Federal Student-Loan SharksPrint
Why is the government gouging our college kids? The new law on loan rates just makes things worse
By William J. Quirk
September 5, 2013
Education, Thomas Jefferson believed, should be free. Its universal availability was at the center of his vision for the republic. In the wake of the Constitution’s drafting in Philadelphia, he remarked in a letter to James Madison, “Above all things I hope the education of the common people will be attended to, convinced that on their good sense we may rely with the most security for the preservation of a due degree of liberty.” In 1778, Jefferson proposed to the Virginia legislature a bill for the “More General Diffusion of Knowledge.” The bill’s preamble reads, “those entrusted with power,” in all forms of government, “have perverted it into tyranny,” and “the most effectual means of preventing this would be to illuminate, as far as practicable, the minds of the people at large.” When Jefferson thought about the nation’s education system, writes Merrill D. Peterson in Thomas Jefferson and the New Nation (1970), he “projected three distinct grades of education—elementary, middle, and higher—the whole rising like a pyramid from the local communities.” Elementary schools would freely educate all children in reading, writing, and other basics. The middle and higher schools would be selective and charge tuition, except for poor students who passed rigorous examinations and received state scholarships. From its opening in 1825 until 1860, Jefferson’s University of Virginia charged a tuition of $75 per session.
Perhaps it won’t surprise you to hear that we have very few Jeffersons in the 113th United States Congress, but then we don’t have any in the White House or the Department of Education. Congress spent the summer bickering over whether the rates for student loans for higher education would double on July 1, from 3.4 to 6.8 percent. They did double through congressional inaction; but at the end of July, Congress passed a Senate compromise that fixes rates annually to the 10-year U.S. Treasury note plus 2.05 percent, capped at 8.25 percent. This year’s rate will be 3.9 percent for undergraduates and 5.4 percent for graduate students, who have traditionally paid a higher rate. In the press, the new bill was hailed for decreasing rates and saving students significant amounts in interest. But of course the bill actually increases rates by half a percentage point from what it had been before July 1. The federal government is in effect levying a new tax on college students in a program that already raises an obscene amount of money for the Treasury and is jeopardizing the financial future of a whole generation of young Americans. Our third president, it’s fair to say, would be disappointed if not disgusted.
In his 2010 State of the Union address, our 44th and current president proposed to “finally end the unwarranted taxpayer subsidies that go to banks for student loans.” We all agree with that; but what should we have done next? For starters, the government could have stopped being so greedy and instead made direct loans to students at its cost. With the current cost of funding at 0.7 percent, that approach would have put student loans at around one percent. President Obama apparently never considered that course—by continuing the same high rates, the same high profits go to the government instead of to the banks.
Government loans are wildly profitable. If you borrow at 0.7 percent and lend at 3.9 or 5.4 percent, you have what’s called a favorable spread. The Congressional Budget Office reports that the government makes 36 cents on every dollar lent to undergraduates and 64 cents on every dollar lent to graduate students and parents. The loans cannot be absolved through bankruptcy except under extreme conditions, and the government can, without even a court order, garnish wages, disability payments, and Social Security. Indeed, the only certain way to beat the government is to die without any assets—an extreme course of action.
The original student-loan program followed Jefferson. Passed in 1958, as part of the National Defense Education Act—a response to Sputnik—it provided for Treasury loans to students at three percent. The government’s borrowing rate was 3.1 percent in 1957. The program gave priority to “students with a superior academic background” who expressed an interest in teaching elementary or secondary school, and to students with a “superior capacity” for “science, mathematics, engineering, or a modern foreign language.” Loans were limited to 10 years and were forgiven if the student went into public school teaching.
In 1965, as part of President Johnson’s Great Society program, Congress passed the Higher Education Act. The law introduced the government-guaranteed bank loan, which today has grown to more than $1 trillion in student loans outstanding—an amount greater than credit card debt and second only to mortgage debt. The guaranteed loan program created the student aid industry, led by the banks and the government-sponsored entity Sallie Mae. The industry has enjoyed significant profits from high interest rates on riskless loans. Sallie Mae stock rose more than 1,900 percent between 1995 and 2005. Its CEO, Albert Lord, made $225 million between 1999 and 2004.
As the industry attached a giant siphon to students’ lifetime earnings, the nation began an experiment not in illuminating young minds or upholding the Jeffersonian educational ideal but in finding out what would happen if our college graduates started their working lives with a large negative net worth.
Who came up with the idea that anyone should profit from student loans? Would it be a surprise to hear that the banks and the lenders were involved? When Congress created the guaranteed bank loan in 1965, Sen. Wayne Morse, a Democrat from Oregon, said,
The loan program that we have worked out in this bill is the result of prolonged conferences with the representatives of financial institutions of this country, the banks, and the loaning agencies, the Treasury, the Bureau of the Budget, and with the Department of Health, Education, and Welfare.
