A Greater Structural Problem: How the Student Loan Industry Works
by Daniel Luzer
A few weeks ago the Institute for Higher Education Policy issued a report indicating that student loan delinquency was becoming a huge problem for former college students; only 37 percent of borrowers were able to fully pay them back on time. In light of this information the Monthly recently spoke about student loans with Paul Combe (right), the President and CEO of American Student Assistance, one of America’s largest student loan guarantors.
Washington Monthly: Most people don’t actually know what your organization is, unless they have student loans and they have a specific relationship with your organization. Explain what ASA is and what it does.
Paul Combe: ASA is a loan guarantor. It’s a non-profit organization whose focus is helping education loan borrowers manage their debt. It’s as simple as that
WM: Tell me briefly what a guarantor is.
PC: Their traditional role, going back to the 70s, was to encourage local banks to participate in the then new federal Guaranteed Student Loan programs. Guarantors provided financial aid information to students within their states to help them access and finance a higher education. They acted on behalf of the Department of Education making sure that schools and lenders stuck to the federal rules and regulations pertinent to the loan program.
One of the key functions they have is to insure the lender against default. Guarantors manage a process called pre-claims; when a loan becomes more than 60 days past due, the lender notifies the guarantor that they may have a default claim coming up. The guarantor’s job is to try to get the borrower back in good standing. If the loan defaults, the guarantor pays the lender the claim for the loan, which pays the lender off in the process. And on behalf of the federal government the guarantor holds that loan, and collects on it.
WM: Is there any equivalent in regular loans, in normal consumer debt?
PC: No, not really. So if you have a consumer loan that is 60 or 90 days past due, it starts to be written off by the lender and is sold off for some cents on the dollar, to agencies who handle bad debts. The federal loan program is like taxes, the loan never goes away. If you look at this from the lenders point of view the consumers have very few protections. So it’s a very different loan. Federal student loans are exempt from normal consumer , truth in lending protections. There is no analogous functionality within the lending industry for a guarantor or the functions they perform.
WM: When did we start to have institutions like yours?
PC: ASA was created in 1956 when the state of Massachusetts decided that people needed help financing higher education. State legislation created institutions like ASA, and the individual banks in the state created a guarantee pool. So basically it was an insurance pool. That allowed the banks to lend to 17-year-old kids.
WM: Because in normal loans you can’t loan to people who don’t have assets or income.
PC: Exactly. The point of it was to provide this guaranteed pool for lenders to encourage lenders to lend to people for college. The first federal loan program was the National Defense Student Loan, created in 1958. And that was created as a revolving pool, managed by the schools. So the idea was the federal government could seed money in, the school would lend it to the students, the students would pay back the loan at interest, the interest would go into a pool, they’d have more money to lend to future students. That process couldn’t keep up with the growing need.
Later, with the passage of the Higher Education Act of 1964 the federal government developed the insurance model and for the guarantors to be involved in the program, and for us to actually manage that and bring private lenders into the program. Basically, the guarantor’s role was to make the program successful, which they did, very well.
WM: But before the 1950s, people still went to college. How did people go to college without these complicated loan programs?
PC: If you look back at the demographics of people who went to college it was primarily upper middle class population. The first financial aid program changed the American landscape, it was the GI Bill at the end of World War II. Everybody who was GI, regardless of social background, had the chance to go to college. And when those people who got that education had their own children, guess what? They wanted their kids to be able to go too.
WM: But by that time college was a lot more expensive and so we got financial aid as we now know it?
PC: Sort of. The GI Bill spurred a lot of research done in the 50s on financial aid. That’s when they came up with the current financial aid system, where need analysis was perfected. And need analysis in those days was a purely economic measure—there was no politics involved, a purely economic process controlled by the colleges to determine how much someone could afford to pay for higher education.
I became a financial aid officer in the mid-70s. The mantra of that time was “access and choice;” in other words that every student who should be able to go to college, should go, and they should be able to go to the college of their choice. That eroded from “access and choice,” to “access” only, and now we have “access and success.”
WM: So what does this mean now? What does ASA actually do with students and institutions to try and help people manage debt?
PC: Internally, at ASA, it’s called proactive education debt management. This means getting a hold of the borrower before the major events occur, and make sure they have the information they need to make the right decision. We believe that all borrowers are working in good faith. We’re not trying to protect the federal government. We’re not trying to protect the lender. We’re trying to protect the consumer. The borrower wants to manage his debt. Very few people are trying to shirk it.
If you contact a borrower—if you’re proactive about it and you contact them beforehand—you can cut delinquency by 50 percent. And if you cut delinquency, obviously, that cuts default.
WM: Why does delinquency occur?
PC: If there are 30 million borrowers out there, there are 30 million reasons. But think of this in economic terms. The student loan, after you graduate from college, has zero utility. It’s like paying for a car that you crashed five years ago.
