Student Loans: 2008 Recession Part II
Forgiveness or not, the future isn’t bright.
In 2008, Sub-Prime Residential Mortgage Backed Securities (RMBS) were provided to homeowners whom did not meet the traditional financial standards to own a home. That resulted to a large default of the market. Some companies ended up bankrupt and forced to close. Families became homeless and jobless. Retirement accounts plunged to new lows. The children and next generation of those families, would become the next investors on platforms like Robinhood and protestors of Occupy Wall Street. Demanding changes in financial systems that appear to protect or solely benefit the rich on the lives of the poor and less fortune.
Only for the cycle and greed to continue in another debt security, Student Loans Asset Backed Securities (SLABS).
The Birth of Federal Student Loans
In 1958, the first ever student loan program was introduced under the National Defense Education Act of 1958. These loans would be direct loans funded by the U.S Treasury funds, following a recommendation from Economist Milton Friedman. Although when congress wanted to expand on the start, budget rules made the guaranteed approach increasingly attractive.
Under 1965 budget rules, a direct student loan, would show up on the budget as a total loss in the year it was made, even though the interest would be paid in the future. In contrast, a guaranteed loan, that had the full faith and credit of the U.S Federal government behind a private bank loan, would provide no up-front budget cost, because the government payments for defaults and interest would not exist until future payments started. At the time, Economist were concerned on accounting process, because it could create financial commitment difficulties in the future.
Following that year the Higher Education Act (HEA) of 1965 was signed into law by President Lydon Johnson. The goal of the act was to provide increasing educational resources of colleges and universities in the United States to lower income classes by providing financial assistance to post secondary students. The HEA helped create what we know today as the Free Application for Federal Student Aid (FAFSA)program that allowed students to qualify for scholarships, grant programs, low-interest loans and work study programs. As a result of this bill, the Pell Grant and Stafford Loans programs were created.
In the HEA bill, the Federal Family Educational Loan (FFEL) program was a system of private student loans that were subsidized and guaranteed by the U.S Federal government. Since the creation of the HEA bill, there have been several re-authorization of the bill, that have included reforms to improve the program mainly for the investors, and occasionally the borrowers.
Borrowers with the FFEL loans were not eligible for Public Service Loan Forgiveness Programs when made available. Often times borrowers were made unaware that their loans were not eligible for these programs. They could gain access to forgiveness, if they consolidated their loans with the new Federal Direct Student Loans program made later, but previous payments before the consolidation would not be considered for forgiveness.
These loans were built for the benefit of both congress not having to take on the administrative cost and fees associated with direct lending loans and the investors to have the protection of their loans not being forgive under the current policy of the programs.
And it did not stop there, either…
President Joe Biden involvement in Student Loan Reform Bills
In 1978, President Joe Biden as former Senator at the time, signed a bill called the Middle Income Student Assistance Act, which eliminated income restrictions on federal loans to expand eligibility to all students. In order to get lenders on board with the policy changes, he wrote a separate bill that would block students ability to seek bankruptcy on student loans after graduation, in an effort to protect investors.
In 1980, Biden involvement expanded, as he continued to create new loan programs to expand the individuals eligible regardless of not meeting current financial requirements. These programs included the Parent Loan for Undergraduate Students (PLUS) and started the Auxiliary Loans to Assist Students (ALAS) in 1981. The ALAS program allowed students to be eligible without parental financial support.
Following, in 1984, Biden helped get a bill signed by President Ronald Reagan, to allow non-higher education loans like vocation schools to be included in the protections of future bankruptcy cases. This protected investors from their funds to be defaulted due to rights of borrowers being practiced.
Later in the 1980’s provisions were added to bills to prevent students to be eligible for future aid if they defaulted on previous Guaranteed Student Loan programs. In 2005, the Bankruptcy Bill was introduced to make it near impossible for borrowers to reduce their student loan debt responsibilities. In an effort to protect investors, the Bankruptcy Abuse Prevention and Consumer Protection act raised requirement to pursue Chapter 7 bankruptcy protections. In an effort to make it harder for borrowers to receive options of removing debt that they could not afford to pay, to protect investors and generate more funding for future debt securities.
