Loan programs

Review of Andrew Ross, "Creditocracy and the Case for Debt Refusal"

The golden age of unsolicited credit-card applications ended about five years ago. It must have been a relief at the post office. At least ten envelopes came each week -- often with non-functioning replica cards enclosed, to elicit the anticipatory thrill of fresh plastic in the recipient’s hot little hand.

For a while, I would open each envelope and carefully shred anything with my name on it, lest an identity thief go on a shopping spree in my name. But at some point I gave up, because there were just too many of them. Besides, any identity thief worth worrying about enjoyed better options than trash-diving for unopened mail.

Something started happening circa 2006 or ’07. More and more often, the very envelopes carried wording to the effect that approval for a new card was a formality, so act now! With the benefit of hindsight, this reads as a last surge of economic acceleration before the crash just ahead. But at the time, I figured that credit-card companies were growing desperate to grab our attention, since many of us were throwing the offers away without a second glance.

The two alternatives -- turbocharged consumerism on the one hand, the depleted willingness (or capacity) of consumers to take on more debt, on the other -- are not mutually exclusive. It was subprime mortgages rather than overextended credit cards that brought the go-go ’00s to an early end, but each was a manifestation of the system Andrew Ross writes about in Creditocracy and the Case for Debt Refusal (OR Books).

Ross, a professor of social and cultural analysis at New York University, was active in Occupy Wall Street, and Creditocracy bears a few traces of the movement, both in its plainspoken and inclusive expressions of anger (this I like) and its redeployment of old anarco-syndicalist ideas (that, not so much).

One commonplace account of the near-collapse of the world financial system in 2008 is that it was the product of consumer hedonism at its most irresponsible. It was just deserts for people playing Xbox on jumbo flat-screen TVs in subprime-mortgaged houses they shouldn't be in. Whatever the limits of its explanatory power, this interpretation allows for a pleasing discharge of moralistic aggression. Hence its popularity. The most familiar argument opposing it places the blame, rather, on bankers, brokers, and other criminals “too big to jail.” It was they who were greedy and short-sighted, not average people.

Besides the more obvious similarities, what these explanations share is an implication that the disaster could have been avoided with some self-discipline and the understanding that hyperbolic discounting is a very bad habit.

Ross leans in the anti-plutocratic direction, but he proves ultimately less interested in the morality of anyone’s decisions than he is in the framework that permits, or demands, those decisions in the first place. The system he calls “creditocracy” turns out debt as fast and efficiently as Detroit once did automobiles, and just as profitably:

“Financiers seek to wrap debt around every possible asset and income stream,” he writes, “ensuring a flow of interest from each…. [T]he tipping point for a creditocracy occurs when ‘economic rents’ – from debt-leveraging, capital gains, manipulation of paper claims through derivatives and other forms of financial engineering – are no longer merely supplementary sources of income, but have become the most reliable and effective instrument for the amassing of wealth and influence.”

At that level of description, Ross has simply given a new name to what Rudolf Hilferding, writing a hundred years ago, called “finance capital.” But what Hilferding had in mind was the merger of banking and industrial capitalism – the marriage of big money and big factories, with monopoly presiding. Creditocracy, by contrast, “goes small,” insinuating itself into every nook and cranny of life. The relationship between creditor and debtor takes many different shapes, some more overt than others.

When you take out a student loan or a mortgage, your submission to the financial system is more or less deliberate, and in any event explicit. It runs deeper, and proves less purely voluntary, if you have to use credit cards in lieu of unemployment insurance. The credit relationship is much more efficiently disguised if it takes the form of an unpaid internship – the “exchange” of your time and skills for intangible and impossible-to-quantify  credit” toward a future job, if you’re lucky.

