The Student Loan Bubble: Eerily Similar to the Home Mortgage Crisis

A few months ago, Steve Rhode posted a thought-provoking blog titled "The Student Loan Bubble That Many Don't Want to See."  He argued that student-loan indebtedness is in a bubble that will soon burst, creating two huge problems:

First, when the student-loan market collapses, postsecondary education will be out of reach for most people,  which will "put a drag on the overall economy as fewer and fewer people will be able to pay for tuition that outpaces inflation."

Second, a sharp contraction in federal student-loan revenue along with a shrinking student base will force many colleges to cut tuition, putting them under enormous financial stress. Rhode predicts that "[m]any schools, public and private, will fail."

Mr. Rhode sees a parallel between the the student loan program and the overheated housing market that led to a global financial crisis in 2008.  Just as financiers packaged home mortgages into mortgage-backed securities called ABS, the banks have bundled student loans into so-called SLABS, or student-loan asset backed securities.

The home-mortgage market went into free fall when investors woke up to the fact that the ratings services (Moody's, Fitch, etc.) had rated ABS as investment grade when in fact a lot of them were junk because they were packed with mortgages that were headed for default.

Now we see Moody's and Fitch downgrading SLABS based on the fact that student borrowers are not paying off their loans as investors expected. More than 5 million borrowers have signed up for income-driven repayment plans that lower monthly loan payments and stretch out the repayment period from 10 years to 20 or even 25 years. SLABS investors now don't know when or how much they are going to be paid on their investments.

Some policy commentators reject the notion that the student-loan market is in a bubble. In a book published last year, Beth Akers and Matthew M. Chingos wrote: "Student loans have a zero chance of becoming the next housing crisis because the market is too small and essentially functions as a government program rather than a market." Akers and Chingos point out that student debt represents only 10 percent of overall consumer debt while home mortgages accounts for 70 percent of household indebtedness.

Personally, I think Steve Rhode is right: Higher education is sustained by a student loan bubble that the nation's colleges and universities refuse to see. In fact, there are eerie similarities between the housing market before it crashed in 2008 and the current level of student-loan indebtedness.

First,  higher education at many colleges and universities is wildly overpriced, just as the housing market was overpriced in the early 2000s. This is particularly true in the for-profit sector and at private liberal arts colleges.

As as been widely reported, liberal arts colleges are now discounting tuition for freshman students by almost 50 percent--a clear sign that their posted tuition prices are too high. And for-profit colleges are seeing enrollment declines. University of Phoenix, for example, has seen its enrollments drop by about half over the past 5 years.

Second, the monitoring agencies for both markets failed to do their jobs. As illustrated in the movie The Big Short, the financial ratings agencies rated mortgage backed securities as investment grade when in fact those bundled mortgages included a lot of  subprime mortgages.

Likewise, the Department of Education reports three-year default rates for student loans that vastly understates how many student borrowers are failing to pay back their loans. DOE recently reported that about 10 percent of the most recent cohort of student borrowers defaulted within three years. But the five-year default rate is 28 percent; and the five-year default rate for a recent cohort of students who attended for-profit schools is a shocking 47 percent.

And of course the government's vigorous effort to get distressed student borrowers into income-driven repayment plans also helps hide the true default rate. A high percentage of people who enter IDRs are making loan payments so low that they will never pay off their loans.

In short, Steve Rhode's analysis is correct.  A rising level of student-loan debt has created a bubble; and the bubble is going to burst. Colleges raised tuition prices far above the nation's inflation rate, knowing that students would simply take out larger student loans to pay their tuition bills. Millions of Americans paid too much for their postsecondary education and can't pay back their loans.

So far, the Department of Education has hidden the magnitude of this crisis, but the game will soon be up. Colleges are closing at an accelerating rate, stock prices for publicly traded for-profit colleges are down, and long-term default rates are shockingly high.

It is true, as Akers and Chingos pointed out, that the student-loan market is not nearly as large as the home-mortgage market when it crashed in 2008. But Akers and Chingos fail to acknowledge the enormous human cost that has been imposed on millions of Americans who took out student loans in the hope of getting an education that would lead to a better life.

Instead, all many Americans got by taking out student loans is an enormous debt load that they can't pay off or discharge in bankruptcy. Eight million Americans have defaulted on their student loans; 5.6 million are in income-driven repayment plans that stretch their payment obligations out for as long as 25 years, and millions more are playing for time by putting their loans in forbearance or deferment.

References

Beth Akers and Matthew Chingos. Game of Loans: The Rhetoric and Reality of Student Debt. (Princeton, NJ: Princeton University Press, 2016).

