By R. Michael Smith, Esq.
Attorney at Law
Cincinnati, Ohio.
michael@rmsbankruptcy.com
As we observe the growing discussion over the tremendous amount of outstanding student loan debt, several points of clarification might do us well. There are those favoring relief for debtors now unable to pay their student loans. They have proposed various forms of relief, including several forgiveness programs and re-allowing such debts to be discharged in bankruptcy under more usual circumstances. On the other side are those pointing out that any relief must inevitably put the forgiven debt on the backs of tax payers, as the loans were federally guaranteed.
Close analysis of this near-crises debt situation indicates that it was not brought about by well-meaning federal guarantees, or by less-than-wise borrowers. The real culprit was the unwise process that emerged, allowing lenders and universities to take advantage of both taxpayers and those prospective, but poor, students. They traded on the hopes and dreams of the inexperienced and unqualified, reaping windfalls of other peoples’ money, often never delivering on the implicit promises of upward economic mobility.
With the promise of federal guarantees (and a degree of prodding toward lower borrower qualifications), banks began to lend to prospective students without ordinary safeguards or the kind of analyses they would impose on any other class of borrowers. Thus, for a business loan, banks inquire as to the borrowers’ credit worthiness, expertise & experience in the field, and prospect for making a profit in the future.
By contrast, hardly any standards of review were applied to the student applicant, other than the more recent push to obtain credit-worthy co-makers. There was no lender inquiry as to whether the applicant had the qualifications to attend college, i.e., high school grades, post-high school activities, the prospects of making a living with the degree sought, and, perhaps more crucially, follow-up review of the borrower’s academic progress. Absent any reasonable gate-keeping functions, huge numbers of the nearly unqualified received significant funds for average or less than average course work in often dubious programs.
Naturally, upon ending their education process, these would be unable to obtain gainful employment in a higher paying field. Just as predictably, they could not pay back the loans. We call this process, by the way, negligent lending, for which the banks, where such is proven in the individual case, should bear their own losses.
The other partner to this ill-begotten marriage are the universities. The expansion of available student aid money, whether loans or governmental grants, has proven to be a wide & deep river of constantly replenished cash. The result was a two-fold incentive: to admit as many as might qualify for the student aid; and to increase the tuition and expenses so as to get more student aid.
Of course, the natural gate keeping function that would have operated to minimally safeguard the public treasury should have been the usual and proper admission standards for colleges and universities. Under usual admissions processes, there must be shown some degree of class standing, along with admissions test scores reasonably predictive of an ability to negotiate a college curriculum. Such qualifications would also function to qualify those well-motivated and equipped for success i.e., future loan repayment!!
However, seeing an army of those who would qualify for full coverage of need-based financial aid, but who were less qualified (unqualified) academically, they set up alternative admission tracks. Adding to this impulse was the panacea of helping the poor, disadvantaged, and socially marginal to advance through education into the American mainstream.
While the ordinary admission process might require good academic standing, higher class rank, above average (or even average!) SAT or ACT scores, a separate process was invented for the large numbers of those already financial aid qualified. Rather, an old process was expanded well beyond the original intention.
Most universities maintain a sort of academic back-door for benevolent admissions, by which those deemed properly motivated, but less academically qualified might be conditionally admitted for an opportunity to prove their ability to navigate a college curriculum. Such students could be formally admitted into the university, but only into a track or euphemistically named college, set up for lower level (designated “remedial”) course work. Ordinarily, such process would be for riskier admissions, done with the hope of building up their academic capabilities, before permitting admission into the regular college programs. Others were admitted provisionally into less than rigorous academic disciplines, with very little prospect for making a living with such degrees.
The universities simply expanded these admissions processes to admit all who could be qualified for financial aid. The result was a stupendous financial success for the university. Money flowed for tuition and room & board in a never ending stream! They could raise the costs, and the federal money would still flow in! This, of course, they have done, to the detriment of those paying their own way.
The emergent picture was of universities able to have their coffers filled annually with federally guaranteed money, from an ever-increasing supply of the academically unqualified, but hopeful, paying ridiculously increasing rates for tuition, room & board. The universities provided no gate-keeper functions, but instead, took advantage of the hopes of those unqualified by background or experience to evaluate their own future prospects, or the viability of the programs they were counseled into.