The switch from direct loans to guaranteed loans was an accounting fiddle: direct loans showed as a budget expenditure, and the guaranteed loans did not. The Johnson administration was seeking to keep overall budget numbers down in view of its heavy expenses for the war in Vietnam. No one mentioned that a parasitic industry had been created, one that could make money without risk.
The program not only became a profit center, first for the banks and Sallie Mae and then for the federal government, but it also became the main support for a profligate American higher education system. In 2011–12, the program pumped $113 billion into colleges and universities, which amounts to about 35 percent of the total tuition bill. Private colleges and universities typically receive an estimated 60 percent of their tuition from student loans; law schools, 80 percent. The student-loan program is growing bigger and bigger. It has already increased almost 10 times since 1989–90 ($12 billion), tripled since 1999–2000 ($33 billion), and doubled since 2004–05 ($55 billion).
One sign from the 2011 Occupy Wall Street protests read, “Borrowed $26,400, Paid Back $32,700, Still owe $45,276.” As the sign implies, there is no escape from student-loan debt. If a student defaults, he is headed, as financial-aid expert Mark Kantrowitz told Business Week in a metaphor mash-up, “for a trip through hell with no light at the end of the tunnel.”
A 10-year loan can almost double because of debt collection charges of nearly 20 percent. The federal government paid collection agencies $1.4 billion in 2011. Those who predict that student loans are a bubble about to pop note that the increasing cost of tuition and the increased debt load carried by students are similar to housing debts in 2007. But student loans are forever: unlike a house, a student loan can’t be abandoned. The students owe their soul to the company store. And the biggest cost of the student-loan fiasco may not be the crushing debt to the individual graduate but the deflation of that entrepreneurial spirit that distinguishes the United States from much of the rest of the world.
Debt is silent. It creeps along, but once it is incurred, the obligation is as strong as death. Two-thirds of graduates leave college with student loans, owing on average $26,600. A dependent student (one under 24 who is still supported by parents) can borrow up to $31,000 at 3.9 percent over a five-year term by taking out Stafford loans. An “independent” student can borrow as much as $57,500 at the same rate. Parents can borrow further at 6.4 percent. About 90 percent of law students graduate with debt averaging more than $100,000. Each year a graduate student can borrow $138,500 at 5.41 percent and an additional amount up to the “cost of attendance,” say, $54,000 at 7.9 percent.
Up to 3.7 million former students owe over $54,000 and 1.1 million owe more than $100,000. Over two million Americans 60 or older still have outstanding student loans. The miracle of compound interest works against the student. A loan at six percent interest doubles in 12 years—at three percent, it doubles in 24 years. The government, universities, and bankers have captured a substantial part of the student’s future income stream.
Real people exist behind these figures. Consider the example of Alan Collinge, who attended the University of Southern California, taking out $38,000 in loans for his undergraduate and graduate degrees in aerospace engineering. He got a job at Caltech and repaid $7,000 before leaving his job. He could not find a new one and stopped paying Sallie Mae after it refused any forbearance of his debt. He eventually owed $100,000 and couldn’t get a military contractor job because of his bad credit. In 2008, the U.S. Department of Education offered to waive his accrued interest and fees, according to The New York Times. He is now an activist on the subject of student-loan debt. Fortune magazine reports that in the early 2000s, Sallie Mae charged one student at Katharine Gibbs, a for-profit school, 28 percent interest—a stated 14 percent and a supplemental fee. Angelica Gonzales did not graduate from Emory University but owes $60,000 on student loans and is earning $8.50 an hour as a clerk in a furniture store.
Since World War II, there has been a sharp increase in the percentage and number of high school graduates who enroll at colleges and universities. In 1958, 24 percent were enrolled; in 1980, 45 percent; in 2010, 68 percent. (The total number of students doubled between 1980 and 2012, to 19.7 million.) Since 1964, the student-loan industry has financed the increased demand.
The Economist from December 1, 2012, reports that the cost of higher education per student since 1983 has risen by five times the rate of inflation. In comparison, medical costs have gone up twice the rate of inflation. Between 2000 and 2010, tuition rose 42 percent at public institutions and 31 percent at private ones.
Before the era of student loans, college tuition was substantial, but it didn’t threaten a student’s long-term financial health. A college kid could contribute a good part of the cost by working summers and holidays. But very few summer jobs pay well enough to make a dent in a $40,000 tuition bill. To pay tuition, room, and board for four years at Harvard today, at about $65,000 a year, parents need to earn (assuming a 50 percent tax cost) in the neighborhood of $520,000 in pretax money—a pretty exclusive neighborhood. Harvard’s tuition was $1,520 in 1960. Adjusting for inflation, that amount would still be only $11,990 today, but the actual price is $40,016. Tuition at Columbia University cost $1,450 in 1960, which would be $11,438 today, but the current cost is $46,846. State schools have also dramatically increased what they charge. In-state tuition at the University of Virginia cost $490 in 1960, which would be $3,865 in today’s dollars, but the current cost is $12,458. Although the government has piles of studies denying it, student loans appear to have induced, or at least facilitated, the astonishing rise in tuition.
