More than 40 million Americans have student debt, totaling at least $1.2 trillion. On average, borrowers out of school owe $36,000, with a monthly payment of $680. Roughly 11 percent of borrowers are in default. Overall, indebtedness discourages people from starting degrees, families and businesses, dragging everyone down.
Or almost everyone. One person's debt is another person's asset. What some owe, others own. And student debtors don't just cut checks to lenders. Our money flows to third parties — including investors.
One rarely discussed feature of the "student loan industrial complex" is the $200 billion market for student loan asset-backed securities (SLABS). This is a circular business, involving lenders like Sallie Mae and big banks like Wells Fargo and Bank of America. Like mortgages, student loans get pooled and repackaged into new financial products (securities). The lenders then sell the securities to investors. Investors receive the reward of monthly loan payments, plus interest. They can hold the securities themselves, trade them or bet on them. In turn, lenders receive quick cash, including fees and commissions, and push the risk of the underlying loans onto investors. This shift allows lenders to make more, and larger, loans.
In theory, more loans means the securitization process benefits borrowers.
But reality suggests otherwise. Student debt is special, as borrowers shoulder most consequences of non-payment. As such, SLABS players gain from an increasing supply of student debtors saddled with heavy, almost inescapable burdens.
Absent the most extreme circumstances, borrowers can't declare bankruptcy and have their student loans forgiven like other debts. The threshold for relief is so high, and lawyers are so expensive, that fewer than 1,000 borrowers even try each year. For most loans, if borrowers don't pay on time, the government can dip into wages, unemployment benefits, tax refunds and even Social Security checks. Unlike mortgage borrowers, who can hand over their keys and walk away, student debtors can't return their diplomas. Overall, these constraints for borrowers make SLABS uniquely safe investments. As one corporate attorney explained in the Wall Street Journal last year, SLABS are attractive primarily because of harsh bankruptcy legislation.
Most SLABS investors also benefit from government insurance. From 1965 to 2010, both public and private lenders made loans with 97 to100 percent of their value insured by the federal government. Of the outstanding volume of SLABS, $160 billion worth (roughly 80 percent) are backed by these government-insured loans. This means even if borrowers default, and investors have to wait for their money, they're still guaranteed to get it.
You'd think a surefire bailout would decrease resistance to debtor relief. But investors want timely payments; they fear federal relief programs might slow cash flow from an otherwise "bulletproof asset class." This creates twisted incentives, especially for SLABS players involved in loan servicing: They often have a stake in borrowers defaulting rather than paying smaller amounts over a longer period of time.
It's perverse policy — bankers are pampered because student debtors are hounded and pounded. To help borrowers, the government should facilitate bankruptcy reform and expand federal relief programs. But we have deeper problems: Lenders, servicers, collectors and investors prosper while students suffer because schools increasingly rely on private tuition rather than public funding.
The Higher Education Act, which governs the administration of many federal student aid programs, has expired. Its reauthorization is a crossroads. Elites want to cut federal lending in favor of private lending, but that's no good for borrowers or the economy overall, especially when one factors in private loan securitization. Private SLABS, or P-SLABS, are even more harmful than their counterparts. They're especially enticing to investors precisely because the underlying loans are even worse for debtors than federal loans — they have higher rates and stiffer terms. Coupled with grim changes to the bankruptcy code, demand for P-SLABS has already spiked total costs for students. The P-SLABS market is currently worth only $37 billion, but it's hot enough to include start-ups. If the market expands and explodes, things will worsen for borrowers; governments tend to stabilize financial markets by suspending the force of law for creditors and further tightening the screws on debtors.
As Mike Konczal has argued in Rolling Stone, rather than privatizing higher education finance, we should simply replace federal lending with stable federal spending. A public option of free college would not only fend off a SLABS nightmare, it would decrease student debt and lower tuition by pressuring the private sector to compete.
There are many ways to reprioritize funding to pay for free college. Above all, though, the myth that Washington is broke holds us back. The federal government doesn't have to balance its budget like states or schools, so it certainly doesn't have to profit from students. It can afford to simply spend money it's already lending, and absent inflation, it needn't increase taxes to do so. Even if you disagree with this increasingly popular perspective, higher education ultimately "pays for itself." In the long run, educated people tend to stuff public coffers by paying more in income and payroll taxes, and relying less on welfare programs.
We need free public universities, community colleges and historically black colleges and universities (or HBCUs). Those truly concerned with a swelling education sector should recognize why it's engorged. Most people pursue college because they want decent jobs. A true commitment to full employment and living wages would curb matriculation at schools that don't deliver — like for-profit colleges, the major sources of defaults and fiscal waste.
Most Americans agree that education is the great equalizer — everyone's climb to security and further opportunity. Yet our current policies kneecap students while giving financial firms a leg up. If we truly value learning, we'll stop bankrolling profiteers and put our public money where our mouth is.
Author: Raúl Carrillo