Earlier this month, the Department of Education rolled out two major initiatives designed to help the millions of young Americans who have defaulted on their student loan debts, and provide better information regarding their loan payment options. (Recent estimates suggest that between 5 and 12 million young Americans fall into default after graduating college.) DOE also announced an ambitious plan to jump-start a massive public relations campaign raising awareness about the federal government's Income-Based Repayment Program.
The changes that DOE introduced this week are fairly comprehensive, ranging from stronger Family and Medical Leave Act protections for social workers on 10-year Income-Based Repayment plans, to programs that will help to rehabilitate the loans of individuals who've defaulted at a fixed, affordable rate. Most of these provisions are admirable, and they'll undoubtedly provide current and former students with better information about their loan payment options, while protecting them from some of the worst and most abusive tactics employed by predatory lenders and loan collectors. And yet, when taken together, the new rules (and the P.R. campaign soon to follow) paint the troubling picture of a bureaucracy overeager to raise revenue, even at the expense of America's most financially vulnerable age group.
To fully grasp the dangerous conflict of interest that rests at the center of our current student loan system, one needs to have an understanding of the recent history of the law.
Before 2010, the federal government provided students with publicly funded loans facilitated by private banks. While the loans were federally backed (and therefore protected from market forces), private banks reaped the sizable profits that these loans were generating. Quite understandably, this was a wildly unpopular system, and in the wake of massive electoral victories throughout the House and Senate, Democrats in Congress started work to pass a measure called the Student Aid and Fiscal Responsibility Act, which would eliminate the big banks acting as "middlemen" for publicly financed student loans. In the new system, the federal government would make loans directly to students. At the time, the change was universally hailed in the mainstream press as a victory for students against multinational banks, such as in this fairly typical article for the New York Times, dated March 25, 2010:
Since the bank-based loan program began in 1965, commercial banks like Sallie Mae and Nelnet have received guaranteed federal subsidies to lend money to students, with the government assuming nearly all the risk. Democrats have long denounced the program, saying it fattened the bottom line for banks at the expense of students and taxpayers.
Democrats celebrated the legislation, a centerpiece of President Obama’s education agenda, as a far-reaching overhaul of federal financial aid, providing a huge infusion of money to the Pell grant program and offering new help to lower-income graduates in getting out from under crushing student debt.
The article's authors go on to note that the bill was actually little more than a tepid, watered-down piece of political grandstanding (of course, not in those words). While the new rules were projected to net the federal government a significant windfall -- according to a White House press release from the period, "These reforms save the taxpayers $68 billion over the next decade by ending the subsidies given to banks and middlemen who handle student loans" -- they were unlikely to help current and former students, as the Times article noted:
[..] for individual students, the increase in the maximum Pell grant — to $5,900 in 2019-20 from $5,550 for the 2010-11 school year — is minuscule, compared with the steep, inexorable rise in tuition for public and private colleges alike.
And because college costs are rising so quickly, the maximum Pell grant now covers only about a third of the average cost of attending a public university, compared with three-quarters in the 1970s, when the program began. So each year, more students graduate with debt of more than $20,000.
Still, these initiatives were largely supported by a Democratic Congress, and SAFRA was soon the law of the land. Now three years have passed, and in many ways, the more things have changed, the more they've stayed the same.
Since the law was enacted in 2010, young Americans have taken on an excess of $200 billion in new loans. To put that number in perspective, $200 billion was the total student loan debt held by all Americans in the year 2000. The provisions that the Democratic-controlled Congress enacted did practically nothing to address this burgeoning crisis; instead, they created a dangerous conflict of interest, where the federal government stands to make considerable profits off student loans -- and simultaneously faces enormous risk if economic crisis strikes again. And yet whether we should trust the Department of Education's newest initiatives hinges greatly on whether we think the government is profiting off student loans -- a matter of some debate. Unsurprisingly, once the federal government became a massive lending institution, reasonable questions as to its motives started to surface. Last summer, Rolling Stone author Matt Taibbi explained in detail how the government might stand to profit off young America's collective misery:
While it's not commonly discussed on the Hill, the government actually stands to make an enormous profit on the president's new federal student-loan system, an estimated $184 billion over 10 years, a boondoggle paid for by hyperinflated tuition costs and fueled by a government-sponsored predatory-lending program that makes even the most ruthless private credit-card company seem like a "Save the Panda" charity. Why is this happening? The answer lies in a sociopathic marriage of private-sector greed and government force that will make you shake your head in wonder at the way modern America sucks blood out of its young.
It's easy to understand Taibbi's frustration, but what if he's wrong? What if, rather than profiting off our loans, the government actually stands to lose money from them? In a response for the National Review, Jason Richwine suggests that Taibbi'
The federal government projects $184 billion in student-loan profit over the next ten years only because it ignores the market risk inherent in expecting a given amount of loan money to be repaid. When the CBO instead applied fair-value
accounting methods to the student-loan program, the $184 billion profit became a $95 billion cost. And if it were not for the government’s “ruthless” attempts to collect from delinquent borrowers, which Taibbi deplores, the cost to taxpayers would be even greater.
Taibbi might suggest that "fair-value accounting" is a pointless standard to abide by, given that student loans are almost entirely nondischargeable, but it's not unthinkable that another major economic crisis could lead to millions of delinquent borrowers completely incapable of repaying their loans.
So why does any of this matter?
If the government is set to lose tens of billions of dollars due to federally backed student loans, and if policymakers assume that the cause of this unfunded liability is delinquent borrowers and defaulting millennials, we start to see why the Department of Education might be so eager to revamp the rules -- and why we should be intensely skeptical of any new programs they seek to implement.
