Student Loans: The Profit and the Pauper
The New York Times
July 29, 2007
Student Loans | Viewpoint
The Profit and the Pauper
By JOE NOCERA
I GRADUATED from college about $8,000 in debt.
Yes, I know, with English majors now emerging from graduate school saddled with as much as $100,000 worth of student loans, my puny amount seems almost laughable. But it was a different era — 1974 — and, at least to me, it was real money.
I was exactly the kind of person the student loan program is intended to help; without those loans, I could never have afforded to go to a private university. But I was also the kind of college graduate who was always going to struggle to pay the loans back. I entered the job market in the teeth of a recession. I had to ask for a one-year “hardship” delay because I couldn’t find a job. And when I finally did find work, it was fulfilling but low-paying.
Consequently, I was constantly falling behind on my payments. The bank that administered my federally guaranteed loans would send a stern notice whenever I got too far behind, which would prompt me to cobble together a few payments by skipping some other bill. Then I would start falling behind again.
Though I found the situation onerous at the time, what strikes me now is how benign it actually was. My bank probably didn’t make a dime on me. It never raised my interest rate as punishment, nor did I ever have to pay any late fees. My chronic tardiness didn’t even affect my credit rating. And had I defaulted, I would not have had my wages garnished, or been stuck with the debt if I had filed for bankruptcy. All of which can happen today.
“Student loans have become big business,” says Barmak Nassirian, the executive director of the American Association of Collegiate Registrars and Admissions Officers — and high interest rates and hefty late fees are part of what makes it so profitable. Many a student comes out of college only to discover that his loan has become a noose around his neck.
For some months now, the news about student loans has largely been about scandal — how lenders have curried favor with financial aid officers to get on their “preferred lender” lists, for instance. Bills in both the House and the Senate aim to reform the system. But there is a larger, perhaps sadder story here: How did this critically important social program become so unmoored from its original intent, which was to help poor and middle-class students pay for college? To put it another way, why did student loans become more about shareholders than about students?
GEORGE MILLER, a Democratic Congressman from California, has been obsessing about student loans for a long time. “If you were going to start this program all over again,” he says “you would go back to the concept that this is a service, and an investment, provided by the federal government. And you would probably go back to a direct loan program, funded with some sort of revolving fund. That is how the G.I. bill worked. But that is now viewed as foreign and wrongheaded. Now we have this idea that there has to be a business model.”
Representative Miller is the author of the bill passed by the House earlier this month. It calls for many useful changes. It raises the amount a student can borrow, which is necessary because the cost of college has risen so dramatically. Over the next five years it cuts interest rates in half, to 3.4 percent, for the neediest students. It insures that no more than 15 percent of a graduate’s income would have to go toward repayment — an important idea, since recent graduates shouldn’t have to choose a job based solely on how much it pays.
But let’s be honest here. No reform legislation is going to change the essential nature of any business, and student loans are no exception.
Big lenders will see their subsidies lowered, but they will still be guaranteed big profits. They will still be able to charge those late fees and higher interest rates when borrowers get in trouble. And they will still be able to pursue deadbeats practically into the grave, since people who file for bankruptcy have to keep paying back their student loans — an astonishing exception to the bankruptcy law that lenders lobbied for, and won, in the 1990s. The student loan business will still be, well, a business.
The critical markers in the evolution of the student loan begin, really, with the decision to offer federally guaranteed loans through banks and other financial institutions. It didn’t have to be done that way. Congress could have decided that only the government could lend taxpayer dollars. But without a middleman, the loans would be listed as outstanding on the government’s books, thus increasing the federal deficit. It was far more politically attractive to use banks to make the loans, and then guarantee them with the taxpayers’ money.
Even with the guarantee, banks were not terribly excited about administering a loan program for college students with uncertain job prospects. So the government tried to make lending even more attractive. It subsidized the interest rates. In the case of a default, it guaranteed that banks would get back not just the principal but the interest. It took all the risk out of lending.
And to get more loans into the hands of students, in 1972 the government established a quasi-government entity, the Student Loan Marketing Association, now known as Sallie Mae. Sallie’s role was to buy up student loans from banks, freeing capital for yet more loans. It could also market and service loans, but it could not originate them. Although always a corporation — much the way Fannie Mae and Freddie Mac have both government status and corporate status — “it didn’t go all out in search of the next buck,” Mr. Nassarian says.
