This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org
This article is from the
May/June 2015 issue.
at a 30% discount.
Educational debt has become a ticking time bomb. With over $1 trillion in outstanding loan balances, the student loan industry has a lot in common with the sub-prime mortgage industry, which went into a devastating crisis in 2007-8. Both rely on a financial innovation called “asset-backed securitization” (see sidebar below) to raise capital and to hedge risk—in other words, to raise money for loans and to reduce the likelihood that investors will lose their money. Student loans asset-backed securitization—or SLABS—means student loan agencies package student debts and sell them to investors who expect to get their money back, plus interest, as students pay back their loans. In theory, selling off nicely bundled packages of debt to investors allows these institutions to turn around more quickly and make new loans. For this reason, SLABS is touted as the main channel through which the lending industry moves funds from investors to students—and so is supposed to be of mutual benefit to students, lenders, and institutional investors such as hedge funds and pension funds.
Like the sub-prime housing industry, however, SLABS ultimately depends on the ability of borrowers to meet their debt obligations. Herein lies the rub. Since as far back as the recession of 2001, the majority of student debtors have not been able to get decent paying jobs upon leaving college.
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.
Debtfare and Discipline
STUDENT DEBT GLOSSARY
Default on a debt is the failure to make payment on interest or principal when it falls due.
Dischargeable debt is debt that can be cleared through bankruptcy proceedings. The federal government has enacted laws to prevent students from attempting to wipe out their education debt by filing for bankruptcy, unless they can prove “undue hardship”—and even then courts have been unwilling to discharge student debt.
Federal Direct Loan Program (FDLP) is a new law, enacted in 2010, under which public student loans originate directly from the U.S. Department of Education, effectively ending the ability of banks to issue federal government-backed student loans.
Government Sponsored Enterprises (GSEs) were created by Congress to enhance the efficiency of funds flowing between saving and borrowing in key areas of the economy. GSEs Fannie Mae and Freddie Mac are associated with housing, while GSE Sallie Mae deals with education. GSEs assist in the flow of funds by providing loan guarantees, reducing lenders’ risk of losses due to borrower default.
Stafford Loans are a kind of fixed-interest-rate federal student loan. They are the most affordable type of student loan.
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.
The debtfare state’s extension of super-creditor status to dominant private institutions like Sallie Mae deepens the hold corporations have over education financing. One out of every five students carries private loans, which have higher interest rates than government loans and carry fees that add to the balance. Many students are turning to private loans to augment their federal loans due to the increasing costs of living (health care and rent) and tuition (especially at for-profit colleges).
To manage the relentless wave of defaults, the government introduced the College Cost Reduction and Access Act in 2007 (effective July 1, 2009), which tweaked various aspects of the BAPCPA. While the law included some small victories for individuals holding public student loans, it also created a system of income-based repayment plans under which student debtors would be compelled to pay (through wage garnishment) 15% of their discretionary incomes (earnings available for savings or spending on non-essentials) for a period of 25 years. Only after this period would the borrowers be able to apply for cancellation of the remaining debt. It should be underlined that this system applies only to public educational loans (e.g., Direct Loan and the Federal Family Education Loan (or FFEL) programs) and to those student debtors who earn enough discretionary income to permit the garnishment. Moreover, it is an income-based repayment system that favours public-service employees over other workers. Under the Loan Forgiveness for Public Service program, for instance, public-service employees can apply for the remaining debt cancellation after paying 15% of their discretionary income for 10 years. All other student debtors are required to pay 15% of their discretionary income for 25 years before applying for the remaining balance of their debt to be cancelled.
The Rhetoric of Consumer Protection
Framing private educational lending as a consumer protection issue makes it seem as if the root cause of the student debt problem is the predatory practices of private educational lenders, distorting the role of the debtfare state. The state has played a critical role in the construction and normalization of students’ increased reliance on loans—both public and private—to fund their higher education. It has withdrawn funding for education, overseen the rise in student tuition and fees, and shifted from grant-based to loan-based financing. In other words, the consumer protection framing veils the role of the debtfare state in actively facilitating predatory practices.
Consumer protection has also remained largely rhetorical. Consumer protection for student loans does not deal with the social dimensions of student debt risk, such as defaulting, dropping out of college, moving back home, working two or more jobs, putting off marriage and starting families, and even—despite the long odds—filing for bankruptcy to reduce overall debt loads.
This has not been uncontested. Growing numbers of student debtors have channelled their anger and frustration with the management of these loans through numerous acts of protest, active lobbying, and advocacy to achieve debt justice. One of the more popular mobilizations has been the Occupy Student Debt Campaign—a loose network of several thousand student debtors and debt activists that sprang out of the Occupy Wall Street protests.
Occupy’s Strike Debt Working Group and Rolling Jubilee Fund grabbed headlines with their “search and destroy” campaign in 2013. Using donated funds (largely through crowdsourcing), Rolling Jubilee located and purchased student debt at discounted prices and then abolished it. The campaign has cancelled $3.85 million of privately held debt through this approach. Rolling Jubilee acknowledges that this gesture was symbolic in that it sought to expose how debt operates and to empower student debtors.
The Debt Collective emerged from Rolling Jubilee and from growing student outrage with the exploitative strategies pursued by for-profit colleges. The group aims to create a platform for advocacy and for debtors to unite in collective action. One such act of resistance has been the country’s first student debt strike, in which more than 100 former students of the for-profit Corinthian College system are refusing to pay their federal loans. For-profit colleges like Corinthian derive 66% of their revenues from federal student loans. (See Chris Cooper, “The Corinthian Crisis,” Dollars & Sense, May/June 2015.)
These activist organizations have been vital in exposing the injustices and exploitative nature of the student loan industry. One of their most important roles has been to politicize debt, convincing insolvent borrowers that they should move beyond the dehumanizing narrative of debt as an individual problem by collectively challenging the moral sanctity of debt. Building on this momentum will require a focus on the powerful class interests that have benefited from student loans—from the issuance of private and public loans, to servicing and securitizing student debt, to collections. While protestors are right to vilify and target key corporate players such as Sallie Mae, more critical light needs to be cast on the role of the debtfare state in both legitimating the profitable “poverty industry” and failing to provide adequate public support for social programs, including education.
The poverty industry includes educational lending, but extends to other forms of consumer credit—such as payday loans, credit cards, sub-prime housing loans—all of which feed off of and reproduce marginalization and insecurity. The increasing reliance on expensive personal loans to replace or augment wages—as well as obtain an education—is not a natural phenomenon. Rather, it is a social construction that needs be revealed, attacked, and uprooted, not negotiated within the territory of consumer protection, which is sponsored by the debtfare state and the capitalist interests it represents.