And if that doesn’t pan out, you might end up working in one of the less desirable positions at Walmart or Taco Bell, among other corporations that banks have persuaded, Ross writes, “to pay their employees with prepaid debit cards that are only lightly regulated.” The banks then “charge the users fees to make ATM withdrawls and retail purchases, along with inactivity fees for using their cards. Almost all of these are minimum or subminimum wage employees, compelled to fork over a fee to enjoy their paycheck." (The practice was described in a New York Times article a few months ago.)

In next week’s column, I’ll consider Ross’s analysis of how the impact of creditocracy on education amounts to a ruthless exploitation, not just of present-day society, but of the future. We’ll also take a look at the comparable argument in a new book called The Falling Rate of Learning and the Neoliberal Endgame (Zero Books) by David J. Blacker, a professor of philosophy of education and legal studies at the University of Delaware.    

Until then, I’ll sign off by mentioning that someone has just sent me an application for a $40,000 line of credit. This must be evidence of that “recovery” one reads about. If so, we’re in real trouble.

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Consumer Advocacy Group Calls for Tighter Oversight of Sallie Mae, Other Loan Servicers

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The federal government needs to do a better job of overseeing the companies it hires to service student loans, especially the largest player, a new report says. 

Average student debt for borrowers in 2012 climbed over $29,000

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A report released Wednesday shows another student debt figure is continuing to rise: 2012 college graduates who took out loans borrowed an average of $29,400 of debt to pay for their education. 

Federal regulators finalize rule to provide more oversight of student loan servicers

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The Consumer Financial Protection Bureau has finalized its authority to more closely monitor student loan servicing companies to make sure they're following the law and not misleading consumers. 

Higher One agrees to $15 million settlement to resolve charges over fees

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The controversial provider of debit cards on college campuses says it has reached a preliminary agreement to pay $15 million to settle claims that its fees and marketing practices were predatory. 

Education Dept. will email 3.5 million student-loan borrowers about income-based repayment

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Education Department plans to email 3.5 million borrowers of federal student loans over the next six weeks in effort to boost lagging participation in income-based repayment.

New report calls for income-based repayment system that operates like payroll taxes

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A new policy proposal recommends that the federal government replace its array of student loan repayment options with an income-based program that functions like a payroll tax.

U.S. should change PLUS loan program to protect borrowers and taxpayers (essay)

This week, the U.S. Department of Education announced changes to the PLUS loan underwriting standards that may help previously denied PLUS loan applicants obtain loans. This will be welcome news to previously approved loan applicants who found themselves unexpectedly denied last year.

But federal PLUS loans can be risky business for graduate students and parents of undergraduates who can use them to borrow up to the full cost of attendance at college. Much more can be done to protect consumers from getting too deeply into debt. The Department of Education recently added PLUS loan underwriting standards to its list of items to potentially consider during negotiated rule-making, the process where students, advocates and colleges work with the federal government to hash out new regulations.

The National Association of Student Financial Aid Administrators offers three recommendations to add vital consumer protections to Federal PLUS loans.

Separate Parent PLUS Loans from Graduate PLUS Loans. Currently, there is one PLUS Loan program available to both parents (Parent PLUS) and graduate/professional students (Grad PLUS). This is a relatively new development: the Grad PLUS program was simply added onto the existing Parent PLUS program in 2005 to help graduate students cover the increasing costs of their programs.

While the borrowing profiles of parents and graduate students differ greatly, the same credit standards are applied to both. Lumping these groups together makes little practical sense. Separating the Grad PLUS and Parent PLUS programs would allow for vital variations in credit standards, loan limits, and interest rates that should be tailored to these two different populations.

Increase Loan Underwriting Standards on Parent Loans for New Students. Appropriate underwriting not only protects the lender (in this case the taxpayer), but also borrowers, by preventing them from getting into unmanageable amounts of debt.

The underwriting criteria for PLUS loans are minimal, resulting in approvals for parents who may not actually be in the best financial position to borrow. In fact, each year colleges field thousands of pleas from parents who have been approved for PLUS loans but believe they should have been denied. These parents know they cannot afford the loan debt on their income or have little experience with any form of significant debt. Yet, in order for dependent undergraduate students to receive additional federal loans in their own name, parents must first apply for -- and be denied -- a PLUS loan.