Admittedly, it seems counterintuitive that student loans, intended to make college more affordable, have fueled skyrocketing tuition. But as education policy consultant Arthur M. Hauptman wrote in Inside Higher Ed in 2011, “There is a strong correlation over time between student and parent loan availability and rapidly rising tuitions. Common sense suggests that growing availability of student loans at reasonable rates has made it easier for many institutions to raise their prices.”
It is hard to understand how higher education can be so expensive. Harvard says tuition pays only half its cost; the rest comes from its considerable endowment. Why does it cost $80,000 for nine months of education? Science courses require some expensive equipment, but most courses are taught in large lecture format, often by assistant professors if not by graduate student teaching assistants. Cost, of course, may have nothing to do with it—the schools look to be charging what they can get, not what they need to operate.
The slowest-growing expenditure in higher education is the cost of professors. From 1999–2000 to 2009–2010, the average salary for male faculty increased by five percent, adjusted for inflation—indeed, faculty salaries, adjusted for inflation, have increased only eight percent since 1970. The faculty-student ratio in colleges and universities was 16.6 to one in 1976, and is 16 to one now. Costs for administrators and buildings, on the other hand, have shot up. In 1976, universities had 50 administrators to support 100 teachers; today there are 100 nonfaculty professional employees per 100 teachers. University presidents and administrators are highly paid. The president of Ohio State received $1.9 million, as well as $600,000 in expenses, before his resignation this summer. Yale’s former president earned $1.6 million in 2010.
From 2001 to 2011, debt levels doubled as America’s universities went on a Taj Mahal binge. Luxurious suites replaced dormitory rooms with common bathrooms. Plush physical education centers replaced gyms. Many universities added to building costs by making side bets with investment banks about the direction of interest rates. University presidents became so overconfident that they thought they could beat Goldman Sachs on interest-rate bets. The schools lost every bet. Harvard, Yale, Cornell, Dartmouth, Georgetown, and Rockefeller University have all paid substantial sums to escape from their bad bets. In 2004, Harvard, led by Lawrence Summers, former secretary of the Treasury for President Clinton and director of the National Economic Council for President Obama, entered into interest-rate bets with Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Bank of America. Harvard lost, and in 2008 the school spent $1.8 billion paying off its gambling debt.
The two fastest-growing student-loan programs—nonguaranteed private loans and student loans at for-profit schools—run together. Both are expensive and of doubtful value. Private loans—from bankers to students and parents without a federal guarantee—make up 15 percent of the $1 trillion in outstanding loans. The very existence of private loans to students is puzzling, since government guarantees were created only because private lenders would not lend to students with no credit history. But Congress changed the laws in 2005 when it decided that students could not get rid of the loans, as a practical matter, in bankruptcy. Private loans today offer the banks the best of all worlds: the loans can’t be erased in bankruptcy, but the banks can charge any interest rate or fees they want.
Why private loans should have this no-bankruptcy protection is not clear. The idea was first proposed in 1999 by Sen. Lindsey Graham, a Republican from South Carolina, who stated that his bill would “make sure that the loan volume necessary to take care of college expenses are available for students.” The 2005 statute, one section of a major bankruptcy revision, was enacted with no debate or discussion. President George W. Bush, on signing the law, made no reference to the provision. Proponents of preventing students from getting rid of their loans in bankruptcy testified at a 2009 House hearing, arguing that changing the law would lead to more bankruptcies and result in more losses for the system to absorb. Rep. Howard Coble, a North Carolina Republican, asked, “What lender is going to make student loans if the borrower can file Chapter 7 the day after graduation and thereby fully discharge the debt?” But this is equally true of mortgages and credit card debt, for which bankruptcy is allowed.
The inability of student borrowers to get free of their loan debt gives the lenders a lifetime lien on students’ earnings. The private loans can cause hardship to a co-signer because they—unlike government loans—are not discharged in the case of death or disability. There are a few forgiveness programs for government loans, but they are not available for private ones. With these special advantages, the private loan business took off. One-third of graduates in 2008 used private loans averaging $12,550. Sallie Mae is currently separating its guaranteed loan portfolio from its private loans, in the belief that the latter business can be a hot stock.