Of course, President Joe Biden previous signed bills that helped shaped the dilemmas of the Student Loan program in this country, leaves to question his true commitment to Student Loan forgiveness for borrowers. For decades, the country protected investors intentions over the borrowers. They guaranteed their investment back, but left borrowers without their investment guaranteed, a stable career with income that can payback both the loans and their livelihood in attempt at the American Dream.
Guaranteeing one with without the other one, just increases delinquent and default risks for both investors and borrowers. Making a protected investment a risky one for borrowers. As well as increases the removal of trust that its citizens has in its government systems.
The delinquent and default risk of student loans in the U.S
When you have low-interest rate guaranteed U.S Government debt securities, your chances on default and delinquency simply increase to a common rate. In order to be considered as a delinquent account, your student loans must reach 270 days late or 9 months.
Once your account is considered defaulted, the principal and interest are due with the collection cost. Currently the default rate is 11.4%. According to a 2018 Forbes article, 40% of borrowers are expected to default on their debt by 2023. Keeping in mind that these predictions were made prior to the pandemic of COVID; so the true results could be worse than predicted.
In 2018, there were more than 44M borrowers that totaled $1.5 Trillion in student loans. The average debt of graduates in 2016 and 2017 ranged from $37,000 to $40,000 total. In 2022, our total student loan debt has accumulated to $1.7 Trillion. That is an $200B increase in less than 4 years time span.
According to the Urban Institute and a report from The Brookings Institution, On average approximately 250,000 students default on their debt every quarter; that is nearly 1M students every year. It takes on average 19.4 years to pay off student loans, although the Standard Repayment Plan provided by FAFSA currently is approximately 10 years long. If you enroll in Pay As You Earn (PAYE) program, payments are 10% of your discretionary income, divided by 12 months, but never more than the 10 years from the Standard Repayment Plan period. That is far less than the time period it would take a borrower to repay their debt to investors.
Also students with less student loan balances are at a greater risk of default. 32% of borrowers with a balance of $5,000 or less defaulted at least once within 4 years compared with 15% of borrowers who owned more than $35,000. Showing that lower-income households are being the most impacted by these policies.
Traditionally when financial institutions and lending firms determine the qualifications of prospective borrowers to receive loans, they are interested in their current financial welfare of the borrower. Although over the years, the reform of policies that President Joe Biden supported allowed students whom could never before qualify because of the risk associated to lending money to their financial background, increased the risk on borrowers futures.
In a Statista report from 2021, it showcases the changes from 2016–2021 of recent college graduates finding themselves in careers that are making minimum wage. Approximately a minimum of 11.1% to a maximum of 13.8% of Bachelor college graduates with no higher degrees or furthering education received minimum wage jobs.
According to a Politifact article, Senator Elizabeth Warren has stated nearly 40% of college students that attended college and received federal student loans as a financial need, did not complete the degree, but still faced the financial responsibility of these debts, regardless. Of 40% of student borrowers, 23% received EBT benefits from the government, indicating they were from lower income classes.
Pew Trust Institute, conducted a study in 2018, that showcased that today 1 in 5 Federal Student loan borrowers or 8M Americans are in default. Being in default of these loans, not only can impact your current financial situation, but also your career. Some current employers look at your credit report prior to hiring employees, and being defaulted on student loan debt, can ruin future career opportunities.
The continuation of protection investors over borrowers
During the 2008 Recession, President George W. Bush was concerned that creditors would not be able to continue to create more student loans under FFEL program due to the lack of funds available to them since the Residential Mortgage Backed Security (RMBS) corruption. So, he created a temporary program called the Ensuring Continued Access to Student Loans Act (ECASLA).
