Our May issue was all about the state of education in America…
And today, we bring you an essay that we couldn’t fit in the magazine… It’s the “missing chapter” that explains the history and rationale behind the incredible rise in student-loan debt.
Read on for more…
Good Intentions and Fiscal Recklessness
By Bryan Beach, financial analyst
Over the past 10 years, students (most of whom have virtually no income) have racked up enormous debts. As of 2017, student debt totals more than $1.5 trillion – the second-largest source of household debt after home mortgages.
Incredibly, that’s what our entire federal government owed a little more than 30 years ago. Virtually all this money was borrowed in only the last 10 years.
The average college student graduates with more than $30,000 in debt… and by his late twenties, has racked up more than $6,000 in credit-card debt. Meanwhile, median earnings for Americans aged 25-34 are $36,000-$40,000.
Can you imagine starting out your adult life with a personal debt-to-income level at close to 100%? What does this say about the state of our economy? What does this say about the state of our culture?
All the signs show that the debt piled on our youth will become another catastrophic bubble in the American economy.
This expansion had nothing to do with real supply and demand or the creation of value. Instead, it was simply an outgrowth of the government’s good intentions and fiscal recklessness…
The government first got into the student-loan business in the late 1950s. President Dwight “Ike” Eisenhower decided the U.S. needed to mint a lot of new engineers and scientists to catch up with the Soviet Union’s first successful efforts in space. So the federal government began providing low-interest-rate college loans to America’s best and brightest…
Then in 1965, Lyndon Johnson changed the focus from national defense to social welfare. As part of the “Great Society” initiatives, the new Federal Family Education Loan Program (FFELP) gave loans to low-income students.
More important, Johnson changed the way the government financed the loans. Instead of loaning students money directly, FFELP loans would be made by banks… but the government would still pick up the tab on defaults. That created an environment where banks could recklessly lend, without any risk of default.
In 1972, Richard Nixon and Congress created the Student Loan Marketing Association (better known as “Sallie Mae”) to service these debts. In 1984, its shares began trading on the New York Stock Exchange. Ultimately, Sallie Mae “privatized,” formally cutting its ties with the U.S. government. As we’ll show you, no entity would profit more from Johnson’s gravy train.
Student loans grew steadily and – for the most part – slowly, until around 1992, when the U.S. Congress decided to include for-profit institutions in the official definition of “institution of higher learning.” Suddenly, “for-profit” colleges were eligible to receive financial aid. Two years later, the for-profit University of Phoenix went public… backed by Wall Street’s money.
By 2000, for-profits were spending tens of millions of dollars lobbying in Washington, and the government began encouraging more citizens to pursue higher education.
How Lenders Can Exploit a Broken System
As the 2007-2008 mortgage crisis showed… when you shield lenders and borrowers from the consequences of reckless behavior, they act recklessly. This is the definition of “moral hazard.”
And as you’ll see, the student-loan program has become one vast moral hazard…
For years, Sallie Mae’s business model churned out mountains of cash. It was impossible not to. Sallie Mae got to borrow from government agencies at miniscule rates, loan it to borrowers for high rates… and if the deal went bad, the taxpayers were on the hook.
Starting in the 1990s, politicians began pressing to eliminate the system’s moral hazard by going back to the Sputnik-era direct-loan system. But Sallie Mae and the for-profit colleges were a powerful lobbying force and fended off legislative changes for nearly 15 years.
By 2010, the gig was up. As part of the Health Care and Education Reconciliation Act of 2010, Congress established that the only entity able to issue government-backed loans would be the U.S. government. That meant Sallie Mae could no longer originate loans backed by the U.S. government. Its gravy train had ended.
To fill the void left by originating FFELP loans, Sallie Mae turned up the heat on another revenue stream – servicing loans held by others. Uncle Sam doesn’t want to be bothered with actually collecting payments. Sallie Mae was happy to do that for a fee.
Sallie Mae quickly recognized that collecting payments on active accounts was a lousy, low-margin business. To really make money in the servicing business, you had to collect delinquent accounts.
This created a new moral hazard… Sallie Mae had no incentive to keep loans current. So it treated the borrowers like dirt. According to various filed and settled claims, Sallie Mae employees intentionally sent confusing or misleading correspondence. They neglected to tell borrowers about loan relief they were entitled to. They called them dozens of times, day and night.
The company’s “bad cop” tactics infuriated borrowers, often making them even less likely to pay. This played right into Sallie Mae’s hands. Once a borrower moved from the “small fee” service-revenue bucket to the “fat percentage” delinquency bucket… Sallie Mae turned on the charm. It brought in its “good cops,” who cooperated with the customers and collected the cash.
It worked. Sallie Mae regularly generated $300 million-$500 million a year in “Contingency Revenue.”
The Tide Turns Against Sallie Mae
Eventually, Sallie Mae’s tactics caught up with it. Frustrated constituents began writing their congressmen. Various media outlets reported on Sallie Mae’s deplorable customer-satisfaction statistics. Thousands of people followed the “I HATE SALLIE MAE” Facebook page. Finally, when it became news that the company had specifically targeted 78,000 military servicemen with its predatory practices… Sallie Mae was officially in Washington’s crosshairs.
