Student Loans and Default Risk
AB reader Grace reads this post and offers us a related story by Alan M. Collinge:
When Congress amended the Higher Education Act 10 years ago, defaulted student loans became the easiest and most lucrative debt to issue and collect. The amendments imposed huge fees on defaulted student loans and took away bankruptcy protection for student borrowers. It banned refinancing of many student loans, and also allowed draconian collection measures to be taken against student borrowers, including wage garnishment, tax garnishment, withholding of professional certifications, termination from employment, and even Social Security garnishment. Harvard Professor Elizabeth Warren told The Wall Street Journal that “student loan debt collectors have power that would make a mobster envious.” And no one makes the mobsters greener than Al Lord and his Student Loan Marketing Corporation, also known as Sallie Mae.
One would think that low default risk would translate into low interest rates in a competitive market. But Mr. Collinge, who is the founder of Student Loan Justice – suggests this market is not all that competitive:
In the company’s annual report, Lord attributed his company’s 29% core cash earnings-per-share growth in large part to fees collected from defaulted loans. He forgot to mention that the law allowed him to forbid Sallie’s customers from refinancing with competitors offering better deals. Meanwhile, the borrowers suffer. Many student loan debtors in default find themselves unable to function in society, and are faced with a decision to either continue the paralysis and live in fear, or begin making payments on a massively inflated amount – often double, triple or quadruple what they originally borrowed. StudentLoanJustice.Org has received thousands of stories from citizens whose lives have been shattered by their student loans. People who default on student loans are typically decent citizens who, for one reason or another, were not able to capitalize on their education. Most agree that they are responsible to pay back what they borrowed, but most cannot afford to pay back the wildly increased amounts that the federal law has allowed to be imposed upon them. The student loan system in the U.S. has been hijacked by Albert Lord and his friends. Let there be no mistake: These are not creative geniuses who invented a new product or service. These are not captains of industry who built markets and competed their way to the top. Rather, these are nothing more than well-connected executives who took an existing market and used their weight in Congress to erect insurmountable barriers to competition. Here are just two examples: Sallie Mae convinced Congress that allowing borrowers to reconsolidate student loans would cost taxpayers money, so they banned it. Then they sidestepped the law against inducements (also known as kickbacks) by permitting Sallie Mae to loan schools money to make student loans in the school’s name, then sell them to Sallie Mae for a “commission.”
Mr. Collinge is suggesting that these firms got Congress to tilt the market place in their favor and against the interests of those who have taken out student loans.
Update: Dean Baker continues his discussion of welfare for the rich
In many cases, these businesses are extremely poor credit risks, so a 4 percent interest rate would be at least 4 percentage points lower than what they would pay in the private sector. Assuming that the subsidy is 4 percentage points, this implies a maximum of $60,000 a year in subsidies, that could last as long as 30 years. (Contrast this with TANF cash payments that average around $6,000 a year and have a maximum duration of 5 years.) I don’t have anything against small businesses, but the idea that these folks are free marketers is nonsense. They get serious subsidies and this should be made clear in discussing their benefits. It’s not obvious that it’s better to hand a small business owner $60,000 than to give child care subsidies for 20 kids.
So if take out a student loan, Congress can tilt the bankruptcy rules so default is very difficult and the White House wants no government provided subsidies. But if you start a small business, you get bankruptcy protection and an interest rate subsidy.