Lately there have been some powerful articles profiling college grads and others who are struggling to make their student loan payments. While all of the reporting does a great job of personalizing the debilitating financial distress a generation of young adults is currently experiencing, there are so many numbers being bandied about that it’s hard to figure out who owes what and to whom, how bad the problem truly is and what’s being done (or not) to remedy the situation.
In his Bloomberg piece, Peter Coy writes about the prospective bursting of a trillion-dollar debt bubble that can be traced back to, among other things, the increasingly unaffordable cost of college. He also touches upon the need for bankruptcy reform—a topic that Ron Lieber covered in a related story the week before.
In contrast, Andrew Martin focuses on the debt-collection companies that, according to his piece in the New York Times, are exacerbating the problem because they appear to be paid more to resolve defaults than they are to prevent them from occurring in the first place. John Hechinger also wrote about this issue a few months ago.
These are all important and illuminating stories, but I worry that we’re losing our way in this stormy sea of statistics. So, let’s start by deconstructing the data points.
Crunching the Numbers
According to the U.S. Department of Education’s 2011 Agency Financial Report, the government held $530 billion of student loans as of September 30, 2011 (note: September 30 marks then end of government’s fiscal year). The report also discloses (in Note 6) that the feds are on the hook for an additional $321 billion of student loans that other lenders originated on its behalf prior to the 2010 implementation of the DOE’s Direct Loan Program, which replaced the discontinued Federal Family Education Loan Program (FFEL).
Therefore, if total student loan debt is roughly $1 trillion and if the government owns or guarantees 85% of that amount ($530 billion plus $321 billion), it would appear that private student loans make up the $150 billion balance, right?
Yes, but before you dismiss the private lenders for being a very small part of the problem, consider this: these companies still own the aforementioned $321 billion that’s guaranteed by the feds. (In fact, SallieMae owned $138 billion of that amount as of December 31, 2011.) That means they actually control $471 billion of the $1 trillion, or 47% compared with the government’s 53%.
In other words, the private lenders aren’t just the tail wagging the dog—they are the dog, along with the government.
As for the past-due payment data, according to a March 2012 Federal Reserve Bank of New York report, student loan payment delinquencies, which the FRBNY defines as 90 or more days past due, totaled 8.9%.
First of all, a delinquent payment is one that remains unpaid after its grace period. That means 5, 10 or perhaps, 15 days past the due date—not 90. A more accurate (and meaningful) measurement would be to report delinquencies at 30 or more days past due. More on that in a moment.
Second, think about how hard it is to catch up after one or two months of missed payments, let alone three or more. The odds are people who find themselves in this predicament will remain there for some time, incurring late fees and added interest.
And third, the FRBNY notes in its report that even the 8.9% rate that’s measured at 90 days is misleading. That’s because it estimates that only 47% of all student loans are in repayment mode (the rest are in deferral because the students are still in school). Therefore, that 8.9% is actually closer to 19%. Moreover, the FRBNY estimates that approximately 27% of borrowers had one or more accounts past due at that time of its report, which leads me to my next point.
This very high rate of delinquency is all the more reason to focus on how this massive portfolio of loans is being managed. To start, it is absolutely mind boggling to me how the incentives to cure loan defaults could be greater than those that are intended to discourage them from occurring in the first place. It’s analogous to paying someone to show up for work and awarding a bonus for doing the job.
Given that the aggregate student loan debt is a little less than 10% of the value of all consumer indebtedness and nearly $150 billion more than for credit cards alone, it’s no wonder that those who work in the “accounts receivable management industry”—as the debt collection companies prefer to be known—are pretty enthusiastic about their future prospects, particularly when, according to Andrew Martin’s article, the DOE paid out a little more than $1.4 billion to its authorized collection companies this past year: $355 million to unaffiliated firms and just over $1 billion to so-called guarantee agencies—the private lenders that had been the middlemen under the discontinued FFEL Program.
Frankly, it’s that $1 billion that troubles me the most, and not because of its magnitude. I’m trying to understand the rationale behind compensating a company for originating a loan and then again for remedying what it had already put on the books. In my former life, we used to call this “chewing the same food twice,” and prohibited it. The government and SallieMae appear to think otherwise because Sallie’s collection company subsidiary, Pioneer Credit Recovery, Inc., continues to earn fees for the work it’s been doing on the government’s and its corporate parent’s behalf.
This notwithstanding, loan remediation isn’t easy, and those who specialize in this area deserve to be compensated for their efforts. But the ultimate owner of the loans (the government in this instance) has to decide whether the goal of collecting materially past-due dollars is more important than the preventative work its agents should be doing day-in and day-out.
I say that because compensation drives behavior. As such, paying a higher bounty for the collection of defaulted loans will pretty much assure that there’ll be a constant flow of them. I also believe that standing by as a borrower misses more payments than he or she can ever hope to make up is immoral, especially when that borrower could have been preemptively transitioned into one of the many relief programs the government admits are not being utilized to the extent that it had envisioned, which leads me to my last point.
What Needs to be Done
Sure, we can point our fingers at the schools for pursuing a flawed business model that has tuition prices increasing at more than twice the rate of inflation, the government and private lenders that facilitated this unsustainable scheme with easy money packaged within unrealistic repayment terms at unjustified interest rates (for the private loans), and the parents and students who failed to shop and borrow prudently. But we are where we are: dealing with a younger generation who, for the first time in memory, are facing the prospect of living in the shadow of their parents’ economic accomplishments, not to mention what this portends for our country.
Once again, I am advocating for the expansion of the government’s Income-Based Repayment Program to include all loans without preconditions (i.e.; older, restructured, defaulted and private loans), using a 10% of discretionary income formula with a maximum term of 20 years, and an interest rate that’s equal to that which is currently being charged under the subsidized Stafford Loan program (3.4%). The government can well afford to do this.
I also believe the bankruptcy laws should be changed to permit the discharge of private student loan debt because it’s the only way to properly motivate those lenders to work in good faith with their financially distressed borrowers. Education loans are uncollateralized: there’s nothing to repossess and sell in order to offset the loss. Consequently, bankruptcy is the last thing a lender should want to see happen.
And finally, if the government continues to outsource its payment collection process, the direction it gives, the goals it sets and the incentives it pays should be revisited. After all, we’re talking about debts that are often the size of mortgages, held by borrowers who may never be able to generate enough cash flow to pay them back. These loans require active management with modifications put into place well before the payments start to go missing, even if it means that the lenders may not be repaid in full.
There’s an old lending adage: “A rolling loan gathers no loss.” As long as you keep modifying the payments and extending the repayment term, you’ll stand a better chance of coming out whole. Unfortunately, I just can’t see how this will come to pass when you consider the magnitude of the unpaid debt, the low probability of full repayment—even with more time to do so—and most of all, the hopelessness that’s felt by those whose lives have been diminished because of poor advice and misguided decisions. The popping of this debt bubble is going to grow more painful and costly the longer we wait.
This story is an Op/Ed contribution to Credit.com and does not represent the views of the company or its affiliates.
Image: Hartwig HKD, via Flickr