The government passed various measures – primarily from 2007-2013 – to ease the borrowers’ burden, including:
- Allowing students to put off payments if they attend graduate school.
- Capping the exorbitant “Contingency Fee” plan.
- Holding servicers accountable for how they treated customers.
- Implementing “Income-Based Repayment” (“IBR”) and “Pay as You Earn” plans, which cap payments at a percentage of disposable income… or allow borrowers at a certain income level to cease payments altogether. Often, any balances not repaid after 20 years will be forgiven.
- Allowing graduate students to essentially borrow unlimited amounts under various federal programs (in contrast to capped undergraduate loans).
- Creating a “not-for-profit loophole,” which forgives the entire outstanding balance after 10 years for any graduate student who becomes a teacher, public defender, or works at a not-for-profit organization.
As always… the government’s best intentions simply gave borrowers license to act recklessly. It shifted the “moral hazard” from the lenders to the borrowers.
Take Bonnie Kurowski-Alicea, a chronic borrower who managed to run up a $209,000 tab earning a doctorate from Capella University in “Industrial Organizational Psychology.” Bonnie couldn’t find a job after earning her online undergraduate degree, so she compounded the problem by piling one useless degree on top of the other. As the Wall Street Journal pointed out, “Dr.” Kurowski-Alicea’s main motivation for earning master’s and doctorate degrees was to postpone repaying her student loans. Her unemployed husband has $75,000 of student loans himself.
Then there’s Virginia Murphy. Her student loans for Tulane Law School added up to nearly $150,000. According to the Wall Street Journal, Murphy never had any intention of paying the money back. Loan forgiveness was “the only reason (she) even considered” going to law school. Thanks to the IBR program, Murphy’s monthly payment doesn’t even cover the interest… which means her outstanding balance actually increases every month. As a public defender, her loan balance will be forgiven after 10 years… at which point the outstanding balance will have ballooned to more than $300,000.
The “not-for-profit loophole” was intended for folks like Murphy who, by serving the community as a public defender, is presumably forgoing more lucrative opportunities in the private sector.
But most of the forgiven “not-for-profit” loans will benefit doctors and surgeons. People like Emily Van Kirk and her husband, who managed to rack up $700,000 of debt while attending medical school in St. Maarten. Much of this balance will be forgiven as – like a lot of doctors – the couple plans on working in hospitals. (Uncle Sam must have forgotten that almost 80% of hospitals are “not for profit”… leaving a loophole a mile wide for some of the workforce’s highest wage-earners.)
Many student loans went to honest people who plan on paying back every penny they borrowed.
But some… an awful lot, in fact… had no such plan. Hundreds of billions of dollars in student debt is out there that won’t be or can’t be repaid. And the result is going to be a disaster.
Editor’s note: This article has been updated to correct an error in the original version. We had inaccurately reported Virginia Murphy’s student loan amount and balance. She took on student debt of approximately $150,000, including tuition and living expenses, which grew to more than $250,000 when the Wall Street Journal published an article featuring her. We regret the error.
If you’re interested in reading more about America’s debt bubble, we recommend the new book, The American Jubilee…
Massive amounts of debt have been piled on the weakest in our society. The poor – and especially the young and poor in our country – have no hope of being able to afford the American dream anymore.
When this bubble breaks, it will be an entire generation of young Americans who will suffer.
And it’s not just the size of Americans’ debts that’s the problem… It’s who owes the money that’s the bigger concern. When the rich get in trouble with debt, it’s an economic problem. But when the poor and middle class get in trouble with debt, it’s a political problem.
That’s what makes a national “Debt Jubilee” inevitable. To read more about this problem, click here.
Now on to the latest news…
Far more Americans are having trouble “keeping up” than you realize…
At a time of rock-bottom joblessness, high corporate profits, and a booming stock market, more than 40% of U.S. households cannot pay the basics of a middle-class lifestyle.
A fantastic read from American Consequences contributor Matt Labash about writer and reporter Charlie LeDuff in Detroit…
“I got love for people,” he says without guile, not a pronouncement you hear generally misanthropic reporters make every day. Charlie saw the Hole getting deeper – more and more falling prey to the effects of corporate greed, government neglect, or personal dissolution.
In the meantime, the New Yorker is reporting on rich folks eating gilded food…
The whole point of eating Ainsworth’s wings (or the gold-leaf donut that was once sold in Brooklyn, or the maki roll dressed in gilded nori in Tokyo), by contrast, is the languid extravagance of destroying value.Robert Shiller warns on cryptocurrencies with a look back at the rise of “time money” in the 1800s…
New ideas for money seem to go with the territory of revolution, accompanied by a compelling, easily understood narrative…Infighting and disorganization inside a left-leaning grassroots group…
‘Our Revolution’ has shown no ability to tip a major Democratic election in its favor — despite possessing Sanders’ email list, the envy of the Democratic Party — and can claim no major wins in 2018 as its own.
And let us know what you’re reading at [email protected].
With P.J. O’Rourke and the American Consequences Editorial Staff
May 23, 2018