The sole credit criterion for PLUS loans is that an applicant “not have an adverse credit history,” meaning they cannot be 90 or more days delinquent on any debt or have defaulted or received a bankruptcy discharge in the last five years.  Put another way, having no credit is tantamount to having good credit for purposes of a PLUS loan and -- perhaps even more troubling -- approval from the government doesn’t require even a simple debt-to-income analysis.

Using the current definition of adverse credit makes sense for graduate students who haven’t had time to build a credit history. Ignoring debt-to-income ratios also makes sense for graduate students whose earnings will increase based on the very educations they’re financing.

But parental earnings don’t increase because of an educational investment in their children. And unlike graduate borrowers, parents lack access to loan forgiveness programs offered through public service or the government's Pay As You Earn plan. When determining credit worthiness, parent eligibility credit criteria should include some measure of likely ability to repay, such as a debt‐to‐income measure, FICO score, or another test of adequate resources. Allowing parents to assume unmanageable amounts of debt presents a fiscal and moral hazard to both the taxpayer and borrower.

It must be noted that any changes to restrict access to Parent PLUS loans should only impact new students, so as not to disrupt current enrollments. ED learned this the hard way after the agency unexpectedly, and with little fanfare, tweaked underwriting standards last year. The move resulted in harsh criticism from some students, institutions, and lawmakers. Rep. Marcia Fudge (D-Ohio), chair of the Congressional Black Caucus, claimed in an August 1 statement that the change disproportionately impacted students attending historically black institutions and demanded that ED “immediately suspend use of the new ‘adverse credit’ criteria as a determinant for Federal Parent PLUS Loan eligibility.”

In response, ED has begun reconsidering previously denied PLUS loan applicants. Lest anyone believe the lesson here is to never reconsider underwriting standards that ultimately protect parent borrowers, it should be pointed out that the furor would likely have been much less had this not disrupted currently enrolled students who are now depending on these funds to graduate.

More Transparency in Federal PLUS Borrowing. Good public policy must be built on good data, yet the availability of data on federal PLUS borrowing is abysmal. Basic information about PLUS loan approval or denial rates, default and delinquency rates, and repayment plan distributions are difficult if not impossible to obtain. While Congress and the Education Department have significantly increased disclosures requirements placed on colleges regarding graduate earnings, dropout rates, repayment rates, educational costs, and Stafford loan defaults, there is no comparable level of disclosure from the department on Federal Parent or Grad PLUS loan borrowing.

The feds certainly have this information, so why not share it?

Efforts to better target the PLUS programs to the groups they serve, bolster underwriting standards for parent borrowers, and increase transparency would significantly strengthen the programs and help ensure that these federal loan dollars are used to provide access to higher education without crushing current and future borrowers.

Justin Draeger is president of the National Association of Student Financial Aid Administrators.

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Congress should create a well-designed income-based loan program (essay)

The 2007 College Cost Reduction and Access Act (CCRAA) spawned two huge problems in federal financial aid: It caused fights over arbitrary interest rates and it established an ill-designed student loan repayment program.

On interest rates, the 2007 law gradually lowered rates on some student loans from 6.8% to 3.4% and then scheduled an increase back to 6.8%. Of course, once rates reached 3.4%, it was more than a little difficult to explain that this was an arbitrary number chosen in 2007, and therefore should exert no influence in determining rates going forward. Fortunately, Washington has finally come to its senses, and will avoid this problem in the future by tying interest rates on student loans to the government’s own cost of borrowing, thus fixing the first problem spawned by the CCRAA of 2007.

While we wait for the ink to dry on the interest rate compromise, policymakers should turn their attention to the even bigger problem with the CCRAA of 2007 – the income-based repayment (IBR) program. IBR, in typical Washington fashion, took a great idea — income-contingent lending (ICL) -- and “fixed” it until all that was good about it was no more.