The for-profit schools, owned and operated as businesses, are growing very fast. Between 1998 and 2008, enrollment at not-for-profits increased by 31 percent, while enrollment at for-profits grew 225 percent. The federal government has financed for-profits since 1992, but the national interest served by doing so is far from apparent. The high-profit-margin industry created by federal support has attracted hedge funds, which now account for almost a quarter of all student loans. A 2012 Senate committee report noted that 76 percent of students attending the for-profits were enrolled in schools owned either by a corporation traded on a major exchange or by a private equity firm. The report estimated that in 2009, when all federal revenue sources are considered, the 15 publicly traded for-profit companies received 86 percent of revenues from Title IV sources. Title IV includes all federal loans and grants in aid of education.
The co-CEO of the for-profit University of Phoenix is paid $25 million a year. Congress, the Senate report notes, has failed to hold companies accountable to taxpayers for providing quality education. More than half of the roughly one million students enrolled in for-profit schools in 2008–2009 had left by mid-2010 without a degree or certificate. The for-profit schools in some cases double dip—they lend money to their students, profiting from the lending as well as from tuition.
More than 90 percent of students at for-profit schools are saddled with loans that, as the Senate report put it, “may follow them throughout their lives, and can create a financial burden that is extremely difficult, and sometimes impossible, to escape.” The students and the taxpayer bear all the risk, and the for-profit industry reaps all the rewards.
The Old Testament provides for a jubilee year every 50 years, when all debts are forgiven. The federal student-loan program does have three versions of jubilee year: debt is forgiven if you work for a federal, state, or local government for 10 years, make payments for 25 years, or pay 10 percent of your disposable income for 20 years. The debt forgiven can be a large number, easily as much as $250,000, since interest rolls up during forbearance periods—times when monthly loan payments are temporarily postponed or reduced because of hardship. Except in the case of government service, however, the Internal Revenue Code considers the canceled debt to be ordinary taxable income.
The federal government currently lends money to big banks through the Federal Reserve discount window at 0.75 percent but charges graduate students 5.4 percent. Sen. Elizabeth Warren, a Democrat from Massachusetts, notes that the government is charging students “interest rates that are nine times higher than the rates for the biggest banks—the same banks that destroyed millions of jobs and nearly broke the economy. That isn’t right.” She introduced a bill “to give students the same deal that we give to the big banks.” Senator Warren’s proposal, applied to new and outstanding debt, would be a major reform but has very little chance of passage.
President Obama seemed ideally suited to bring about fundamental reform of the student-loan program: “I know this firsthand—Michelle and I, we did not finish paying off our student loans until about nine years ago. And our student loans cost more than our mortgage. Right when we wanted to start saving for Sasha and Malia’s college education, we were still paying off our own college education.” The president pointed out that he had signed a law “that says you’ll only have to pay 10 percent of your monthly income towards your … federal student loans once you graduate … [so if] you want to go into a profession that does not pay a lot of money, but gives you a lot of satisfaction, you are still capable of doing that and supporting yourself.” He has also increased the amount available through Pell grants from $14.6 billion in 2008 to $40 billion in 2012. But President Obama’s major change has been to shift the student-loan program’s huge profits from the bankers to the government, which is no help at all to students.
Under existing tax principles, students should be entitled to some relief. Current government interpretations, however, are not fair. Parents are not allowed to deduct tuition and related expenses paid for their children. Students themselves have had very limited success deducting education costs as a business expense. Existing tax law generally provides a deduction for the costs of producing income. Education is certainly a cost of earning income, but the Internal Revenue Service does not see it that way.
Properly, education cost should be viewed as if the student were constructing a building. If factory owners can depreciate their cost over the useful life of their buildings, why can’t students depreciate the cost of their education? And why not let students write off their cost as fast as they want? The reduced tax bill will let students make a dent in their outstanding student debt. A doctor or lawyer, with a student-loan debt of $125,000, might earn $150,000 and owe $50,000 in taxes. Under my proposal, the professional could use a $125,000 deduction to save $50,000 in taxes. It would help.
Professional school tuition should be a business expense because anyone who wants to pursue a career as a doctor, a lawyer, an architect, or any number of other professions cannot avoid paying it. College expenses may be harder to justify, but even these, I would argue, are legitimate business expenses, since an undergraduate degree is necessary to get into a professional school.
The country’s student-loan experiment is coming to a bad end—all the numbers are getting too big. Congress created a system with no checks; the only incentive for the industry and for schools has been to do more. More students means more profit. But for-profit universities and now traditional universities are facing a fall-off in the student population that has already made it hard for some schools to fill this year’s class. Even if the numbers weren’t falling, do we really want to perpetuate a system that hurts ambitious young people in the service of greed? Private lenders are greedy, the for-profits are greedy, and the federal government is greedy, too. The incentives need to be changed, returning the program to its Jeffersonian roots. What society will get back is an educated citizenry that can afford to put its education to use.
William J. Quirk was a professor at the University of South Carolina School of Law and a former contributing editor of The New Republic. He died in September 2014.