The ECASLA allowed the U.S Department of Education to buy guaranteed loans by private lenders. The proceeds from the loans were used to create new student loans. This created a secondary market for the loans that were owned by bondholders in the private market. Congress decided to undefined the new purchase authority requirements, to provide the U.S DOE full discretion to design and administer the program.
In result, the U.S DOE created 4 separate loan purchase arrangements under the ECASLA. Including: a put option (letting bondholders provide back the loan for a better interest rate), an asset-back commercial paper (a secured short-term maturities with a maximum of 270 days corporate security that is backed by the government), financial arrangements, and a short-term purchase program.
During the hardship of all families in the 2008 recession, including families of student loans debts, whom weren’t able to find work and defaulting of their debts, were left for their own. Meanwhile congress was protecting investors debts, and guaranteeing protection of capital through tax dollars from the working class.
These predatory actions by the Federal Government continued until 2010. When President Barack Obama came to office, he signed the Health Care and Education Reconciliation Act of 2010, that started the Federal Direct Loan Program. To this day, it remains the only government back student loan program in the U.S.
The Act ended the FFEL program that gave subsidies to private banks to give out federally insured loans. Instead now loans would be administered by the Department of Education through federal funds. This removed the middle man that was occurring, and make it cheaper to borrow debt in the United States. Loans were forgiven after 20 years, instead of the previous 25 years. Additionally, the bill did make it easier for parents to take out federal loans for students.
Despite actions of recent reform on bills and calling for student loan forgiveness, Congress continues to make changes that allow students to borrow incredible amounts of debt on non-traditional financial suitability recommendations, making default risks higher.
Higher Education Act (HEA) Re-authorizations
In the Consolidated Appropriations Act 2021, through policy changes through the Omnibus (Spending Budget Bill), they changed the FAFSA application to be easier to use. Removed Expected Family Contribution (EFC) changed the calculator formulas and made the name Student Aid Index (SAI).
The bill expands the Subsidized Usage Limit Applies (SULA) requirement to provide more loan lending opportunity by raising the limit above the previous 150% of the published length of their program.
Despite the knowledge we now know of how these student loans can be predatory for low-income students, congress continues to make changes to the policy to allow more individuals, take higher maximum debt amounts at the discretion of the colleges financial aid offices.
The nearing student loan recession period
Ever since President Joe Biden won the President title, the idea of loan forgiveness, has been tossed around often, and the continuous push to pause student loans have become more than 2 years now.
With sites like strike.debtcollective.org that is protesting to end Student Loan payments forever. Senator Elizabeth Warren said she would support a student loan strike from borrowers, if borrowers decided to, because forgiveness has been due for a while.
For investors, because their loans were always guaranteed, the Federal Government would have to forgive both $1.7T of Student Loans, and find $28B a year to repay bondholders for the annual interest payments till the debt matures.
Meaning if President Joe Biden doesn’t forgive the loans, and students do go on strike, which is highly likely, over $1.7T of student loans has a high chance of defaulting, preventing borrowers from their personal income. When Student loans get defaulted, the federal government will garnish your salary, tax refunds, disability and social security. Making family households already living paycheck to paycheck fall deeper in financial debt. Which would cause a major recession across all industries since nearly 40M Americans still owe payments for student loans.
In addition, government-private sector partnerships like Nelnet and Great Lakes for U.S DOE Loans will no longer be administering the payment for these loans. The U.S DOE is removing contract relationships, where students will be able to make payments directly on the Studentaid.gov website versus a provider.
While the government creates reform to remove the middle man that was the private market and investors out of the Student Loan industry, it’s not the reform needed to prevent a recessionary period or regain trust with American citizens. There is still millions of Americans every year signing Mastery Promissory Notes (MPN) agreeing to payback loans, whom aren’t financially educated or fully understanding the contracts they are signing.
Not educating students on financial literacy to understand the situations they are putting themselves in, may increase the loan programs in this country, but it doesn’t mean they will get paid. A loan program only works if the payments are received or the system that depends on them crashes to flames. The U.S DOE Student loan program is one lighter away from a huge flame on Wall Street.