In the 1990s, two important events took place. First, Congress finally decided to lend directly to students. The Direct Loan Program was an immediate hit; within a few years, it had 40 percent of the market. But this was not the kind of G.I. bill, revolving-fund loan that Representative Miller envisions; its intent was to minimize the cost to the taxpayer, not to the student. So it had many of the late fees and higher interest penalties that private lenders were allowed to impose, and the interest rate was the same, 6.8 percent. Shortly after the program passed, the Republicans won both houses of Congress, and began fighting a rear-guard action against it.
Second, Sallie Mae broke away from the federal government. Its chief executive was an aggressive, profit-oriented man named Albert L. Lord, who feared that the Direct Loan Program would hurt Sallie. Privatization would enable him to fight back.
Once it had the ability to originate loans, Sallie devised marketing plans, sought ways to undercut the government lending program and began convincing college financial aid officers to give it special preference. It wasn’t too long before private lenders won back some of the market share they had lost to the Direct Loan Program; they now control about 75 percent of the market.
As for Sallie Mae, by early 2006, it controlled 35 percent of the federally guaranteed student loan market; No. 2, Citibank, had less than 10 percent. Sallie is also the dominant player in the private student loan market — that is, loans that are not federally guaranteed. Between the two, it originated $23.4 billion in loans last year alone, and made more than $1 billion in profits.
“Sallie revolutionized the industry,” says Representative Miller, and he doesn’t mean that as a compliment. It imposed fees and penalties that added costs when students were already having trouble repaying loans — while increasing Sallie’s profits. It bought its own collection agency. It lobbied to make it nearly impossible for borrowers to escape their student debt. (It was aided along the way by occasional reports of the wealthy reneging on their student debt, thus saddling the taxpayer with the bill.)
On one level, what Sallie Mae did under Mr. Lord’s leadership was consistent with the times. The dotcom bubble was in full flower. The only thing Americans seemed to care about was whether a company’s stock price was rising. And Sallie’s was certainly doing that — more than 1,400 percent between 1995 and 2006. But in our obsession with the market, we had forgotten that this stock’s performance resulted in no small part from Sallie Mae — like many of its competitors — making money on the backs of struggling college graduates. It was a little like the credit card business: the “best” customers aren’t the ones who pay off their monthly charges on time; they’re the ones who can’t. For the student loan industry, the best customers are the students who take on more debt than they can handle to get through school. What’s been lost is the idea that student loans are a service with benefits that transcend the financial.
Meanwhile, Mr. Lord, who stepped down as C.E.O. in 2006 and is currently chairman, was getting rich; between 1999 and 2004, his pay package was worth $235 million, most of it in stock options. In April, Sallie Mae agreed to be bought by a private equity consortium for $26 billion. When the deal closes, as it is expected to in the fall, Mr. Lord will walk off with an additional $135 million.
No company likes to think of itself as rapacious, and Sallie Mae is no exception. When I spoke to the company spokesman, Tom Joyce, he portrayed Sallie Mae as a company that is doing well by doing good.
Sallie dominates the marketplace because people like its products, he said. If wages are garnished to pay back a college loan, that is Congress’s fault, because Congress passed the law. “The private sector is more efficient in making and collecting loans,” he said. “When is the last time you had good service from the government?”
As for the pending legislation, Mr. Joyce said that cutting government subsidies will whittle Sallie’s already thin margins to nearly nothing, and student borrowers will wind up bearing extra costs. “Let’s be careful of the unintended consequences,” he said. When I asked him about the social goals — as opposed to the business goal — of lending to college students, he replied, “Universities are huge businesses with huge endowments. Shouldn’t their vendors be in business, too?”
It’s good that Congress is wrestling with the problem of student loans. Let’s hope a decent law emerges. But let’s also keep in mind that student loans went from being a service to a business because that’s the way the larger society has evolved over the past few decades. And until society changes, we can hardly expect the student loan business to change.
It’s a sobering lesson in the limits of capitalism. As a culture, we praise the ability of the market to create the proper incentives and do more good than not. And mostly that’s true. But there are some things that are too important to entrust to the profit motive. Shouldn’t paying for a college education be one of them?
Joe Nocera writes the Talking Business column for The Times.
