Student Loans - Beyond The Interest Rate Debate

Originally Published on forbes.com on April 25th,2012

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President Obama is arguing to keep the interest rate on a class of student loans from increasing.  Alan Collinge is hunting bigger game, a complete systemic reform.  A recent proposal for a forgiveness program just does not cut it in his view.  Here are his thoughts.

Freshman Congressman Hansen Clarke (D-MI) recently introduced HR 4170:  The Student LoanForgiveness Act.  The legislation has received quite a lot of media attention, and strong support from well-networked groups on Facebook, and other platforms.   Unfortunately, the bill looks far less like a forgiveness plan, and far more like yet another repayment/earned benefit plan combined with a bailout for banks who made highly risky loans without sufficient underwriting.  Unfortunately, I have to give it an unequivocal “thumbs down” from the citizen’s perspective.  Here is my take:

The Bill:  HR 4170 aims to accomplish a number of goals for student borrowers, including the creation of a new, 10-year forgiveness program, a permanent 3.4% cap on the interest rate for federal loans, a reduction in the length of the Public Service Forgiveness program from 10 years to 5, and the creation of a mechanism by which the Government purchases private loans, and brings them into the federal program.

I have all of the same reservations with the 10-year repayment plan that I’vewritten about elsewhere in the past. Like the other repayment programs, this is fraught with risk, uncertainty, and clear downsides that could and certainly will prove to be life-wreckers for many, all things being equal.

Of particular concern: The Department of Education would absolutely attempt to kick as many people out of this program as possible to avoid having to forgive the large amounts that they would be liable for (Google “disability discharge”, and “Department of Education” if you have any doubts about the Department’s track record on granting discharges for other reasons).  As such, the completion rate of this or similar programs (like the existing IBR and PSLF programs) will ultimately be very small.

How Small?For example…earned benefits that banks and credit card companies routinely offer to their borrowers (ie interest rate reductions for ontime payments, etc) have a success rate of about 15%. For federal student loans, this is not going to get it done for the people.  Not even close. In the presence of bankruptcy protections, I would have more faith in the current and proposed repayment programs, but not in their absence. Not by a longshot.

What should concern the public generally about this bill is that it does nothing to address the systemic problems with the lending system such as inflation, predatory foundations in the absence of consumer protections, systemic corruption, and others.

Also, because of a maximum forgiveness on principal of $45,000 for new loans(consolidation loans, for example), this would not be very helpfulfor people with defaulted loans with large balances, and large fees attached.

What really angers me as an “Occupier” who is sick and tired of seeing the banks come out of every cesspool they create smelling like roses:  a private loan purchasing program in the legislation that is essentially another bank-bailout by which the lenders can get full book value (plus penalties and fees) for their worst performing loans. This is disgusting to me as a citizen.

I also have reservations about this from the borrowers perspective: I have heard others voice hesitancy about “federalizing” their loans because of the absence of consumer protections, strong collection powers of the government, etc. I agree with those concerns- they are not trivial.

Also very concerning- and this is why trying to codify a repayment program like this is so difficult- is the means for “paying” for this legislation. This bill calls upon a little known DOD fund used for overseas contingency operations (OCO) to pay for the costs associated with this legislation. This fund has had as little as $0.2 billion and as much as $168 billion in it in various years that I could find. This raises a plethora of new questions, and problems that you can imagine. This is beyond shaky.

The problems with this legislation really only underscore the need to restore bankruptcy and perhaps other fundamental consumer protections to student loans. The Department of Education would be far more likely to come up with a good workable set of forgiveness programs with fundamental protections in place. Conversely, history (decades of history) clearly demonstrates that the Department will not do anything to help students in their absence.

So I’m unfortunately having to call this bill a dog that won’t hunt for the citizenry. If someone steps up to argue for actual student loan forgiveness, there certainly is a strong, surprisingly realistic argument to be made for that, but we haven’t heard it yet from the politicians, advocates, or anyone that I have read to this point. This is unfortunate.

Alan Collinge is the founder of StudentLoanJustice.org.

You can follow me on twitter @peterreillycpa.