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Unforgiven: Inside America’s Student Loan Bubble

by on April 26, 2012

Rickina Velte was four classes away from earning her bachelor’s degree before mounting student debt and the difficulty of raising a family as a student forced her to drop out. “I now am over $65,000 in debt with payments spiraling towards $400 a month,” she says. “I’ve consolidated at least twice, but I can’t keep track of where the payments are going. I can’t see a light at the end of the tunnel. My job barely pays enough to cover childcare and school expenses for my boys. I’m considering filing for bankruptcy, but I know that my student debt won’t be included. And on top of that, my husband is in the military and a bankruptcy could damage his security clearance. I’m at my wits’ end.”

Rickina’s story is tragic, but it’s just one of many. These days, tales of suffocating student debt are a dime a dozen. The national student debt now officially stands just shy of $1 trillion, and default rates for some loans are as high as 20% in some areas of the country. It’s easy to see that there’s something wrong with the way we pay for college.

But while media outlets continue to churn out reports on an impending student loan crisis, nobody has bothered to stop and wonder how exactly we got here in the first place. There’s been no talk of where or why things went wrong. We’d like to fix that. In this article, we’ll review the history of student lending and explore how unchecked enthusiasm for college, combined with an unregulated industry, has lead to the biggest financial crisis we’ve experienced since the housing collapse of 2008.

Sowing the Seeds of Student Aid

Let’s start at the beginning.The idea of financial aid for college students was introduced by the Indiana General Assembly in 1935. The assembly awarded college fee remissions to students who scored the highest on a variety of competitive tests. The pursuit of discounted college tuition quickly became so popular that the state created the Indiana State Financial Aid Association to oversee the distribution of scholarships at state schools like Indiana University.

The program was well-run, and as a result, many colleges in neighboring states elected to join the ISFAA as well. However, despite the ISFAA’s success, the program would remain relatively small until after World War II, when the race against the Soviet Union for global superiority drove the United States to push for higher education harder than it ever had before.

The U.S. government started looking for a way to get more of its citizens into college when the baby boom took off in the years following World War II. When the USSR successfully launched Sputnik in 1957, the U.S finally took action. In 1958, Congress passed the National Defense Education Act. The act set up a loan specifically designed to help students from lower-income families pay for college. The loan carried a 5% interest rate, and students had 10 years to pay if off after graduation. Believe it or not, this loan still exists today, though it’s now known as the Federal Perkins Loan.

The National Defense Education Act proved to be a rousing success. Over the next two decades, the government introduced numerous bills and programs designed to make the dream of higher education attainable by any citizen from any social class. These include the College Work-Study program (which allowed students to take co-ops to help subsidize the costs of their degrees), the Educational Opportunity Grant Program (which allowed exceptional students from low-income families to attend college for free) and the Middle Assistance Act, which removed the income on limit federal aid programs in order to make loans more available to America’s emerging middle class.

By 1983, the Department of Education had paid out more than $6 billion in student loans. Thanks to the availability of financial aid, America’s colleges and universities were enrolling over 10 million students annually. As a result, the perception of higher education changed.

A college degree was no longer considered an exceptional achievement, but a mandatory benchmark in a young person’s career. This, in turn, created an increased demand for graduate degrees, so Congress passed the Student Loan Consolidation and Technical Amendments Act, which allowed students pursuing a Master’s or PhD to consolidate their new loans with their existing ones into a Guaranteed Student Loan with a 10% interest rate.

At the time, the emphasis on higher education made sense. Between 1984 and 2008, unemployment peaked at 7.5% and was sometimes as low as 4%. People with college degrees were expected to earn 75% to 100% more in their lifetimes than people who only had a high school diploma. So where did things go wrong?

A State of Calamity

When we examine the student loan situation today, it looks like the garden we planted during the Cold War has grown out of control. Tuition has risen by 3,400% since 1972. The average student debt is now sitting at $25,000, up 25% in 10 years. The interest on loans guaranteed by the government-sponsored enterprise Sallie Mae is currently 3.4%, but it is set to double in July 2012. If it does, students will incur an additional $6.3 billion in debt over the 2012-2013 school year. Overall, national student debt is expected to exceed $1 trillion by the end of the year.