So you’re going to pay those things that have the greatest utility for you at the moment: You’re going to pay your credit card, your car payment, your rent, your food bills, all these things, your utilities. And somewhere down at the end of that list is your student loan. The student loan is the first thing that goes out, and the last thing that comes back in.
It’s a rational economic decision, and the intent is to eventually pay it. The borrowers don’t know the rules. They don’t know when they’re passing over these magic thresholds that put them in different categories. They’re just living their lives.
There’s zero reason for anybody to default on a student loan. There are enough remedies in this program to save anybody. There are deferments, there are forbearances, there are income based repayments. If people are given the right information at the right time, they shouldn’t become delinquent, and they should never default.
WM: I understand that there are a whole bunch of different things that you can help people with student loans to do to avoid delinquency but ultimately we’ve decided to finance higher education largely through personal debt. Does that work?
PC: I think there is a greater structural problem. But that threshold for that greater structural problem was passed in the 80s when debt became the primary means of financing access to higher education. There’s now approximately $100 billion in students loans made annually. Even if you froze college costs right now, the average indebtedness is $23,000 dollars. If by magic you were able to come up with another $100 billion for Pell grants, we’ve still got a problem. We’ve got 30 million people who are in debt and as the IHEP study shows, two out of five of them are in trouble, at least.
WM: Is there any reason to think that this is going to get any better?
PC: No. There is some rationale for student loans. From a public policy point of view — he who benefits, pays. You can’t work your way through college anymore, but you can use some debt. But the question is what the rational level for that debt is.
Yes, the federal government should pay for college, the states should pay for it, the parents should pay for it, the institutions should pay for it, and the students should pay for it themselves. But some 65 percent of college aid is now paid for in the form of loans. If we are doing that, what kind of services should we supply to the consumers afterward? No one has thought through the ramifications of this. If we are getting students into debt, don’t we have an obligation to help them get out of debt?
We have to come up with a better solution, but as long as there’s a loan program on the books -then we have to help manage them.
As soon as the promissory note is signed, the relationship between that borrower and the federal government changes. The federal government has an obligation to supply the kinds of services, consumer services, those people need to be successful.
Congress has done a good job of supplying the remedies. It’s just that there’s nobody charged with communicating with the borrower effectively. There’s no incentive structure anywhere to provide services to borrowers.
WM: What if people just stopped paying on the loans, would massive defaults draw attention to something unsustainable?
PC: Well, there are personal implications of that. The cost of defaulting on these federal loans is really high- it ruins your credit score; it shows up on anything from trying to rent an apartment, to buying a car. It increases your cost of any other consumer product you’re going to buy.
Most of the default, and a substantial portion of the delinquency, is actually on people who tried, but failed, to go to school.
WM: They’re dropouts?
PC: Non graduates. This means they don’t even have the economic benefits of the education.
WM: Right, they just have debt.
PC: Robert Shireman once said that federal student aid programs are a “bridge” for people to get from one part of life to the next part of life. Federal loans are a bridge, and if something happens on that bridge that affects them the rest of their lives, there’s a liability to help them solve that problem. We forget to think of these people because they’re recipients when they take the loan. But they’re also consumers with rights and obligations yet without the experience they need to manage their debt properly.
If you look at the for-profit school data, and the community college data, you’ll see that the percentage of borrowers connected with these institutions who use the debt management services, forbearances and so on, is very small. Those people go right from getting the loan, dropping out of school, and defaulting with nothing in between. Those are the people with the least information, and the least support systems. They tend to be more marginal students.
WM: Well don’t they also make the least money?
PC: Well that’s true. But it has nothing to do with money; there are remedies but if you look at the process they went through to get to default, there is no process: they don’t do anything, they go right to default.
WM: Right, they never got to the point where they were trying to make payments on their limited incomes.
PC: Obama has a policy: he wants to increase education attainment to 20 million, which would be the highest rate in the world. It’s a worthy thing. But you’ve got to be able to make it so that people are encouraged to try. If trying and failing means getting stuck with a stupid loan for the rest of your life, it’s problematic.
WM: The population who goes to school and doesn’t graduate, if you identify them beforehand, wouldn’t you just be recommending that they not go to school at all?
PC: No. Some people may get into the wrong program. Think of it this way - you start a program, and you realize: “I had dreams of becoming a doctor,” but you get in there and realize, “I can’t even do Algebra,” and you fail. But perhaps you could be a pretty good nurse. But by defaulting on your student loan, you can’t go back to school, because you can’t get aid. You’re denied the benefit of it.
And counseling is important. But you can work around the problem. You can focus on improving completion rates. But you’d still have people graduating with debt that they need to have the right information for. So we need to identify this as an individual consumer problem, one borrower at a time. It’s like doing preventative medicine. And like preventative medicine, it’s expensive. [Image courtesy American Student Assistance]