Student loan debt has become a familiar topic of conversation in the upcoming presidential election. However, this has also been a frequent topic in previous elections, with many promises being made, but eventually left undelivered. Student loan debt in this country exceeds both the accumulated amount of automobile finance debt and even exceeds the total amount of credit card debt. However, the amount of student loan debt which is in a period of active repayment is significantly less than debts and other categories. As a result, the student loan debt continues to increase at a pace that is outstripping the payments that are being made, as most payments are covering only interest and penalties. Because of the special protections that student loan debt enjoys, including protection from discharge in bankruptcy, it is a problem that is not going to go away. Our first blog on this issue was in December 2010, and the situation has continued to deteriorate. How did we get here, and who is to blame? Based on conversations with thousands of consumers, the review of as many documents, and our research, this is what we have learned at Leiden & Leiden. The blame can be spread around very evenly, and these are the parties that are responsible:
The Federal Government
Prior to 1978, student loan debt was treated the same as any other type of personal or installment loan in bankruptcy. This meant that student loans could be easily obtained, and then discharged shortly after the students graduated. This was especially problematic for lenders to graduates who obtained professional degrees, such as medicine or law, and had the long-term prospect of a very high income but were underpaid in their first few years of practice. They were easily eligible to qualify for a Chapter 7 bankruptcy based on their limited income, and discharge the obligations that allowed them to receive their degrees.
To encourage student loan lending, and protect the lender, Congress changed the Bankruptcy Code to require that student loans would have to be in a period of repayment for at least 7 years before they could be discharged in bankruptcy. The Bankruptcy Code was later altered, as part of the Higher Education Act of 1994 – to eliminate a specific timeframe for the discharge of student loans. It also changed the designation from student loan debt to the broader description of educational loan debt, so that loans extended for purposes that did not include the payment of tuition (such as for books, housing, and living expenses) also received the same blanket protection. Under this present version of the Bankruptcy Code, educational loan debt can only be discharged in the exceptionally rare circumstances in which the borrower could demonstrate undue hardship.
The Federal Government also enacted the American Opportunity Credit, which was an income tax credit available to individuals who had been students during that particular tax year. This enabled individuals to borrow money to attend school, with the immediate prospect of receiving up to a $1,000 tax credit, while not having to worry about immediately repaying the student loans which are necessary to qualify for that credit. Citizens who were desperate for money in the short-term could borrow money to attend a semester of school and qualify for the credit, and then worry later about paying the attendant educational loan debt.
Finally, the biggest contribution by the federal government to the student loan crisis was its lack of oversight over the lenders for whom loans were guaranteed and institutions that were receiving the student loan funds. Congress clearly failed the American public for over two decades with respect to the stewardship of taxpayer funds contributed towards higher education and the extension of protection of student loan debt. Contrary to what the public may be told, this is not a recent development and is one which could have easily been averted, or at the worst, diminished.
Student Loan Lenders
There is always going to be a certain amount of risk in lending money to young individuals with no credit history, and no immediate ability to repay. However, the student loan lenders are counting on the fact that graduates will obtain their degrees and will have a continuous source of income with which to service their student loan debt. But the protection from discharge in bankruptcy which had been enacted by Congress created unbridled and financially unsupported optimism among student loan lenders. Their lending standards gradually relaxed, and they were willing to lend more money with longer repayment terms, even though the creditworthiness of their borrowers remained unchanged. There was little or no correlation with respect to the amount that could be borrowed, relative to the institution or type of degree that was being pursued. Institutions that were not previously the recipient of student loans – such as cosmetology schools were truck driving schools – saw an influx of students who were student loan borrowers. The lenders failed to realize that the inability to discharge educational loans in bankruptcy did not mean that the borrowers would have the financial ability or willingness to pay the loans back (especially in the instances when they did not graduate), which is precisely what has occurred.
Financial Aid Offices
Whether the institution was a for-profit institution or a state-sponsored nonprofit institution, the emphasis in financial aid offices began to shift from enabling the education of the student loan borrowers, to maximizing the stream of revenue for the university itself. Many times, the financial obligations of the student loans were inadequately or poorly explained to the students. Parents were contacted on the eve of the semester and informed of tuition shortfalls and convinced to personally guarantee educational loan debt. It became easier to recommend borrowing the money, rather than to seek alternate methods by which a student could finance the completion of their higher education. At worst – especially with some of the for-profit institutions that have now been driven out of the industry – blatant fraud was committed to obtaining educational loan qualifications for otherwise unqualified borrowers.