Anamaria Andriotis. Debt Relief for Students Snarls Market for Their Loans. Wall Street Journal, September 23, 2015.

Patrick Gillespie. University of Phoenix has lost half its students. CNN Money, March 25, 2015.

Adam Looney & Constantine Yannelis, A crisis in student loans? How changes in the characteristics of borrowers and in the institutions they attended contributed to rising default rates. Washington, DC: Brookings Institution (2015).

Steve Rhode. The Student loan Bubble That Many Don't Want to See. Get Out of Debt Guy, July 15, 2016.

Amy Thielen. Declines at For-Profit Colleges Take a Big Toll on Their Stocks. The Street, May 8, 2015.

Kellie Woodhouse. Discounting Grows Again. Inside Higher Ed, August 25, 2015.

Department of Education's fumbling efforts to aid students defrauded by Corinthian Colleges: No relief for the Walking Dead

David Goldman wrote a  highly informative article for Bloomberg yesterday about the Department of Education's fumbling efforts to process Borrower Defense claims filed by people who claim they were defrauded by Corinthian Colleges. I am grateful to Steve Rhode for calling my attention to Goldman's article.

Essentially, here's the story. Corinthian Colleges filed for bankruptcy last year under a cloud of fraud allegations. In fact, the the State of California got a $1.1 billion judgment against Corinthian for its wrongdoing in that state. At the time it filed bankruptcy, Corinthian had 335,000 former students.

DOE has an administrative process whereby it will forgive the student loans taken out by students who were defrauded by for-profit institutions. So far, 82,000 former Corinthian students have filed those claims.  But DOE's process for reviewing those claims is slow. Goldman reported that so far only about 15,000 students have gotten debt relief through the Borrower Defense process.

DOE won't grant blanket forgiveness to all of Corinthian's former students, arguing that not all of them were defrauded.  But in fact, a high percentage were defrauded. As Goldman reported, "Department officials concluded that Corinthian engaged in 'widesperead placement rate fraud' for almost 800 programs at nearly every one of its more than 100 U.S. campuses."

 David Vladek, a former director of the Federal Trade Commission's consumer protection division, said this about Corinthian's former students: "These kids by and large have been scammed, and the Department of Education in some sense is continuing the harm by making them jump through hoops to get the relief to which they are entitled."

But it gets worse. Not only is DOE not processing loan-forgiveness claims quickly, it is actually employing debt collectors to hound Corinthian's former students, even though most of these students are entitled to have their loans forgiven.  Although DOE states on its web site that it will stop all loan collection efforts on Corinthian borrowers, that statement is not true.

Indeed, DOE's debt collection activities are a hell of a lot more efficient than their loan forgiveness process. As Maggie Robb, a consumer-rights attorney, observed, " When the Department of Education wants to collect money, it doesn't stop."

Goldman's story focused solely on Corinthian Colleges' former students, but there are hundreds of thousands of people who took out loans to attend for-profit colleges who have been scammed. I know one woman with a documented claim for fraud against DeVry University who filed a Borrower Defense claim with DOE last August and still hasn't gotten a response from DOE.

In short, people who have been defrauded by the for-profit college industry are the real life representations of the Walking Dead. Fraud victims have debt hanging over their heads, which DOE has not discharged; and if they default on their loans they are subject to abusive debt collection tactics, wage garnishment, income-tax offsets, and ruined credit. Many are continuing to make loan payments on debt they don't really owe; and most did not get fair value for their for-profit college experiences.

In DOE's defense, the Department is simply overwhelmed by the implosion of the for-profit college industry. It does not have the resources to process claims by Corinthian students or to even notify those students that they may be entitled to debt relief. ITT's closure and bankruptcy will bring a deluge of new claims, and other for-profits are sure to follow over the next few months. (Globe University and Charlotte School of Law, for example, have been accused of misrepresentation and many of their students will be filing Borrower Defense claims.)

There is really only one sensible solution: DOE should allow all people who borrowed money to attend for-profit colleges and who are insolvent to file for bankruptcy relief in the federal bankruptcy courts. Whether or not a a particular student debtor can prove fraud should be irrelevant. If they took out loans to attend a for-profit college, the odds are better than even that they were scammed or did not get fair value for their money.

Students who were scammed by for-profit colleges are the Walking Dead.

Note: All quotations come from Mr. Goldman's article.

References

David Goldman. The U.S. Government Is Collecting Student Loans It Promised to Forgive, Bloomberg News, December 19, 2016.