Student Loan Accountability: Put College Skin into the Game

Banks are required to have skin in the game when they originate and sell off high risk mortgages in public markets. This is a post financial meltdown reform. When selling low down payment mortgages to the markets banks must keep a portion of these home-grown mortgages on their own books. No longer can banks pass along the burdens of bad underwriting to financial markets without paying a big price.  

Prior to the 2008 financial crises, the big Wall Street banks (and many smaller banks like Angelo Mozilo's Countrywide Financial) ran mortgage production shops free from obligation. They placed mortgages, collected hefty fees and then sold mortgages off to unfortunate investors who were left holding the bag when inadequately vetted, no down payment and improperly priced loans became delinquent or went into default. There was little financial penalty if the originating banks failed to conduct the necessary due diligence or properly judge credit risk. To the contrary, in many cases originating banks cashed in on their malfeasance when, acting as loan servicers, they reaped the benefit of late payment charges and earned downstream foreclosure fees. 

While the real estate bubble was building, the chattering class said it was all to the good because lax loan standards were reaching out to minorities and promoting the laudable social objective of increasing home ownership. Liar loans resulted. Loan placements surged and real estate values skyrocketed. The real estate bubble was formed, which bursted ignominiously in late 2007 and through 2008, precipitating the worst recession in post World War II economic history.

So what do we have now? A college tuition bubble, blown to the bursting point by an unaccountable student loan process. It comes to you, growing by leaps and bounds, courtesy of crony collaboration between the good ole U.S. government and college administrators, fronted by students, institutions of higher education and university systems, and financed by loans. These days most anyone who wants tuition help qualifies for student loans so long as a college or university accepts them and certifies the student is making adequate progress towards a degree. The chattering class says, of course, the simple standards and simple program are promoting education and reaching out to minorities.  They publish tables showing the difference in average incomes between high school and college graduates, implying to naive 17 and 18 year old students that they, by matriculation, too will increase their earning potential regardless of the school, the degree or their academic performance.

As of 2013 total student loan debt has eclipsed $1 trillion, tripling in less than a decade. Recent graduates (and a portion of the 40 percent who fail to graduate) are saddled with an average of $35,000 debt.  The average borrower has $25,000 in debt, which has risen by 70 percent in less than a decade. 

Nothing this side of a pawn shop or a loan shark's fiefdom, is higher risk than student loans.  Almost 7 million borrowers, or 17 percent, are 90+ days delinquent. The 30-49 year age cohort has a higher delinquency rate. That's because the core delinquency rates are much higher than meets the eye, 31 percent for borrowers in repayment status. Many of the younger borrowers have yet to go into default only because they are temporarily in a period of grace or forbearance, such as due to the fact they are still in school.  

Yet the student loan balances continue to skyrocket, with balances now eclipsing even the Home Equity Line of Credit (HELOC) loans which played such a big role in driving the financial crisis.

Student loan debt is the only form of consumer debt that has grown since the peak of consumer debt in 2008. Balances of student loans have eclipsed both auto loans and credit cards, making student loan debt the largest form of consumer debt outside of mortgages. 

It's a mess.  The progressive political and lousy liberal answer is to clean up the mess by is loaning more and more at lesser and lesser rates.  Loan leverage destroys, so let's have more of it, right?

College administrators couldn't be happier with the policy and the numbers. Not only are they politically simpatico, but they collect big time on the vigorish. Student loans are administered by the colleges or universities. According to the United States Department of Education,

Typically, the college first applies your grant or loan money toward your tuition, fees, and (if you live on campus)room and board. Any money left over is paid to you for other expenses. You might be able to choose whether the leftover money comes to you by check, cash, a credit to your bank account, or another method.

In other words, first priority, the money goes straight into university administration pockets. Only the excess, which is usually nothing, comes back to the student.

Now here comes Massachusetts Senator Elizabeth Warren, who supports the lax and looney loosely administered student loan program as a moral imperative.  She says that efforts to reform the student loan system are "morally wrong." Instead of addressing issues and solving vexing problems, she is just one more sanctimonious, mean spirited, lying liberal, questioning the morality of her political competitors. The lady is scum.

Warren attacks to provide cover for slavishly serving the home team to the dereliction of the greater good. Her base is in Boston metropolitan area, known collectively as "America's College Town."

On the streets of Boston, college students are literally everywhere. More than 250,000 call it home which keeps the city young and energized. In fact, one in every five people is either a student or affiliated with higher education. And yes, there are more than 80 colleges in the region, but that is just the beginning. 