What Income-Contingent Lending Can Offer

Under income-contingent lending, the amount borrowers pay each month is tied to their incomes, so borrowers repay less in months when their incomes fall (such as during an unemployment spell), and repay more quickly when their incomes rise. Arguments in favor of ICL are so strong that advocates have included the late Nobel laureates Milton Friedman on the right and James Tobin on the left.

ICL’s greatest strength is that it eliminates the possibility of default. Borrowers are never put in situations where they can’t afford to make their payments, since payments automatically decline when income declines. This is a huge stress reducer for students, and it can also be beneficial for lenders, since it reduces the possibility that they will get nothing back.

income-contingent lending also improves access and equality of opportunity. Current loan programs do not increase access as much as they should, because many borrowers fear being trapped in permanent financial purgatory by their student loan debts. By simplifying lending and eliminating the fear of default, ICL would be more attractive for those segments of the population that currently avoid student loans (and therefore college).

Another set of advantages stem from getting the government out of the student loan lending business. While an ICL with the government as the lender would be administratively cost-efficient (since loan repayments could be incorporated into the existing tax-withholding system), the benefits of moving to private lending are even greater.

It is true that past private student lending in this country certainly hasn’t inspired confidence, with subsidy-fueled corruption and high interest rates being the two most accurate descriptors. But these characteristics were driven not by anything inherent in private lending, but by poorly designed features of those lending programs. Past corruption was due to the fact that the federal government set interest rates and offered subsidies to lenders. And high current interest rates on private loans are due to the lack of collateral and the fact that individuals typically resort to private loans after maxing out their federal loan (meaning they already have a lot of debt, which makes lending to them risky). A properly designed ICL overcomes all of these problems, since there are no subsidies, the government doesn’t set interest rates, and the student’s future earnings function as collateral for their student loans.

The main advantage of private lending is that interest rates would no longer be one-size-fits-all. Currently, a stellar student in a field with many job opportunities (e.g., nursing) pays the same interest rate as a bottom-of-the-class student in a field with dismal job prospects (e.g., law) despite differences in the riskiness of lending to these two students.

With private lending that would no longer be the case, and the stellar nursing student would be able to obtain a lower interest rate than a slacker law student. Private lending would therefore provide students with more guidance on their choice of majors and provide incentives for students to do well in school. In addition, with private lending, the  political pandering we just witnessed in setting interest rates would be eliminated, and public funding would be freed up for other uses (such as expanding Pell grants).  

Potential Drawbacks of Poorly Designed ICLs

Some drawbacks can be exacerbated if an ICL is not properly designed. First is “adverse selection.” This is particularly problematic when borrowers are jointly responsible for their class (or cohort’s) total amount borrowed, as was the case in a Yale University experiment in the 1970s (more on that a bit later). With cohort-based accounts, those students expecting to have high incomes will avoid loans, while those students expecting low incomes will eagerly borrow, confident that others will repay their loans for them. This problem can be avoided by establishing individual, rather than cohort, accounts. While the amount due monthly for each student would still be contingent on income, the total amount repaid (except for interest) would not be. High earners simply would pay off their personal debt faster.

The second potential drawback is “moral hazard,” which could apply to students or colleges. Some students might try to deliberately lower their incomes to lower their monthly payments. While there isn’t much danger of students choosing to remain unemployed to avoid repaying their debts, there is the danger that some might seek out jobs with greater nonmonetary compensation such as travel or vacation time. This danger could be handled by designing individual accounts and eliminating loan forgiveness in all but the most extreme cases.

Moral hazard could also apply to colleges, if they see the students’ reduced fear of borrowing as a license to raise tuitions. Law schools are the poster children for this phenomenon, with loose lending standards for federal GradPLUS loans leading to skyrocketing law school tuitions and debt. This danger could be mitigated by including reasonable eligibility criteria and imposing strict annual and aggregate loan limits in the program’s design.