Like a swarm of locusts, other opportunists flooded into the field. Small, shady, for-profit schools emerged, who promised expertise in a wide range of fields, but could not deliver a job. They too, pull the net filled with unqualified applicants, admitting them without much scrutiny, then deliver to them little or nothing that will help their future prospects.
While there have also been successes through student loans, for all too many, the universities and other schools have willingly structured and participated in a scam for a great many. The result is that unimaginable sums of debt have been created, with, in all too many cases, virtually no prospect of having the money repaid. For decades, such funds gone into the university coffers, without risk to them and with no obligation to deliver anything. Accordingly, there is a sense in which they should stand liable for the harms their actions have caused.
Of course, the tax payers did not cause this vast ocean of unpaid student loan debt. Most legislators could have anticipated the cabal that emerged between lenders and universities. Noone signed up for this! Morally, it seems justified to put the burden of the unpaid debt back where it belongs: on the backs of negligent lenders and culpable colleges.
At present, there is a hue and cry over whether to permit forgiveness or a bankruptcy process for student loan debt. Nearly every congressional cycle has a bill introduced to do so. Each year, such bills die without action. There are, of course, well-entrenched interests quietly pressuring the process. First in line, naturally, is the Federal Government, which has foolishly guaranteed debt without safeguards. The amount of debt that could be forgiven under any program is absolutely staggering. Governmental payouts for discharged or otherwise abolished student loans would utterly destroy our federal government’s fiscal soundness for years. No administration could easily agree to such a plan.
Second in line are lending institutions holding student loan debt. Their oxen could not avoid a congressional goring, at least to some extent. What the government could not absorb would need to be written off. Of course there are Constitutional protections against retro-active negations of vested contractual rights. Government can’t easily welch on the deal! But if it means we all suffer, they must as well.
Third in line are the Universities and hodgepodge of institutions that feed on financial aid programs. If we begin cleaning house on this messy arrangement, access to financial aid will be, must be, more limited. If it begins to be limited by more normal lending criteria, coupled with closer regulation of university admissions (of whom, and to what programs), then the government’s nose will be inside the tent. And the flow of money will surely diminish.
Frankly, it would appear impossible to get any meaningful relief in the student debt arena under the very best of circumstances. It could only come about alongside a determined effort to re-define liability for the existing debt. Further, redefinition of the entire financial aid process, including creation of actual responsibility of universities and colleges, must be a centerpiece of any effective reform.
PROPOSED SOLUTIONS
To fully address the incredible amount of student loan debt, and attendant complications, we would likely need a spectrum of solutions, more of an omnibus bill. Top of the list would be to incentivize repayment. We do this easily enough by allowing a tax deduction for the full amounts repaid on student loans, and regardless of income level.
The present allowance for interest payments is, of course, subject to the rather fraudulent and artless accounting game of the lenders in capitalizing unpaid interest owed into the principal of the loan itself. Thus, we now have loans that have festered awhile, and are as much as 90-95 % capitalized interest upon capitalized interest. Nearly all the loan owed is truly interest!!
Further, we want to create an incentive for repayment–not co-conspire in gamesmanship. If someone is able to reduce their income by paying on their student loan, thereby saving the amount of taxes they owe, it is a far cheaper price than the government’s guarantee of the entire loan. Of course, one with higher income will be able to repay more– if there is an incentive to do so!
Obviously, those with truly high incomes will have already paid off their loans; however, someone who is making more than $50,000. per year but less than $125,000. per year are in that middle class range where an incentive would be of greatest benefit. This is the range where mortgages & car payments, not to mention the wide range of children’s expenses would eat up the income. An incentive to repay is of greater value here, because there may, from time to time, be lump sums available to throw at the student loans.
There should be no decreasing deduction based on income, if we really want to see these loans repaid. Any deduction available will necessarily end when the loan is repaid, making it a hoped for, temporarily available, deduction. Once all the loans are paid back, the ability to write it off is gone. The more they pay back, and the sooner, ultimately reducing the government’s guarantee load, the better for all.