And of course there are the horror stories, the suicides and the tales of people like Bob Johnson, who took on student debt not once but twice in order to find work in an ailing market and who are now struggling just to stay off welfare. After graduating in 1987 with a BA in journalism, the NYC native struggled to find work. By the time he got a job that paid about $800 a month, he had already been forced to defer his loans twice. When he was laid off in the mid-’90s, he decided to go back to school for his MFA in theatre management, believing that it would increase his chances for employment. “I went back to school,” he says, “and foolishly took out more loans.”

Bob was laid off again when the recession struck in 2008. He has since struggled to find work. He’s managed to stay off of welfare by picking up odd jobs that run the gamut from photography and video production to apartment painting and social media coaching. In the meantime, his student debt has grown from less than $100,000 to several hundred thousand dollars. “The money coming in is not great,” he says. “I currently have $700 or so in the bank, $400 in a drawer and $5K in a retirement account that will probably eventually be seized by the student loan people. It eats at me every day. I don’t ever see myself getting out of debt. I worry about my future.”

Young professionals aren’t the only ones struggling with student debt, either. For every self-made baby boomer who is sick of hearing kids complain about their debt, there’s another for whom the dream of a lucrative post-college career turned sour. At the moment, people 60 and over owe more than $36 billion in student loans, and people aged 40-49 account for 15% of all student debtors.

“I didn’t understand at the time what I was signing or the consequences,” says Faith, who is still paying off her student loans at 44. “I didn’t understand about compound interest. I’ve tried to negotiate with them. I’ve begged for help from them. All Sallie Mae says is, ‘You’ll have to pay it back no matter what.’ But I can’t. I’ll probably die with this debt, and I’m just about to give up and stop even trying.”

A college degree was once the key to a brighter future. Now it’s more like a financial prison sentence for so many Americans. Where did things go wrong?

credit: jjinsf94115 via flickr

A Two-Headed Snake

Many people blame the job market, and on the surface, it makes sense. According to the Economic Policy Institute, the unemployment rate for Americans aged 16-24 is the worst it’s been in the 60 years that the institute has been monitoring the data. This is especially true for minorities. While the unemployment rate for white college graduates sits at 8.4%, it pales in comparison to the 13.8% unemployment rate for Latino college graduates and the 18% rate for black graduates. While the terrible job market certainly exacerbates the student debt crisis, it doesn’t explain why so many students have come to struggle with such significant debt.

When we trace the evolution of the student loan crisis, we see two major forces at work. The first is the ever-growing importance that we place on having a college degree, even though the majority of Americans have their doubts as to what higher education can actually provide for their children. For example, a study by Pew Research found that 57% of Americans think that college is not a good value, and 75% believe that it is too expensive for most people to afford. And yet, in a separate study, Pew discovered that 94% of parents still expect their children to go to college.

In many ways, it seems like a natural expectation. Think about what your grandfather did for a living, then what your father did, and then what career your parents expected of you. As a parent, you want your child to have a better life than the one you were able to provide for them. Unfortunately, this becomes exponentially harder to do with every generation, since the number of available “good” jobs is shrinking and becoming increasingly specialized. The Bureau of Labor Statistics states that “mid-skill” jobs – jobs that require less education than a bachelor’s degree – will account for 45% of the available work in 2014. But the rate of enrollment for trade and tech schools isn’t trending that way.

College students from middle-class families enter the system expecting to earn a certain amount of money for a certain career. When things don’t work out that way, life becomes difficult. Saddled with debt and in search of meaningful work, they’re forced to move back home and take a minimum-wage or part-time job that can barely pay for the grocery bill. And according to a Brookings Institution study, the odds that they’ll ever get a job related to their degree shrink with every month that passes.

Thomas J. Fox, the community outreach director at Cambridge Credit Counseling in Cambridge, MA, has seen this disconnect between expectations and reality all too often in his line of work. “Like many people in my generation, I was raised with the advice that securing a degree is the key to prosperity in America,” he says. “For the better part of a century, that logic has held true. However, things have changed. No longer is a degree itself a guarantee of success […]. Many students I’ve worked with have an unrealistic expectation on earnings. Many think they’ll enter the workforce making $80,000, with no experience. More alarmingly, others believe they’ll make a YouTube video that will go ‘viral’ gaining them fame and fortune, or develop the next Instagram.”

