerman is the author, most recently, of The Student Loan Swindle: Why It Happened, Who Is To Blame, How The Victims Can Be Saved, available as an e-book in all the usual formats.