Link to Article Source
July 29, 2007
Student Loans | Viewpoint
The Profit and the Pauper
By JOE NOCERA
I GRADUATED from college about $8,000 in debt.
Yes, I know, with English majors now emerging from graduate school saddled with as much as $100,000 worth of student loans, my puny amount seems almost laughable. But it was a different era — 1974 — and, at least to me, it was real money.
I was exactly the kind of person the student loan program is intended to help; without those loans, I could never have afforded to go to a private university. But I was also the kind of college graduate who was always going to struggle to pay the loans back. I entered the job market in the teeth of a recession. I had to ask for a one-year “hardship” delay because I couldn’t find a job. And when I finally did find work, it was fulfilling but low-paying.
Consequently, I was constantly falling behind on my payments. The bank that administered my federally guaranteed loans would send a stern notice whenever I got too far behind, which would prompt me to cobble together a few payments by skipping some other bill. Then I would start falling behind again.
Though I found the situation onerous at the time, what strikes me now is how benign it actually was. My bank probably didn’t make a dime on me. It never raised my interest rate as punishment, nor did I ever have to pay any late fees. My chronic tardiness didn’t even affect my credit rating. And had I defaulted, I would not have had my wages garnished, or been stuck with the debt if I had filed for bankruptcy. All of which can happen today.
“Student loans have become big business,” says Barmak Nassirian, the executive director of the American Association of Collegiate Registrars and Admissions Officers — and high interest rates and hefty late fees are part of what makes it so profitable. Many a student comes out of college only to discover that his loan has become a noose around his neck.
For some months now, the news about student loans has largely been about scandal — how lenders have curried favor with financial aid officers to get on their “preferred lender” lists, for instance. Bills in both the House and the Senate aim to reform the system. But there is a larger, perhaps sadder story here: How did this critically important social program become so unmoored from its original intent, which was to help poor and middle-class students pay for college? To put it another way, why did student loans become more about shareholders than about students?
GEORGE MILLER, a Democratic Congressman from California, has been obsessing about student loans for a long time. “If you were going to start this program all over again,” he says “you would go back to the concept that this is a service, and an investment, provided by the federal government. And you would probably go back to a direct loan program, funded with some sort of revolving fund. That is how the G.I. bill worked. But that is now viewed as foreign and wrongheaded. Now we have this idea that there has to be a business model.”
Representative Miller is the author of the bill passed by the House earlier this month. It calls for many useful changes. It raises the amount a student can borrow, which is necessary because the cost of college has risen so dramatically. Over the next five years it cuts interest rates in half, to 3.4 percent, for the neediest students. It insures that no more than 15 percent of a graduate’s income would have to go toward repayment — an important idea, since recent graduates shouldn’t have to choose a job based solely on how much it pays.
But let’s be honest here. No reform legislation is going to change the essential nature of any business, and student loans are no exception.
Big lenders will see their subsidies lowered, but they will still be guaranteed big profits. They will still be able to charge those late fees and higher interest rates when borrowers get in trouble. And they will still be able to pursue deadbeats practically into the grave, since people who file for bankruptcy have to keep paying back their student loans — an astonishing exception to the bankruptcy law that lenders lobbied for, and won, in the 1990s. The student loan business will still be, well, a business.
The critical markers in the evolution of the student loan begin, really, with the decision to offer federally guaranteed loans through banks and other financial institutions. It didn’t have to be done that way. Congress could have decided that only the government could lend taxpayer dollars. But without a middleman, the loans would be listed as outstanding on the government’s books, thus increasing the federal deficit. It was far more politically attractive to use banks to make the loans, and then guarantee them with the taxpayers’ money.
Even with the guarantee, banks were not terribly excited about administering a loan program for college students with uncertain job prospects. So the government tried to make lending even more attractive. It subsidized the interest rates. In the case of a default, it guaranteed that banks would get back not just the principal but the interest. It took all the risk out of lending.
And to get more loans into the hands of students, in 1972 the government established a quasi-government entity, the Student Loan Marketing Association, now known as Sallie Mae. Sallie’s role was to buy up student loans from banks, freeing capital for yet more loans. It could also market and service loans, but it could not originate them. Although always a corporation — much the way Fannie Mae and Freddie Mac have both government status and corporate status — “it didn’t go all out in search of the next buck,” Mr. Nassarian says.