Take, for instance, the newly announced P.R. campaign to spread the gospel of "Income-Based Repayment." According to a recent DOE press release:
The outreach [campaign] will target federal student loan borrowers who can benefit the most from an income-driven repayment plan. Approximately 3.5 million borrowers will be contacted from now until mid-December. Concurrent with this outreach, FSA will conduct a social media campaign on Facebook, YouTube and Twitter geared toward recent college grads and borrowers.
Throughout President Obama's two terms in office, Income-Based Repayment has been one of his favorite proposals when discussing America's student debt crisis. On the surface, IBR seems fairly clever: Rather than requiring young Americans to make fixed monthly payments regardless of their income, the job market or other macroeconomic forces, IBR pegs a student loan's repayment schedule to that borrower's income, with a guarantee that your loans will be capped at either 10 percent or 15 percent of your total monthly income (depending on your plan), with the repayment term lasting between 10 and 25 years. The most financially successful borrowers will pay off their loans in full, while the less fortunate will never be saddled unnecessarily with a crippling (and economically stifling) debt burden. Or at least, that's how it's supposed to work.
In reality, IBR creates a whole host of negative, unintended consequences, and despite the Obama administration's big promotional push, they've done nothing to deal with its most serious flaws. At the Daily Beast, Megan McArdle wrote a scathing missive on IBR's shortcomings. The first problem is fairly obvious: IBR best serves the very people who need help escaping their student loans the least. Millennials who drop out of school after a year or two face enormous economic challenges, and yet still must fully repay the loans they took out for the degree they didn't attain. But they also hold considerably less debt than someone finishing her J.D., or wrapping up his residence at Johns Hopkins. Put simply, the more debt you've taken (and, consequently, the more education you've completed), the more likely you are to look for methods of minimizing that massive burden. McCardle worries that, "in about 25 years, the government is going to be on the hook for some huge loan balances, particularly for graduate professional education -- architects, lawyers, veterinarians and so forth who never hit the big time."
Even more troublingly, McArdle highlights a particularly cruel and insidious aspect of IBR, that "when that debt gets forgiven, the IRS will treat the forgiven principle as income, and tax you on it." She goes on to quote from an article in the New York Times that should make anyone second-guess signing up for this particular repayment program:
The bad news is that the interest on the debt keeps growing and taxes must be paid on the amount discharged, as if it is a gift. Dr. Schafer sends $400 a month to Sallie Mae, a sum that will rise. But what kind of tax bill awaits her? Asked to run the numbers, GL Advisor, a financial services company that specializes in student loans, calculated that Dr. Schafer’s debt is likely to exceed $650,000 when her tax bill lands 25 years after the start of the loan, which means she will owe the Internal Revenue Service roughly $200,000. That will happen while she is still deep in her career, perhaps around the time she wants to send some children to college.
While it's possible that this provision of the law could be eliminated (or at least modified) if millions of Americans were to sign up for the program, I'd hesitate to stake my financial future to our halfwits in Washington.
But what about the other major changes that the Education Department has announced?
Continuing in its role as the preeminent cheerleader of minor tweaks to our student loan policy, the Times recently highlighted a number of positive changes set to take effect:
Under federal law, those who are in default on federal student loans may “rehabilitate” them by making nine on-time payments in amounts that are “reasonable and affordable.” Rehabilitation lets the borrower get out of default and become eligible for further federal student aid.
Some private debt collectors under contract with the government, however, were failing to offer payments that former students could afford, instead offering payments based, for instance, on a percentage of the borrower’s total debt. Such payments increased the commissions paid to collection agencies, but were often unworkable for borrowers.
In its final rules, the Education Department requires that borrowers who want to rehabilitate loans must first be offered a payment amount similar to what would be offered under the federal income-based repayment program. That option, meant to help borrowers who have high debt in relation to income, caps a borrower’s monthly payments at 15 percent of his or her monthly income.
These are all positive and important changes, and the Obama White House (and the Department of Education) deserves applause for taking substantive steps to protect young Americans from predatory lenders. But questions still linger. If the White House is solely and sincerely concerned about borrowers' inability to repay their loans -- and the long-term consequences therein -- these changes are both sensible and admirable. If, on the other hand, these initiatives are being implemented because the Department of Education is trying to avoid a $100 billion loss over the next decade, these provisions start to resemble a disingenuous attempt at recovering debts and boosting the federal government's balance sheet. Of course, there's no evidence to support such a cynical explanation for these new policies, but when the federal government has the capacity to profit off our suffering, this line of questioning becomes practically inevitable.
If the Obama administration wants to remove these suspicions, it must work earnestly to enact legislation limiting IRS penalties for borrowers in the Income-Based Repayment Program. While certain public service fields provide exemptions from tax penalties, the Department of Education's new public relations initiative is likely to bring huge numbers of borrowers into the IBR program who are ineligible for these exemptions, and may be unaware of the huge IRS payment waiting for them 20 to 25 years down the road. A program that ties student loan payments to income could save literally millions of millennials from a lifetime of economic hardship -- but not if it saddles a generation of Americans with a ticking time bomb of debt, ready to explode at the precise moment that they hope to invest in the next generation's higher education.
(As a postscript, it should be noted that none of these changes will affect the 15 percent of all student loans that are funded by private lenders and not the federal government, nor is IBR available for that debt -- a massive, unnecessary tragedy and national embarrassment deserving of an entirely separate column.)