Lending Left Unchecked Goes Haywire

Many students enroll in expensive four-year universities without considering their future earning potential, and that certainly contributes to the student loan crisis. But it’s the unregulated lending industry itself that bears much of the blame for the skyrocketing debt. Mitchell D. Weiss, a professor of finance at the University of Hartford and the author of “Life Happens – A Practical Guide to Personal Finance from College to Career” sees the student debt crisis as an example of predatory lending gone out of control.

“I counsel a fair amount of students who are struggling with very large levels of debt and the stories are disturbingly similar,” he says. “Many of them were the first in their families to go to college. Mom and Dad didn’t have a lot of money, and they weren’t well versed when it came to financial matters. So, they left it up to Junior to figure out how to make that side of things work.”

Since the typical college student doesn’t know how to get a loan, Weiss says, they tend to lean on university-appointed loan officers for help. From there, the lenders are free to sign the student up for any sort of loan they please and pass it off as a “discounted” rate.

“Not only were the loans pretty easy to get,” Weiss says. “They didn’t have to be paid back until after Junior was done with school. In the meantime, though, the college got its money, the lenders – both government and private – are getting their interest and Junior’s living in Mom and Dad’s basement because the magnitude of his loan payments preclude his ability to afford a place of his own. Adding up the pieces, you have an educational failure that’s compounded by an alignment of interests between the schools and the lenders that runs contrary to those of the student borrower.”

The degree to which the lending industry’s interests have “conflicted” with those of America’s students is staggering. Testifying before Congress in a 1991 hearing, Senator William Roth stated that the Department of Education had an “abysmal record” in providing oversight to university lending policies.

Even that, though, is an understatement. Since the Department of Education became the officiating body in charge of overseeing university lending policies, it has given lending agency executives free reign over the system, and they’ve used their power to squeeze America’s college students for every penny they’re worth. According to Citizens for an Educated and Democratic Republic co-founder Peter O’Lalor, “Predatory lending has been found to be widespread throughout the industry in both nonprofit and for-profit student loan companies. One student loan collection company even went so far as to install a 4,000-gallon shark tank in their headquarters.”

Even the nonprofits are getting in on the action. A 2007 investigation into PHEAA, Pennsylvania’s state lending agency, revealed that executives of the nonprofit had used the income they gained from jacking up interest rates to 9.5% to reward themselves with luxuries like a $45,000 Learjet rental, spa treatments, limousine rides and falconry lessons. Yes, falconry lessons. Further inquiry revealed that PHEAA had been using a legal loophole to overbill the government, and therefore the taxpayers, for $15 million.

In that same year, an investigation led by New York Attorney General Andrew Cuomo revealed that the country’s largest lenders had made illegal arrangements with the loan officers at more than 100 colleges and universities across the country, including Johns Hopkins, Columbia and Syracuse. In exchange for lavish vacations and cash bribes, the officers agreed to put banks like JPMorgan Chase on their school’s list of “preferred lenders.”

And what has the government done to curb this rampant corruption? The late Ted Kennedy probably said it best when he addressed Congress in 2004. “A year ago, Senate Democrats proposed legislation to shut both [lending] loopholes down once and for all. The Senate Republicans did not act on that proposal, did not introduce their own legislation, and did not hold a single hearing. They asked no oversight questions of the Bush Administration. In short, they did nothing.”

Sallie the Jailer

The most disgusting part about the entire student loan crisis is that the agency created to keep student loans in check has done more than anyone else to guarantee that student debt remains a get-rich-quick scheme for industry executives. Founded in 1972, Sallie Mae is the government-sponsored enterprise tasked with backing, managing and collecting student debt. Since it was given that authority, it has systematically stripped student borrowers of every protection they have ever enjoyed.

In 1996, Sallie Mae led the charge to get student loans exempted from the Fair Debt Collection Practices Act. In 1998, it worked with the Consumers Banking Union to lift the statute of limitations on student loans in an amendment to the Higher Education Act. Through these two acts, the heads of Sallie Mae guaranteed that student loans could never be charged off in bankruptcy and that they could never expire. Then, in 2003, Sallie Mae bragged to shareholders that it was able to increase its profit margins by 29% (compared to the previous year’s profits) thanks to the increased amount of debt money it was able to collect under the new legislation.