In the 1990s, two important events took place. First, Congress finally decided to lend directly to students. The Direct Loan Program was an immediate hit; within a few years, it had 40 percent of the market. But this was not the kind of G.I. bill, revolving-fund loan that Representative Miller envisions; its intent was to minimize the cost to the taxpayer, not to the student. So it had many of the late fees and higher interest penalties that private lenders were allowed to impose, and the interest rate was the same, 6.8 percent. Shortly after the program passed, the Republicans won both houses of Congress, and began fighting a rear-guard action against it.
Second, Sallie Mae broke away from the federal government. Its chief executive was an aggressive, profit-oriented man named Albert L. Lord, who feared that the Direct Loan Program would hurt Sallie. Privatization would enable him to fight back.
Once it had the ability to originate loans, Sallie devised marketing plans, sought ways to undercut the government lending program and began convincing college financial aid officers to give it special preference. It wasn’t too long before private lenders won back some of the market share they had lost to the Direct Loan Program; they now control about 75 percent of the market.
As for Sallie Mae, by early 2006, it controlled 35 percent of the federally guaranteed student loan market; No. 2, Citibank, had less than 10 percent. Sallie is also the dominant player in the private student loan market — that is, loans that are not federally guaranteed. Between the two, it originated $23.4 billion in loans last year alone, and made more than $1 billion in profits.
“Sallie revolutionized the industry,” says Representative Miller, and he doesn’t mean that as a compliment. It imposed fees and penalties that added costs when students were already having trouble repaying loans — while increasing Sallie’s profits. It bought its own collection agency. It lobbied to make it nearly impossible for borrowers to escape their student debt. (It was aided along the way by occasional reports of the wealthy reneging on their student debt, thus saddling the taxpayer with the bill.)
On one level, what Sallie Mae did under Mr. Lord’s leadership was consistent with the times. The dotcom bubble was in full flower. The only thing Americans seemed to care about was whether a company’s stock price was rising. And Sallie’s was certainly doing that — more than 1,400 percent between 1995 and 2006. But in our obsession with the market, we had forgotten that this stock’s performance resulted in no small part from Sallie Mae — like many of its competitors — making money on the backs of struggling college graduates. It was a little like the credit card business: the “best” customers aren’t the ones who pay off their monthly charges on time; they’re the ones who can’t. For the student loan industry, the best customers are the students who take on more debt than they can handle to get through school. What’s been lost is the idea that student loans are a service with benefits that transcend the financial.
Meanwhile, Mr. Lord, who stepped down as C.E.O. in 2006 and is currently chairman, was getting rich; between 1999 and 2004, his pay package was worth $235 million, most of it in stock options. In April, Sallie Mae agreed to be bought by a private equity consortium for $26 billion. When the deal closes, as it is expected to in the fall, Mr. Lord will walk off with an additional $135 million.
No company likes to think of itself as rapacious, and Sallie Mae is no exception. When I spoke to the company spokesman, Tom Joyce, he portrayed Sallie Mae as a company that is doing well by doing good.
Sallie dominates the marketplace because people like its products, he said. If wages are garnished to pay back a college loan, that is Congress’s fault, because Congress passed the law. “The private sector is more efficient in making and collecting loans,” he said. “When is the last time you had good service from the government?”
As for the pending legislation, Mr. Joyce said that cutting government subsidies will whittle Sallie’s already thin margins to nearly nothing, and student borrowers will wind up bearing extra costs. “Let’s be careful of the unintended consequences,” he said. When I asked him about the social goals — as opposed to the business goal — of lending to college students, he replied, “Universities are huge businesses with huge endowments. Shouldn’t their vendors be in business, too?”
It’s good that Congress is wrestling with the problem of student loans. Let’s hope a decent law emerges. But let’s also keep in mind that student loans went from being a service to a business because that’s the way the larger society has evolved over the past few decades. And until society changes, we can hardly expect the student loan business to change.
It’s a sobering lesson in the limits of capitalism. As a culture, we praise the ability of the market to create the proper incentives and do more good than not. And mostly that’s true. But there are some things that are too important to entrust to the profit motive. Shouldn’t paying for a college education be one of them?
Joe Nocera writes the Talking Business column for The Times.
Link to Article Source
This entry was posted
on Tuesday, July 31, 2007 at 11:05.