CHANGE THE GOVERNMENT GUARANTEE BASE
At present, the lenders are confident that the US Government is guaranteeing 100% of the unpaid balance of the loan. That should change. The government did not intend to be on the hook for ever increasing interest capitalization, or the specter of abuses in the loan approval process. Therefore, the law should limit the exposer of federal guarantees to the amount of the original loans, plus no more than 4 years of interest from the date the loan first becomes due. This rule should apply whether the loans are consolidated or not. Given the abuses inherent in the front end lending processes, the federal government has every moral right to now limit taxpayer exposer. Further, such a move would certainly create an incentive by lenders to work out settlements with loans that have lain dormant, in default or minimal income status.
PENALIZE UNIVERSITIES FOUND TO BE ABUSING THE PROCESS
The greatest direct beneficiary of the open cornucopia of student aid have been the universities. As mentioned above, many of them have not performed the gate keeping functions related to responsible admissions of reasonably qualified students into meaningful degree programs. Instead, they have found ways to game the system so as to artificially enhance the flow of federal money into their coffers. They cannot be left without a dog in this fight. They cannot be permitted to sit back, paying no cost, and doing nothing to remedy the situation they helped create.
Any unpaid loan by a student who was admitted to their university should have consequences to the university as well. When a student loan goes into default, the student loan money coming to the university from the federal coffers should be reduced by the amount of that loan outstanding. These sums should then be placed in a separate fund to shore up the federal guarantee on the student loan. If the loan is ultimately repaid, then the funds might be released to the university.
The goal is to force the university to admit into their (genuine) degree granting programs those with the academic qualifications to engage the course of study, complete the degree, and ultimately become income producing graduates. This would also require limiting those receiving student loans to programs likely to help them make a future income. A few electives in ethnic or social studies are one thing; to make a degree from such must not be at the risk of taxpayer money. Further, those obtaining mediocre grades or repeatedly dropping courses should not be eligible for further loans without repayment of the original loan. There may be a way back in, if, at their own expense, such student pays for courses and completes them with a high grade point.
The university is the point of contact with the student and is in the best position to identify abuses of loan programs by students. This would include those who qualify for, and take out maximum high loans, who’s course work is observably mediocre, and who’s progress has not been substantial.
DEVELOP RELIABLE LENDING CRITERIA
Frankly, student loans are not the sorts of loans that banks have customarily made over the years. Hence, bankers are not in the same position to evaluate the merits of the borrower, or the continued prospects for successful repayment by the borrower. For example, if the lender makes a construction loan, they have expertise to monitor the process to completion and to place their lien on the finished product. Likewise, new business loans start with a business plan and an analysis of the potential for success of the borrower, including expertise in the field, past successes, etc.
On the other hand, the bank has virtually no criteria for evaluation of an individual prospective student. It’s not simply an unsecured loan; its an unsecured loan to a young person with no job, no history, and no present indicators of ability to repay.
However, in proper exercise of its responsibilities, the bank should develop student focused criteria to avoid the virtual hand out of depositors’ money. Along these lines, most banks seek co-signers for student loans. For the children of the working poor, this amounts to a denial of the loan and a scuttling of their dreams for a better future. Those who are able to obtain co-signers wind up placing the co-signer at the mercy of the student, over whom they are not likely to exercise much control. A defaulting student may quite easily result in a defaulting co-maker.
A better approach would be for the banks to create success profiles for prospective students. It would include developing expertise in the arena of student performance, profitable degree programs, and perhaps even creating linkages between business clients and select students who might one day become profitable employees. Thus, students with superior grades and measurably high motivation might be granted such loans without co-makers. Thereafter, the lenders would monitor grade performance, progress toward income-producing degrees, and uses of borrowed funds for necessary expenses. Such an approach would seem to result in far less risk of depositors money, and that upon the promise of (potential) federal guarantee. There is no free lunch! Not to the banks or the universities.
The student loan issues have grown into problems of such significant proportions that we can no longer turn a blind eye. A comprehensive approach must be on the table, or the festering will continue. There are no easy ways out.