There¹s cross-registration and shared resources between schools, college events open to all students, inter-collegiate concerts, rival sports teams - the inter-connectedness of the student scene is incredible. 

Incredible?  Inter-connected? Young? Energized?  Does anyone really believe that's worth a trillion dollars of vigorish?

Here's the lineup of college crony enterprises whose freight Warren wants the federal government to finance. It's a bunch of way stations for the who's who of the elite.  

			College	Tuition
			MIT	$  42,050
			Harvard	$  38,891
			Harverford	$  45,018
			BU	$  42,400
			BC	$  44,870
			Tufts	$  43,688
			Northeastern	$  40,780
			Babson College	$  43,520
			Brandeis	$  42,682
			Holy Cross	$  43,660
			Williams College	$  46,330
			Smith	$  42,840
			Amherst	$  42,898
			Average	$  43,048

Slap on a $12K allowance for room and board and the total of average tuition, room and board of $55K exceeds median household income. 

Warren's bill for further reducing interest rates has the widespread support of college presidents, is endorsed by the American Association of University Professors, the American Federation of Teachers and is being pushed by an assortment of colleges and universities.  They want the money, all of them.

The full rejoinder to Warren is here,

In the student-loan world, there's immorality to spare—not in the still historically low interest rates, but in the principal of the thing. Student debt, which recently surpassed the trillion-dollar level in the U.S., is now a major burden on graduates, a burden that is often not offset by increased earnings from a college degree in say, race and gender issues, rather than engineering.

Why do students have so much debt? According to a recent study by Mark Perry, a professor of economics and finance at the University of Michigan at Flint, between 1978 and 2011 college tuition in the U.S. increased at an annual rate of 7.45%, vastly exceeding the rate of inflation and the almost-stagnant rate of growth in family incomes.

According to an extensive 2012 analysis by the Associated Press of college graduates 25 and younger, 50% are either unemployed or in jobs that don't require a college degree. Then there are the large numbers who don't graduate at all. According to the National Student Clearinghouse Research Center, more than 40% of full-time students at four-year institutions fail to graduate within six years. The National Center for Education Statistics reports that almost 75% of community-college students fail to graduate within three years. Those students don't have degrees, but they often still have debt.

Glenn Harlan Reynolds, a law professor at the University of Tennessee, outlines the solution as follows.

In truth, America's student loan problem won't be solved by low interest rates—for many students, the debt would be crippling even if the interest rate were zero.

If we want to solve the very real problem of excessive student-loan debt, college costs need to be brought under control. A 2010 study by the Goldwater Institute identified "administrative bloat" as a leading reason for higher costs. The study found that many American universities now have more salaried administrators than teaching faculty.

Another way to approach costs is to remove the incentives for universities to accept government-subsidized student-loan money regardless of a student's prospects of graduation or gainful employment. Under the current setup, incentives run the other way: Schools get their money up front via student loans; if students are unable to pay the loans back, the burden falls on taxpayers (if the loan was "guaranteed" by the federal government), and the students themselves, while the schools get off scot-free.

A serious student-loan fix would change this incentive. First, federal aid could be capped, perhaps at a national average, or simply indexed to the consumer-price index, making it harder for schools to raise tuition willy-nilly. Second, schools that receive subsidized loan money could be left on the hook for a percentage of the loan balance if students default. I would favor allowing students who can't pay to discharge their loan balances in bankruptcy after a reasonable time—say, five to seven years, maybe even 10—with the institutions that got the money being liable to the guarantors (i.e., the taxpayers) for, say, 10% or 20% of the balance.

You can bet that under this kind of a rule, universities would be much more careful about encouraging students to take on significant debt unless they are fully committed first to graduating, and second to a realistic career path that would enable them to service that debt over time. At the very least, schools would be more likely to warn students of the risks.
Even thinking about the impact of such a "skin in the game" rule for colleges helps to illustrate the irresponsible—even, in Elizabeth Warren's words, "immoral"—way that colleges up to now have dealt with costs and with debt. If lawmakers were serious about helping students pay for college, Congress would be considering more than simply continuing low interest rates on ever-higher student-loan balances.

I disagree with Mr. Reynolds. After all, he works for a university and can't afford to be too tough on his employer.  The universities ought to start paying up at least 50 percent of the defaults and should be given the tools to manage the debt explosion.  Then, and only then, with major reforms, would we see morality, sanity and soundness work their way back into the student loan system.