Under Sallie Mae’s guidance, student aid has become one of the most dangerous loans in the country. These days, when a student takes out a Sallie Mae-backed loan, they’re stepping into a scary financial labyrinth. No matter how old the loan is or how few assets a graduate has, they must still pay their debts – and if they don’t, they’ll be subjected to relentless harassment by debt collection agencies, not to mention lawsuits.

To compound the problem, the average default rate for student loans – 80% of which are backed by Sallie Mae – is 8.8% as of last September. In some states like Missouri, that number can be as high as 20%.

But if you ask any Sallie Mae employee, they’ll tell you things are just peachy. “The economy poses a significant challenge, but the overwhelming majority of our customers are successful in managing their obligations,” Spokesperon Patricia Christel told the Washington Post this March. “Only 3.5 percent of our private education loans default and no one benefits in that situation. That is why we work so diligently to reach customers and counsel them.”

The For-Profit Sham

But if Sallie Mae is bad, then for-profit colleges are worse. These schools – which include the Art Institutes, DeVry University and other online colleges – have been involved in numerous scandals over the past few years. Fueled by the renewed interest in trade careers, many for-profit colleges charge exorbitant fees in exchange for enrollment in career-specific classes. But often, a student can attend such classes through a local tech school for far less.

The for-profit industry has gotten so out of control that one former student loan executive said this to Congress: “In the trade school system, what you sell are dreams. If the student breathes, can write, and is over 18, he is qualified to become a student and to get a loan”.

Due to the low quality of the education that many students receive, the default rate on loans issued by for-profit colleges is disturbingly high. In an investigation into the industry, Senator Tom Harkin (D-IA) found that nearly half of all federal student loan defaults occur at for-profit colleges, even though these schools only enroll 10% of the higher-education student population. Currently, the default rate for all loans issued by for-profit schools is sitting at 15%, much higher than the national average.

A Bubble, or Something Worse?

Now that student debt is pushing $1 trillion, some experts like Robert Reich have begun to throw around the word “bubble” in their articles, likening student loans to the subprime mortgages that collapsed the housing market and triggered the recession in 2008. In many ways, it’s a fair comparison to make. College students are the ultimate subprime borrowers. They have limited, if any, credit history and very little experience with loans – and in many cases the amount of money they’re being handed by Sallie Mae and other lenders is on par with a mortgage. But could the bursting of a student loan bubble really be as catastrophic as the one that toppled the housing market?

Not quite. While some experts are sold on the idea of a bubble, just as many are convinced otherwise. According to For Student Power spokesman Patrick St. John, the structure of student loans inherently prevents them from exploding the way mortgages did in 2008. “The student loan bubble will not burst in the same way the housing market’s bubble burst,” he says. “Federal student loans are fully insured by the federal government, so if a student refuses or is unable to pay, the private loan provider is fully compensated. Because of this ‘built-in bailout’ there won’t be a crisis point like there was with housing.”

However, just because student loans might not be subject to a burst-bubble effect, that doesn’t make them any less problematic. The de-facto bailout that loan companies enjoy may keep the industry from collapsing, but it also makes overhauling the system that much harder – and for every day that passes without reform, our children’s future grows that much bleaker.

“We’re talking about a generation of young men and women who are losing hope of attaining anything close to what their parents have realized for themselves,” says Weiss. “This isn’t only economic in the form of diminished consumerism and the accumulation of wealth, it’s social. Take away the hope for a better tomorrow and the unrest that’ll ensue will, in my opinion, be no less convulsive than what my generation lived through in the late ’60s.”

Fox agrees. “As more people struggle with debt,” he says, “it will make the appeal of college less alluring. We already suffer from a lack of suitable individuals to fill positions. In the end, unchecked student loan debt will diminish our economic leadership position.”

To Forgive or Not to Forgive

Although awareness over an impending student loan crisis is at an all-time high, the debate continues to rage over the best way to fix it. The popular opinion seems to be that we should reinstate student debt forgiveness. Before Sallie Mae had its way with the legislation, the statue of limitations on student loans expired after seven years. They could also be forgiven through bankruptcy. At the moment, the legislators pushing hardest for loan reform believe that rebuilding these escape routes is the best way to ease the burden on America’s students and taxpayers.

