Helaine’s Blog

Want to fix the US student loan crisis? Put colleges on the hook

July 12th, 2013 | via The Guardian

Some colleges have higher default rates than graduation rates, proof that we should evaluate institutions’ risk as well

The question of student loans is taking on an increasing urgency everywhere but Washington.

Rates on federally subsidized loans doubled to almost 7% on July 1, thanks to Congressional bickering and dithering. The latest attempt to roll back the rates failed to get out of the Senate earlier this week, when sponsoring Democrats failed to break a Republican filibuster against the bill.

There’s a clear double standard here. If you are a Congressman who needs to fly somewhere, you can rely on your fellow elected officials to bail you out with special legislation designed to exempt air traffic controllers from the impact of sequester within a day or so. If you are a student who needs to know student loan rates so you can actually apply for one before the start of the academic year later this summer … well, good luck to you. No majority in Congress has your back.

Senator Elizabeth Warren wants to set the rate at 0.75% for the next year, the same rate the Federal Reserve charges banks that borrow money from them on a short-term basis.Others – including many Republicans and President Barack Obama – would like to see a floating rate tied to the ten-year Treasury note.

Conventional wisdom calls the nation’s $1tn in student debt “risky.”

That’s because about 85% of that money is held by the federal government, which has to approve just about everyone eligible who applies. The weight of those billions has bolstered the arguments for conservatives asking the government to back off on subsidies for student loans.

Think about this for a moment. Federal student loan borrowers do not need to put up any collateral – like, a down payment. No house or auto secures the loan. They do not need to prove they will graduate from college or ever make a decent living. Nothing secures the loan. If you don’t pay your mortgage, the bank can foreclose on your home, but no one can rescind your education or college degree. They do not need to know when they sign up for the loan when they will begin to pay their loans back and under what kind of payment plan.

What could be riskier than giving money to someone like this? “If you walked into a bank and said ‘I don’t know when I will repay your loan but what kind of loan will you give me?’ they’d laugh,” says Jason Delisle, director of the Federal Education Budget Project at the New America Foundation.

There’s another way to see it.

Balderdash, says Catherine Ruetschlin, a policy analyst at the progressive think tank Demos. “Student loans are nearly no risk,” she says.

We are, after all, discussing loans that are so sticky, more than one commentator has compared them to indentured servitude. You can’t excise them in bankruptcy court unless you can prove “undue hardship” – something considered an almost impossible standard to meet – so you are on the hook for life. “Inability to discharge is a significant benefit to the creditor,” Ruetschlin notes dryly.

And when it comes to federal student loans, the government can garnish wages, tax refunds and Social Security checks, all in an attempt to get their money back – and it’s not hard for the federal government to get all that info, after all. Chasing people down for their money isn’t free – the federal government contracts the job out to more than two dozen collection agencies, which receive commissions of up to 30% for every loan holder they convince to pay up.

There’s a lot to collect. The three-year default rate on student loans is 13%, which seems high; more than one in 10 student loan borrowers are in default.

But “risky”? No. Because the government has so many avenues to pursue students for the money, the actual recovery rate on federal student loans is well over 90%.

All of this has led some to conclude that the federal government is actually profiting on the back of America’s indebted students, to the tune of $51bn annually. Others, like Delisle, say this isn’t so – instead, some years the government comes out ahead, and some years it does not.

Then there’s the smaller private loan market, which is built for profit. These are the student loans made by banks, who make the government look downright sympathetic. The default rate in the first quarter of 2013 was 4%, according to Moody’s Investors Service. This number doesn’t sound high, but it is significantly greater than the mortgage default rate, which was 1.4% in May.

These loans are harder to get. Student loans from banks almost always require a credit-worthy co-signer, usually a parent. They’re also harder to unload, if that’s possible, than federal loans. There are tales of less-than-empathetic banks chasing after parents to pay back the money if their children die.

So what’s the truth? If you ask Richard Vedder, a professor of economics at Ohio University and the director of the Center for College Affordability and Productivity, part of the problem is that we are going about assessing risk in the wrong way.

We don’t, he believes, simply need to evaluate (or not evaluate) the student. We also need to look to the institution, and financially penalize them if students get in over their heads and can’t pay their bills. That will give them an incentive to both minimize loans, as well as ensure they steer students toward the ones with the lowest interest rates. “Colleges should have some skin in the game,” he says. “There are colleges with higher default rates than graduation rates.”

And all of this ignores the biggest risk of all – how we finance higher education in the United States. The cost of college has been rising faster than incomes and inflation for decades. That’s an unsustainable situation – and one that is bound to end badly for all too many borrowers, no matter what interest rate they receive on their student loans.

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