The State of Student Loans – an interview with Tom Krebs
|September 3, 2012
Previously published on August 31, 2012
As one of the only forms of loans that aren’t dismissed during bankruptcy, student loans are in many ways more severe than others. Additionally, the ability for a debtor to pay off their student loans depends on the assumption that they will be employed commensurate to their education. This relies heavily on the stability of the job market, which after 2007 was decidedly less accommodating to new college graduates.
While it might be tempting to place all of the responsibility on the shoulders of students for taking the loans, there is increasing evidence coming to light that lenders practiced predatory lending habits, most egregiously in the case of for-profit colleges. The result is that there are now trillions of dollars of unpaid student debt, and the number is still growing.
Tom Krebs is the former Director of the Alabama Securities Commission and a lawyer with over 35 years practicing securities law, and he says that the lid is just now being blown off to expose how bad the problem really is.
What was the state of student loans and loan securitization and at the time of the economic collapse?
Tom Krebs: Basically securitization is taking long term liabilities and converting them for short term cash. And it’s taking the risk away from the lender and putting it on the shoulder of investors. You bundle up loans and then you create a waterfall with the cashflows. The loans are paying monthly a stream of income and you put that into a waterfall so the higher rated triple A rates get paid first. This reduced risk and expanded the market.
So there was no problem selling these products. The fact that there was so much demand meant that sometimes you could take $100 million of student loans and sell them in the market for $102 million. It depended on the market. But I will tell you that with respect to the 2005 to 2007 timeframe that it was a blue market. The securitizations actually provided the subprime of student loans.
How did the loan process differ between normal universities and for-profit colleges?
TK: In the normal case, a student applies to obtain a loan – typically more than one – through the university, and then they’d be declared eligible. To determine this, they would look at what the kid was given and what they’d be able to pay and they would decide that he would receive X number of dollars per year.
And there was some certification done by the institution itself. That didn’t happen a lot for the for-profit colleges. By for-profit colleges, I mean the ones that advertise on TV that we’re all so familiar with. These colleges engaged in direct marketing to students. Mass media was their drive. Often times they’d use their own loans and they weren’t careful about the ability of that person to pay. In most instances, loans were only given when you have a co-signatory like a father, but in this period that wasn’t going on. There was more than a trillion dollars of student loan standing in 2011 and $864 billion was federal government loans, and about $150 billion was in private student loans – meaning it wasn’t guaranteed. It seemed to be the channel utilized by the for profit colleges.
How bad was the problem at the time?
TK: At the time of the crisis only 67% of loans required a cosigner. In 2011, 90% required them. This shows you the difference between now and then.
In the years before the economic crisis [roughly 2000-2007], enrollment in for-profit colleges went from around 365k students to about 1.8 million. It blew up astronomically. As the market for securitization grew, so did their enrollment. It’s also interesting to look at other statistics concerning the for-profit college that show they weren’t just taking the students to provide them with an education. For example, the graduation rates for the for-profit colleges was 22% while private colleges were 65% and state schools were 55%. Another interesting fact is that the graduates of four year public universities are graduating with about $17k dollars of student loan. At four year private schools, it’s about $22k dollars of loans. At for-profit schools, about 90% of students have to take out loans of more than $30k dollars. And this is for schools where a lot of their courses are taught online.
Finally, another disconcerting figure is how much of that loan gets paid back. For normal universities it’s 43%. For for-profit ones, it’s 4%. Even though for-profit college students only make up 13% of the US student population, they account for 47% of student loan defaults.
In part because of these figures, I know that the Department of Education is considering the imposition of sanctions against certain schools because of the extremely high default rates. Senator Harkin of Iowa has been holding hearings about some of the for-profit colleges attempting to hide by getting forbearances from students in technical default. It’s their intention to limit the ability of those persons to utilizing Pell grants and government loans.
Was the practice of these lenders illegal?
TK: This is something that’s being debated. One of the things that the Department of Education and Consumer Financial Protection Bureau are concerned about is if borrower students were mislead about the terms of their student loans. Keep in mind, with respect to securitization, the higher the interest rate, the better the deal for the securitization folks and the more investors wanted to buy into those deals.
Though I don’t think we know for sure yet, there is a long string of testimony coming out of congress talking about the marketing tactics of for-profit colleges, citing examples of them going out to homeless shelters and offering the homeless student loans so they can go to school, even giving them travel money. These are predatory tactics.
What is being done to change the situation?
TK: There are a number of issues that have been raised and a number of curative measures put in place for the purpose of making certain that the student is fully apprised of the prospect of borrowers and the terms and conditions of the loan. The Truth in Lending act has been amended to require three different disclosures to be made – one at the time of application, a second when the loan is approved and a third when they get into college. This is opposed to how it was before, when a single notification was made after the student had the money in hand.
What do you think the lesson of the story is?
TK: One of the main issues here is the question of why wasn’t all this information disclosed? Why weren’t investors told that these types of predatory practices were being used in loans that they were being sold? That’s a good question. Were there misrepresentations or material omissions that should have been told but were not? I guess we’ll soon find out, since now that this is coming to light there are a number of lawsuits being filed that will try to hold many of these lenders accountable, and it will have to be decided on a case-by-case basis.
Alex Levin is a writer for Seeger Weiss LLP, a top ranking law Plaintiff’s law firm specializing in medical malpractice, drug injury, and securities and investment fraud.
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