What’s Driving the Student Debt Bubble?
At more than one trillion dollars - that's $1,000,000,000,000 - student loans have grown to exceed total credit card debt. Debt has become a standard part of the college experience. Students take it on because they expect it to pay off in better jobs and higher salaries. But many will be disappointed. The buildup of debt in a weak job market means many of them cannot repay the loans and wind up in default. Many students’ expectations of earning potential, moreover, would be unrealistic even in better economic times.
The boom in student debt derives from the financialization of the U.S. economy. In recent years financial institutions have enjoyed soaring profits and growing political power, as the bailout from the financial crisis of 2008 showed. They created the mortgage bubble by encouraging people to take out loans that were likely to end in foreclosure, deceiving them about the terms of mortgages and “robosigning” documents that borrowers never saw, much less understood. Lenders could afford to offer mortgages at high risk of nonpayment, because they were securitized—packaged and resold to investors—so that the investors, not the lender, stood to lose in case of default. Major banks, moreover, could be confident that they were “too big to fail,” and that the federal government would bail them out if too many loans went bad.
The Student Loan Boom
A recent report by the new federal Consumer Financial Protection Bureau shows that something similar has happened with student loans. Most loans still come from or are subsidized by the federal government, but according to the CFPB the private student loan market grew from less than $7 billion in 2001 to more than $20 billion in 2008 (although it dropped off sharply after the financial crisis, and stands at $5.7 billion today).
Before the financial crisis, banks sought out student loans to create new investment instruments. Circumventing college financial aid offices, they marketed loans directly to students on apparently easy terms, accepting lower minimum credit ratings than required for federal loans and imposing no limit on the amount a student could borrow. Interest rates on these private loans are generally variable and often “risk-based,” that is, higher for borrowers with lower credit ratings.
Like mortgages, these loans are turned into asset-backed securities. Thousands of loans are “sliced and diced” into assets that can be sold as a package to big investors. As with securitized mortgages, the lender bears no risk and therefore has an incentive to market loans without regard for ability to repay.
Students take out loans because they expect payoffs and also because of the escalating cost of college, itself the product of several factors: colleges market themselves by spending lavishly on amenities to attract students, and then raise tuition to pay for them. Many colleges have reduced or abandoned need-based scholarships, instead funding students whose high test scores or other attributes improve the college’s profile, making it more marketable. Even state legislatures are disinvesting in higher education; nationally, spending per public college student, when adjusted for inflation, fell to a 25-year low in 2012.
Nor has government aid kept up with rising costs. Though appropriations for federal Pell Grant aid have risen, the maximum grant is expected to cover less than one-third of the average cost of attendance at public four-year colleges, a level that The Institute for College Access and Success (TICAS) has said would be “the lowest in history.”
The Role of For-Profit Colleges
Students in private, for-profit universities have the biggest debt problems. Enrollment in these schools more than tripled between 2001 and 2010, to 2.4 million, or 13 percent of college students today; they receive about a quarter of federal student loans and grants. A recent report from the Senate Health, Education, Labor and Pensions Committee shows that their educational record is poor. 54% of students entering in 2008-2009 dropped out within two years.
These colleges recruit students aggressively and encourage them to take out federal loans. More than 80% of the revenue of some schools comes from the federal government, either loans or Pell grants. They often entice a student to take out the maximum allowable federal loan by calculating the student’s maximum eligibility, and then offering a “scholarship” to make up the difference between the potential loan and tuition. Among 30 companies that own for-profit colleges, analyzed in the Senate report, an average of 22.4% of revenue went to marketing and recruiting, 19.4% to profits and 17.7% to instruction.
96% of students at for-profit colleges take out loans, compared to 57% at nonprofit private colleges, 48% at four-year public colleges, and 13% at community colleges. Costs are higher than at other schools. Students at for-profit colleges make up 13% of total college enrollment, but account for 47% of the defaults.
The boom in private for-profit colleges has been encouraged by conservative lawmakers, who promote the private sector in education as in other areas, supposedly to bring competition to the education market. They also want to keep the federal government out of lending. Missouri Senate candidate Todd Akin, recently made famous for his statement about “legitimate rape,” says government-supported student loans are “the third stage cancer of socialism” and has called for an end to federal government involvement in favor of an expanded private sector role.
What Happens in Default
With growing indebtedness, student debt default has increased dramatically: According to TICAS’s Project on Student Debt, 8.8% of borrowers who began repayment in 2009 had defaulted by the end of 2010, up from 7% for those entering repayment in 2008. For students at for-profit private institutions, the rate was 15%.
The consequences of default depend significantly on the kind of loan. For federal loans, the government can garnish wages and retain tax refunds. A borrower in default is ineligible to defer payment or receive future loans. Federal loans, however, offer more lenient grace periods and opportunities to defer payment than loans made directly by banks, which have much more rigid repayment conditions. Private lenders can charge additional fees and usually consider the borrower in default after the first missed payment. They must sue in court to collect on a default, but if they succeed they can garnish wages, tap into bank accounts, and put a lien on the defaulter’s home.
Amendments to the federal bankruptcy code passed in 2005 make all student loans—federal, federally guaranteed, or private—nearly impossible to discharge in bankruptcy, so the debt stays with the student for a lifetime, sometimes even beyond. After the financial crisis, lenders began more regularly requiring a cosigner, very likely a parent, who is obligated to pay if the borrower dies.
The nearly simultaneous publication in July of the CFPB report on private student loans and the Senate report on for-profit colleges gives the issues of college financing a needed look. These two experiments with private enterprise in education show that when government subsidizes the “free” market, the businesses that get created are much better at absorbing federal dollars than they are at providing genuine educational services.
But privatization and corporatization affects all kinds of colleges, not just the for-profits but public and traditional private institutions as well. They act more and more like capitalist businesses: see, for example, the full-page ad from Mercy College in the New York Times on September 9, boasting that it has an A rating from Standard & Poor’s. They adopt business-oriented practices, notably the centralization of decision-making in college administrations, deceptive marketing, and reliance on the cheap and disposable labor of adjuncts for the bulk of teaching. Colleges have become more concerned about generating revenue and promoting institutional prestige than about actually educating students.
But the students, especially those trapped in debt, pay the bill.