The Proliferation of For-Profit Colleges/Universities
After the federal government had protected educational loan debt from discharge in bankruptcy and began permissively guaranteeing student loans, the for-profit educational industry exploded. Obviously, it is very difficult for somebody who is already in a career to begin or complete their higher education. Offering classes online, or at non-traditional times, is usually the only way to accommodate a person’s schedule. However, the inundation of slick advertising by the for-profit educational industry promoted unrealistic expectations. Additionally, very little effort was made to keep the clients engaged, especially as their student loan funding began to diminish. Tuition at such institutions was almost entirely derived from borrowed money, rather than accumulated savings from the students. Because almost all of the financial aid and student loan applications were handled in-house, many students had no idea how much they were borrowing, or what the repayment terms would be. As indicated above, many students were falsely led to believe that they were receiving some type of scholarship or grant, which would not require later payments.
The Greed of Traditional, Nonprofit Colleges/Universities
Not to be outdone by the for-profit educational industry, traditional brick and mortar institutions were quick to take advantage of the huge increase in student loan lending. Much like the housing boom, where risky, indefensible real estate loans were extended, artificially driving up housing prices, the educational industry is going through a similar scenario. As money available to students and their families through student loan lending skyrocketed, traditional colleges simply raised their tuition. The price of tuition was based on what somebody was willing and able to pay (i.e. borrow), more so than the quality/quantity of education that was to be delivered. With the additional money generated, colleges and universities pursued ambitious plans for construction, remodeling, and/or expansion of their physical premises, which they used to justify the tuition hikes. If there will be a silver lining to the student loan crisis, regardless of how it is resolved, it will most notably be seen in a reduction in tuition, since the amount of money available to pay for higher education will be substantially diminished, and universities will have to compete for a smaller pool of applicants.
The Borrowers
There is no doubt that a portion of the students was reckless in their borrowing, and paid little attention to the total amount borrowed, or how it would be paid back. Some student loan borrowers were unrealistic about their financial future, and their ability to make their student loan payments going forward. Other students lacked the discipline or opportunity to complete their education and did not obtain a degree which would give them the ability to obtain suitable employment to service their student loan debt. There were probably some student loan borrowers who had no intention of paying the money back, whether or not a degree was achieved. Some borrowers were simply obtaining student loans so that they could be enrolled in school as long as it took to qualify for and receive unemployment benefits, or some other government-sponsored benefit. Other borrowers were simply naïve and relied on the scant information that they were provided by the financial aid office. Regardless of how these borrowers accumulated their educational loan debt, many of them have exacerbated the amount of the debt by applying for deferments and forbearances, in which the interest on the loans is capitalized. Over time, they would wind up owning 50% or more of the actual amount that was paid towards their educational expenses, as interest compounded on interest. In many such circumstances, the amount of the debt becomes so much that the borrowers become hopeless, and make no attempts to address it.
Conclusion
Blame and culpability can be shared by all of these different parties. Obviously, there will be some overlap in responsibility, such as that shared by the financial aid offices and the institutions for whom they served. The finger-pointing between the different factions is to be expected, but has only made the creation of a solution that much more difficult, and maybe impossible. Unfortunately, there is not going to be an easy fix to this problem, and longtime consequences will be borne by all of the parties that are responsible. Some, like the for-profit educational industry, are already feeling the effects, as many schools have been shuttered. Likewise, consumers with a high amount of educational loan debt are struggling to finance housing or automobiles, due to the staggering debt to income ratio generated by the educational loan debt. Traditional institutions of higher education will probably begin feeling the effects in the next decade if student loan lending becomes more restricted, and applications for admission begin to diminish. This is especially true if some type of blanket or even partial student loan forgiveness is enacted, which would make student loan lenders wary of extending new loans, even in the least risky circumstances. Ultimately, the taxpaying citizens of the United States, whom the federal government represents, will bear a disproportionate share of the financial burden for all of the parties involved.
Leiden & Leiden consciously chooses to stay out of politics. However, it is important to be wary of anybody, regardless of party affiliation, who is attempting to seek election by promising some type of partial or full student loan forgiveness. There are too many other factors to be considered, equally economic, legal and political, which do not lend this student loan crisis to an easy resolution. All branches of government will have to play a part, with the active participation and cooperation of the banks that have extended the loans and their shareholders. Ultimately, without the coalition of the responsible parties, the promises of student loan forgiveness will go unmet, much to the disappointment of voters and supporters.