Student Loans I: Yes, Something Is Wrong

The student loan problem seems clear enough on the surface: students are incurring oversized student debt, and they are defaulting on that debt and threatening their ability to access future credit. The approaches to student loan debt collection are fraught with problems, including improper recovery tactics and informational asymmetry regarding repayment options.

But the current public policy conversations miss key issues that contribute to the debt mess, leading to proffered solutions that also miss their mark.

Start with these key facts about student loans: 

The reported student debt loans represent averages, yet the amounts owed can differ dramatically from student to student. That is why solutions like the mandated debt calculator on college websites or the current College Scorecard do not resolve the issues; the disclosure of generic information does not impact student choice meaningfully. 

Many of the problematic student loans are held by individuals who left college before graduation, meaning they have incurred “debt without diploma.” This reality distorts default statistics, making their indicia of school quality misleading. The cost of education is not necessarily commensurate with the quality of the education received, meaning some students pay more and get less, and we do not have an adequate system for measuring educational quality other than accreditation, which is a deeply flawed process. 

Finally, students and their families are woefully unaware of the myriad repayment options, and therefore forgo existing benefits or are taken advantage of by loan servicers. This occurs because we de-link conversations of “front-end” costs of higher education from “back-end” repayment options and opportunities; students and their families are scared off by the front end without knowing that there is meaningful back-end relief.

Given these facts, it becomes clearer why some of the current government reform suggestions are misguided. Two illustrations: 

First, evaluating colleges on a rating system based on the earning levels of their graduates assumes the overwhelming majority of students graduate and that the employment chosen will be high-paying. But we know that not to be true, and for good reason: some students proudly enter public service or other low-paying but publicly beneficial employment. And, in today’s economy, not all students can find employment directly correlated to their field of study. 

We also know that those from high-income families have greater networking opportunities, given family connections. Yes, some schools offer degrees with little or no value, but the solution to student loan indebtedness does not rest on an earnings threshold.

Second, looking at loan default rates as a measure of the success of a college misses that many colleges welcome students from lower income quartiles, and these students have less collegiate success – understandably, although obviously many are working to improve these statistics. The fact that some of these students do not progress to a degree is not a sign of institutional failure any more than student success at elite institutions is a guarantee of those institutions’ quality.  One approach to consider is linking default rates with the types of students being served by an institution.  But one thing that should not change, to the dismay of some: many of the government student loans should not be based on credit worthiness.   

Not that many years ago, private lenders dominated both the student lending and home mortgage markets. This created obvious parallels between lending in these two spheres. Lenders overpriced for risk, provided monies to borrowers who were not credit-worthy, and had loan products with troubling features like sizable front-end fees, high default interest rates and aggressive debt collection practices. 

In both markets, there was an embedded assumption: real estate values would continue to rise and well-paying employment opportunities would be plentiful for college graduates.

Then several things happened. The federal government took over the student loan market, cutting out the private lender as the middleman on government loans on both the front and back end. The economy took a nosedive that led to diminished home values and lower employment opportunities.  And, when the proverbial bubble burst in the home lending markets, lenders sought to foreclose, only to find that their collateral had diminished in value. 

For student loans, the bubble has not burst and, despite hyperbole to the contrary, it is unlikely to burst because the government -- not the private sector -- is the lender. Indeed, this market is intentionally not focused on credit worthiness; if anything, it awards more dollars to those who have weak credit, specifically to enable educational opportunity. 

And while Congress can debate the interest rates charged on student loans, the size of Pell Grants and the growing default rates, it is highly improbable that the student loan market will be privatized any time soon.

But, for the record, there are already signs that private lenders and venture capitalists have re-entered or are ready to re-enter this market, for better or worse. And if the government’s financial aid offerings are or become less beneficial than those in the open market, we will see a resurgence of private lending offered to students and their families. One caution: history tells us that the risks of the private student loan market are substantial; all one has to do is look at lending improprieties before and since the government became the lender-in-chief and the non-student loan predatory lending that targets our least financially stable borrowers.

There are things that can and should be done to improve the government-run student-lending market to encourage our most vulnerable students to pursue higher education at institutions that will serve them well. Here are five timely and doable suggestions worth considering now:

(1) Lower the interest rates on government-issued subsidized Stafford loans. The government is making considerable profit on student loans, and we need to encourage quality, market-sensitive, fiscally wise borrowing, most particularly among vulnerable students. Student loans to our most financially risky students should remain without regard to credit worthiness (the worthiness of the academic institution is point 2).  Otherwise, we will be left with educational opportunity available only for the rich.

(2) Improve the accreditation process so that accreditors assess more thoughtfully and fairly the institutions they govern, whether that accreditation is regional or national.  Currently, there are vastly too many idiosyncrasies in the process, including favoritism, violation of due process and fair dealing, and questionable competency of some of the accreditors.  And the government has not been sufficiently proactive in recognizing accreditors, despite clear authority to do so.

(3) Simplify (as was done successfully with the FAFSA) the repayment options. There are too many options and too many opportunities for students to err in their selection.  We know that income-based repayment is under-utilized, and students become ostriches rather than unraveling and working through the options actually available.  Mandated exit interviews are not a “teachable moment” for this information; we need to inform students more smartly. Consideration should be given to information at the time repayment kicks in --- usually six months post-graduation.

(4) Incentivize college and universities to work on post-graduation default rates (and repayment options) by establishing programs where they (the educational institutions) proactively reach out to their graduates to address repayment options, an initiative we will be trying on our own campus.  Improvement in institutional default rates could be structured to enable increased institutional access to federal monies for work-study or SEOG, the greater the improvement, the greater the increase. 

The suggestion, then, is contrary to the proffered government approach: taking away benefits. The suggestion proffered here uses a carrot, not a stick – offering more aid rather than threatening to take away aid. Importantly, we cannot mandate a meaningful minimum default rate because default rates are clearly correlated to the vulnerability of the student population, and we do not want to disincentivize institutions from serving first-generation, underrepresented minority and low-income students.

(5) Create a new financial product for parents/guardians/family members/friends who want to borrow to assist their children (or those whom they are raising or supporting even if not biological or step children) in progressing through higher education, replacing the current Parent Plus Loan.  The current Parent Plus loan product is too expensive (both at initiation and in terms of interest rates) and more recently too keyed to credit worthiness. The individuals who most need this product are those who are more vulnerable.  And the definition of “parent” is vastly too narrow given the contours of American families today. 

Home ownership and education are both part of the American dream. Both benefit the individuals and larger society.  How we foster both is, however, vastly different. We need to stop shouting about the shared crisis and see how we can truly help students and their families access higher education rather than making them run for the proverbial hills.