Monday, April 26, 2010

Sallie Mae is No Country Bumpkin


Boldfaced text denotes my emphasis.
Underlined black text denotes important terms, concepts, and people.
Italicized text denotes quotations

We know all about the easy money policies that lured people into crushing amounts of mortgage debt, but we hear less about how those same policies have encouraged impossible amounts of debt related to higher education, for undergraduates and graduate students alike – especially in the wake of the financial crisis, when the job picture for these students is so bleak.

While all this misery grips younger generations, Sallie Mae is sitting pretty. She's found a way to loan you money and have a guaranteed return no matter if you go broke.

How has Sallie Mae (and its far smaller competitors) found a way to a risk-free cash flow in an era where the Big Banks, mortgage companies, credit card companies, and even states and towns face record losses? The answer, and of course the problem itself, lies in Washington.

Most student loans have been either directly disbursed or indirectly insured by the federal government. In 2009, the Federal Family Education Loan Program that insures privately-originated loans was ended. The entire federal student loan market is now the Direct Loan ProgramSince the 1970's, it has been the case that federal loans were exempt from bankruptcy discharge (with caveats such as time limits that have been steadily eroded over the decades) in order, they say, to protect the taxpayer.

I am all for protecting the taxpayer, but flooding a specific credit market with government funds and guarantees and saying "have at it" doesn't protect the taxpayer against the mounting defaults in student loans. These defaults are the inevitable results of an over-expensive education and poor job prospects.

Government loans do nothing but cause tuition rates to rise uncontrollably. The reason for this is simple. When loans are either originated or guaranteed by the government, there is little incentive to control the amounts that are ultimately loaned to the student. Schools are the recipients of this money, after all, and they are then encouraged to make expansions, to raise pay for faculty, and of course to make exorbitant pension promises, which they would not have otherwise made. And, of course, if the loans are larger, then the interest received by the lender is larger still. It is a vicious circle indeed.

Next, there are private student loans. These are neither disbursed nor insured by the US Department of Education. As tuition hikes have been steeper than inflation for the last two decades, more students with nowhere to turn take out these dangerous loans to continue their education. The interest rate adjusts every year and can top 20%

Until 2005, private student loans could be discharged in bankruptcy like any other kind of bank loan. However, after that year's revisions to US bankruptcy laws, something profound occurred. Private student loans became the only kind of bank loan to be exempted from bankruptcy protection. The other exempted debts are alimony, child support, criminal fines, and, of course, taxes.

While in school, the payments on a student loan are typically deferred and will remain so for a grace period after the student finishes schooling. Private and many federal student loans, however, accrue interest throughout the education of the student and that interest is added to the total debt load once the grace period is over, a feature called interest capitalization. Thus any further interest charges will accrue on that higher debt load. This is a very dangerous situation.

Say a newly graduated borrower starts a job and begins payments on schedule. A year later, however, they are laid off. Their financial situation that necessitates skipping a student loan payment. Maybe two.

If a borrower fails to make payments, then penalties will rack up. Once they become current again, they make timely payments, but ran into more difficulty. Before missing due dates, they might now try a forbearance from payments. Yet the interest still piles on daily. Forbearance periods are limited and once expired, the borrower finally decides, or is forced through poverty, to simply not make the payments. After some months of harassment and chastisement, the account is considered in default and the loan (including the original principle (borrowed amount), interest, fees, and penalties) is reimbursed to the lender by the federal government and the amount is pursued by a special kind of collection agency called a Student Loan Guarantor
To exit default, the borrower must go through a months-long process known as rehabilitation. Until then, up to 25% of their paycheck (wage garnishment) will be sent to the Guarantor, as well as every last cent of their federal, state, and municipal tax refund (tax refund interception). Federal loans in default do not need a court order to begin wage garnishments, while private lenders must first file a lawsuit.

As of this writing (April 26th, 2010), student loan debt stands at around $700 billion. However, only a fraction of that debt is in repayment. The rest is defaulted, in forbearance, or deferred while in school, racking up interest, waiting for students to graduate in bondage. Schools nationwide would have a budget crisis if federal loans were ended. The only way these schools would remain functional would be if they massively and rapidly cut costs, leading to dramatically lower tuition. Cutting out the financial intermediary and forcing schools to deal with the direct pockets of parents and students will lead these exorbitant tuition rates to come falling back to earth.