If ICL is so great, why has it failed (in America) so far?

While ICL has many advantages, and has worked in Australia, the United Kingdom, and New Zealand, two attempts in to implement an ICL program in United States have not worked. Fortunately, these experiments have taught us mistakes to avoid.  

The first attempt at an ICL in America began at Yale in 1971. It suffered from two serious problems: it was limited to one college and it used a class account, rather than individual accounts. Running an ICL program on a single campus is difficult because colleges have difficulty verifying the income of graduates and collecting payments. The Yale program also used a cohort account in which every student had to keep paying until the entire class’s debt was repaid. High-earning graduates did not like the fact that they paid much more than they borrowed, while some of their classmates paid less. The Yale program stopped accepting new borrowers in 1978.

The second attempt to establish an ICL came in 2007 with the IBR program, which is still in effect. IBR originally limited payments to 15 percent of disposable income (defined as the income above 150 percent of the poverty line), with any remaining balance forgiven after 25 years of repayment (10 years if graduates worked in politically favored professions). The Health Care and Education Reconciliation Act of 2010 cut this to 10 percent of disposable income and 20 years until forgiveness.

Any one of these provisions could work by reducing the generosity of other provisions, but the combination of a large income exemption, low repayment percentage on remaining income, and easy and automatic loan forgiveness have transformed IBR from a ICL-based loan program into a delayed grant program.

This is made clear by the handy calculator Jason Delisle and Alex Holt at the New America Foundation created to accompany their excellent report "Safety Net or Windfall?"  The average undergraduate college graduate who borrowed has $26,600 in debt. If a graduate’s salary grows by 4 percent a year, payments for any student with a starting salary under $30,300 (of which there are many) would not even cover the interest on his or her loans. After 20 years, the entire loan principal would be forgiven at taxpayer expense. In other words, many typical students will not repay their student loans under IBR. Instead, they will receive loan forgiveness worth tens of thousands of dollars. And if those borrowers have children, their loan payments go down even more. For example, if a borrower has a child five years after college, the borrower could have a starting salary of $35,000 and not repay a cent of principal over the life of the loan. In the understated words of Rep. Thomas Petri (R-WI), Income Based Repayment (IBR) “fails to live up to its potential.

The bottom line is that IBR is no longer a loan program. It is a grant program, a delayed grant program. Politicians of both parties could not resist the temptation to promise current students and constituents huge giveaways years from now while leaving the job of figuring out how to pay for it to the policymakers who will inherit these unfunded promises in the future. To avoid this problem, the temptation to make repayment provisions more generous needs to be balanced by the requirement that promises are paid for at the time the promises are made. If politicians want to make the student loan program more generous, they should be the ones that have to sacrifice other priorities to do so, rather than leaving their promises unfunded and sticking future politicians and taxpayers with the bill.

One blatant example of the absence of balance is the continual debate over the length of time students make payments before their loans are forgiven. This debate is completely misguided – loan forgiveness is a solution to a problem (unaffordable payments) that would not exist under a well-designed income-contingent lending program, since ICL already ensures that payments are always affordable. The main reason for loan forgiveness in an ICL is to enable politicians to pander by making unfunded promises.

What Should be Done?

America’s past experiments with ICL programs have taught us valuable lessons about how NOT to design an ICL program. We learned that a single college cannot run an ICL program. We learned that individual accounts are better than communal accounts. We learned that the program should not include any loan forgiveness. And we learned that to avoid ever-increasing unfunded promises, the program needs to be set up so that more generous promises are paid for when they are made — by those who made them.

The advantages of income-contingent lending are so great that we should not delay in implementing this new and better student lending system, making sure to incorporate all the lessons we’ve learned the hard way.

Andrew Gillen is the research director at Education Sector.

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Senate approves student loan bill by surprisingly large margin

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With Democrats split, near-unanimous support from Republicans results in surprisingly comfortable passage for bipartisan compromise to tie student loan rates to market.


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