Fixing Student Loans

[Baron von Schtinkenbutt]

Fixing Student Loans: Let's Give Colleges Some 'Skin in the Game'

Fixing Student Loans: Let's Give Colleges Some 'Skin in the Game'

By Alex J. Pollock Thursday, January 26, 2012

Filed under: Economic Policy, Government & Politics
What lessons on student loans can be learned from the searing national misadventure with mortgages?

There are provocative parallels between student loans and the mortgages that created the disastrous housing bubble. In both cases, the government promoted plausible goals— higher education and home ownership—to excess, through the overexpansion of debt to levels beyond the repayment ability of a large percentage of borrowers. In both cases, the government guaranteed much of the credit, putting the ultimate risk of bad debts on taxpayers. In both cases, debt expansion drove the price of the object being financed (colleges and houses) to heights sustainable only if debt could always be increasing. In mortgages, it could not, and the subsequent collapse raises the question: will there be a similar outcome with student loans?

Professor Richard Vedder, considering the question of a student loan bubble, recently concluded that the worst idea ever "was the creation of federally subsidized student loans in the first place." Can any lessons from the searing national misadventure with mortgages be usefully applied to student loans? I believe so.

A principal lesson from mortgages, nearly universally agreed upon, is that those who create the mortgages should retain a material part of the credit risk. Such "skin in the game" obviously aligns the incentives of the originator of the loan with taxpayer guarantors to control excesses in debt expansion. For mortgages, this "skin in the game" concept was adopted by the Dodd-Frank Act of 2010. More importantly, its advantages are displayed by one of the highest quality mortgage portfolios that exist today: the Mortgage Partnership Finance (MPF) mortgages of the Federal Home Loan Banks. All of these MPF mortgages have credit risk retained by the originator, with excellent results for their credit performance. This program has been operating for more than 14 years.

Let's apply this mortgage lesson to student loans.

Who are the most important parties to have "skin in the game" in student loans? The colleges themselves, of course! They are the effective originators, the promoters, and the chief financial beneficiaries of student loans. It is their rising costs which result in ever more debt and more risk of default for student borrowers and for taxpayers.

The federal student loan programs should simply compel colleges which get proceeds from the programs to maintain a 10 percent first-loss share in the credit performance of the loan. This puts a material risk of excessive and un-repayable debt and of high college costs on those who are promoting the loans. The colleges would stand to take losses on bad loans before the taxpayers, as they should—they would, in financial parlance, be subordinated or "junior" to the taxpayers. A highly desirable improvement in financial structure and incentives!

So, just as for the mortgage lenders, let's give the colleges some "skin in the game."

Alex J. Pollock is a resident fellow at the American Enterprise Institute. He led the creation of the MPF program during the 1990s when President and CEO of the Federal Home Loan Bank of Chicago.

Interesting take on a problem that comes up frequently on Languish.  I certainly think detaching the universities from the problems caused by pushing people to debt finance their degrees exacerbates the problem, but is it enough of the root for something like this to make a dent?  This doesn't address at all the drumbeat of, "You must go to college to be successful!".

[Admiral Yi]

One problem with this dude's suggestion is that, as things stand now, the only way you can default on a student loan is by dying.

Another is that determining the credit-worthiness of borrowers is really the job of the lender, i.e. the Department of Education.

[KRonn]

On a related note, I'd like to see costs of college come way down. Just seems way too expensive to pay prices like twenty thousand or more per year of college. In fact, I'd have to think if the government does more to help students pay for College then the colleges have less incentive to keep tuition down, since students are getting help to pay the uber prices.

[AnchorClanker]

Forgive student loans for national service. 

Seriously - medical, engineering, teachers, etc etc.  Think of it as an extended form of work study or something.

[Admiral Yi]

Forgive student loans for national service. 

Seriously - medical, engineering, teachers, etc etc.  Think of it as an extended form of work study or something.

It's certainly true that loan foregiveness does tend to decrease nonperforming loans, but I think you're missing the point of the article.

And how is engineering related to national service?

[AnchorClanker]

Engineers working pro-bono/low wage for Army Corps of Engineers, rural water boards, etc in return for loan forgiveness.

It's just an idea.  Provides practical experience for the CV and takes care of some/all of loans.  It's an idea, anyway.

[Ideologue]

Forgive student loans for national service. 

Seriously - medical, engineering, teachers, etc etc.  Think of it as an extended form of work study or something.