There is yet another trap in the student loan system: professional licensing. If one defaults on student loans it is quite possible that they will be denied state-sanctioned occupational licenses (such as teachers, medical personnel, trade licenses, etc.). On top of this, if one enters default subsequent to receiving such a license, they may be denied renewal.

What this means is that even if you have the motivation, the knowledge, and yes, the degree, defaulted student loans prevent you from advancing in your career, locking one in low wage employment and garnishment, or unemployment altogether, while the specter of the debt looms.

Unless the federal student loan program is immediately ceased, we will never see falling tuition. Unless the bankruptcy exemption is repealed, we will never see anything but despair from this generation emerging from our schools to no or low-paying jobs.

In reinstating the eligibility of bankruptcy for student loans, the borrower side of this problem is not overlooked. It is indeed true that if borrowers were not there to borrow, there would be no debt crisis. But this ignores the nuances of the issue of education debt. Beyond being non-dischargeable, the fact is that high school children and their parents are bombarded with propaganda regarding making "a million dollars more over your lifetime" when compared to a non-college graduate. 

The years-long scourge of bankruptcy will still be felt and rightly so. One should also note that most people would not simply declare bankruptcy for the very reason that they will have that scourge on their credit report. But for those in dire straits, instead of servicing a perpetual debt, their resources can finally go to productive efforts. These resources and efforts that education is supposed to enhance have been hijacked by statute in order to concentrate wealth. Unfortunately, I doubt the US will undo a risk-free (for now) stream of revenue to the federal government and its crony banks.

The situation is dire. Student loans are a silent crisis because there are no reports of massive losses to lenders in this sector; losses don't particularly exist due to bankruptcy law.  Even if most students don't understand the economics of student loans, they feel the social and familial effects of crushing debt. Parents are also on the hook for loans as both co-signers and the direct borrowers. Stressed as they are, I'm sure all too many sometimes give their kid a tongue lashing over all that money they're spending for their future. 
Indeed, even parents on Social Security, and with little or no other income, can see those checks garnished. This only makes the student angrier and more resentful of the cost of education. They know something is desperately wrong. 

Still, for those with overwhelming private student loan debt, each state has laws related to debt called the statutes of limitation (federal student loans are exempt, they have no statute of limitation). Learn them and enforce them with the help of bankruptcy lawyers on private student loan collectors. Remember that they must win a lawsuit to actually collect from you. State law also prohibits garnishment from varying amounts of disposable income, so if you make less than that capped amount, you may not face garnishment even if the lender has won the lawsuit, And finally remember that any written demand to cease phone contact should end any harassment. 

Finally, the issue of SLABS must be addressed. These are Student Loan Asset Backed Securities. Just as Mortgage [Asset] Backed Securities (MBS) entitled the bondholder to a share of the cash flow from mortgage payments while allowing lenders to make more and larger mortgage loans, SLABS are bonds that are sold to investors which entitles them to a piece of the cash flow of student loan payments while allowing lenders to make more and larger loans when accounts of new students and their parents are first opened.

As we all learned (or didn't?) from the mortgage fiasco, once the mortgage borrower is no longer making payments, the system collapses, as the scheme's cash flow depended on the borrower making timely payments. The reason SLABS have not seen such a crisis is because of the bankruptcy exemption.

But this can only continue for so long. Eventually what is due to investors in interest payments and what is due to employees in wages and benefits will outpace what the Department of Education, Sallie Mae, and company receive in normal loan payments, garnishments, and tax refund seizures, and the bubble has popped. [01/27/2013 EDIT: IT SEEMS EVEN SALLIE MAE UNDERSTANDS THAT THEY WILL NOT BE PAID BACK FOR THEIR LOANS AND SEEK TO PURGE THEIR LOAN PORTFOLIO OF THOSE DEFAULTED ACCOUNTS.]

This government-created and sustained niche financial market is making some very evil people very rich. Corporatocracy is ugly: Big business using the code of law to secure and  expand the profits of their industry. Nauseating.

So for now, it is true, Sallie Mae is no country bumpkin. Former CEO Al Lord told an audience in 2003:

It would be very hard for me to tell you that what I make is not a lot of money.
This usurious snake in the grass (no offense to snakes) made a comfortable $5.4 million  this past year, tragically cut by a third from 2008, but I'm sure he consoles himself on his $4.2 million personal golf course.

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