They do that already.  Public Service Loan Forgiveness Program.  And now, you can go on Income Based Repayment for ten years (often with zero dollar payments), then discharge at the end of a decade.

Your solution is missing a pretty critical factor, unfortunately, isn't it?

Also, Yi's not wrong that it only solves the problem for the individual, by moving it onto the government's ledger.  I'm for this, but it isn't a magic bullet.

[Phillip V]

There are plenty of rich, older men who want to help young women get an education.

http://www.huffingtonpost.com/2011/07/29/seeking-arrangement-college-students_n_913373.html

[Ideologue]

Anyway, I basically think the article's solution is a good one.  Those who profit so immensely off the student loan system--and boy do they--should be the ones financing its failure.  Not the students, not the taxpayer, at least not entirely.  The ones who should take the biggest hit are the bastards who've preyed on the American republic for decades.

[Admiral Yi]

And now, you can go on Income Based Repayment for ten years (often with zero dollar payments), then discharge at the end of a decade.

You sure about this?  I don't remember the discharge part part from when I was working Student Loan Servicing a few years back.

[Ideologue]

The Public Service Loan Forgiveness Program was created to encourage individuals to enter and continue to work full-time in public service jobs. Under this program, you may qualify for forgiveness of the remaining balance due on your eligible federal student loans after you have made 120 payments on loans under certain repayment plans while employed full time by certain public service employers.

Only non-defaulted loans made under the William D. Ford Direct Loan ProgramSM are eligible for loan forgiveness. The Direct Loan Program includes the following types of loans:

    Federal Direct Stafford Loans (Direct Subsidized Loans)
    Federal Direct Unsubsidized Stafford Loans (Direct Unsubsidized Loans)
    Federal Direct PLUS Loans (Direct PLUS Loans)- for parents and graduate or professional students
    Federal Direct Consolidation Loans (Direct Consolidation Loans)


Although loan forgiveness under this program is available only for loans made and repaid under the Direct Loan Program, loans made under other federal student loan programs may qualify for forgiveness if they are consolidated into a Direct Consolidation Loan. Therefore, only payments made on the Direct Consolidation Loan will count toward the required 120 monthly payments.

The 120 required payments must be made under one or more of the following Direct Loan Program repayment plans:

    Income Based Repayment (IBR) Plan
    Income Contingent Repayment Plan
    Standard Repayment Plan with a 10-year repayment period
    Any other Direct Loan Program repayment plan, but only payments that are at least equal to the monthly payment amount that would have been required under the Standard Repayment Plan with a 10-year repayment period may be counted toward the required 120 payments.


Public Service Loan Forgiveness Program Questions and Answers (Q&As)

For additional information on PSLF, check out the Public Service Loan Forgiveness Program Q&As. The Q&As are grouped into four categories: General Information, Eligible Loans, Qualifying Payments, and Qualifying Employment. The answers are dated and, as new questions are added or a previous response is updated, we will include a new date.

Go to the Public Service Loan Forgiveness fact sheet for more information on the terms and conditions of the program and to understand what types of public service jobs qualify.

http://studentaid.ed.gov/PORTALSWebApp/students/english/PSF.jsp

Maybe it's not technically a discharge?  But in any event, they go away.

[Phillip V]

Among 25- to 34-year-old men, one-in-five (19.4 percent) who had a college degree actually earned less than the average male high school graduate, as was also the case for one-in-seven women with a college degree (14.0 percent).

http://www.americanprogress.org/issues/2010/12/college_conundrum.html

[Eddie Teach]

There are plenty of rich, older men who want to help young women get an education.

http://www.huffingtonpost.com/2011/07/29/seeking-arrangement-college-students_n_913373.html

What's the worst that could happen? Beyond rape or death, that is.

[Phillip V]

There are plenty of rich, older men who want to help young women get an education.

http://www.huffingtonpost.com/2011/07/29/seeking-arrangement-college-students_n_913373.html

What's the worst that could happen? Beyond rape or death, that is.

US military recruitment is at more than 100% of its goals. It has a loan repayment program, tuition assistance for future courses every year of service, and an additional GI Bill that covers full cost of 4 years of college + a living stipend.

[Admiral Yi]

Maybe it's not technically a discharge?  But in any event, they go away.

My bad.  I thought you meant *any* borrower who paid under IBR for 10 years got the balance forgiven.