Currently, Majority Whip Richard Durbin – creator of the Durbin amendment – is sponsoring legislation that would reinstate the borrower’s right to charge off private student loans in bankruptcy. Though the borrower would still have to pay their federal loans, the amendment would give distressed graduates a little more wiggle room than they currently enjoy. “The student debt crisis in this country is largely ignored by Congress,” he told Congress in a hearing. “There are a lot of lives that are being changed.”

However, some experts believe that Durbin isn’t taking reform far enough. Senator Hansen Clarke (D-MI) is working in conjunction with Student Loan Justice, a nonprofit organization, to push the Student Loan Forgiveness Act of 2012. The act would allow people with student debt to be forgiven of it if they agree to pay 10% of their discretionary income for a period of 10 years. Furthermore, anyone who takes out student loans after the bill is passed would be eligible for the same deal, with a cap at $45,520 – the average cost of obtaining a four-year degree. Currently, an online petition supporting the bill has more than half a million signatures.

While the debate continues to rage over how much we should forgive student debt, Weiss says that there are plenty of ways that students can lessen their debt burden. These include testing out of as many courses as possible via CLEP and AP exams in order to reduce enrollment fees. Students can also start out at a community college and then transfer credits to a four-year university after two years. Another strategy is to take winter and summer sessions at schools that are less expensive.

Final Thoughts

The student loan crisis is every American’s problem, regardless of our political leanings. Our unyielding infatuation with the four-year college degree and an unchecked and unscrupulous lending industry have together created an abscess on our economy. Every year, student loans get more expensive. Every year, more and more college graduates are forced to default on their debt in the face of an uncertain job market. And every year, scores of retirees are reminded that no matter what they do, there is no escaping a student loan.

It’s a hard sell, since even loan forgiveness offers no guarantee that the buck won’t simply be passed on to the next generation. But the need for change – some change, any change – in the lending industry is no less dire. Something needs to be done, and both parties can agree on that. Regulations need to be tighter on for-profit colleges. We must place an emphasis on making accredited two-year schools just as attractive as traditional universities. Most of all, students need to be well-educated about college debt before they apply to school, not after they graduate from it. Anything at all to get us off this road to calamity we’re headed down.

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{ 9 comments… read them below or add one }

bluecollarworkman April 27, 2012 at 6:03 am

Wow. I had no idea. Maybe not going to college wasn't such a bad idea for me afterall. This is absolutely insane! And the cost of college has increased 3200% since 1972!??!! I don't even understand that number!!!

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bhazelton April 28, 2012 at 5:19 pm

It's absolutely staggering when you take a look at the mathematics involved. The math simply doesn't work out.

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Amanda May 2, 2012 at 5:52 pm

Perhaps you would understand the number, had you gone to college!

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bhazelton May 3, 2012 at 8:22 pm

I do understand the number, and in fact Amanda, I did go to college.

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Debt and Buried May 3, 2012 at 7:07 am

Even the worst bubbles, you recover from. Our student loan debt crisis is going to be like an atom bomb when it call comes crashing down. Our entire higher ed system has to change.

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dawn May 6, 2012 at 7:47 pm

i can stress enough the obscenity of capitalization…paying 8.25% interest on interest…principle now 300% larger…1.4% of all monies paid went to principle…the way i know all this…it has always been a federal loan and they give you the stats…you can't argue silly you have no rights.

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Cynthia May 10, 2012 at 3:09 pm

Kids knew when they borrowed the money that it would have to be paid back one day but they did not care and used some of it to go to Disney World and buy unnecessary things. I worked my ass off and borrowed as little as possible. the students that are having trouble paying loans back borrowed way too much and I do not think that we should forgive ANY of their loan. I have children that borrowed more than they needed and had a good time with it. It is their problem. They knew what they were getting into but choose not to be responsible. Well, now they need to be responsible and pay back this money. The rest of us skrimped and went without. If we forgive these loans just what are we teaching them?

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bhazelton May 11, 2012 at 10:14 am

I couldn't agree with you more. Loan forgiveness might just be the worst kind of precedent to set for our young people. Now, keeping interest rates low and manageable for repayment is another issue that needs to be addressed. Excellent point though.

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Are you serious June 2, 2012 at 11:51 am

Lets all expect everything for free. I am going to go buy a car, house, jet ski, and any other toys i want and then say i can find work to pay for them. I am sorry your degree in pottery isn't paying your bills. You should just take a loan out with the mob, then try to say you don't have the money to pay. If loans are forgiven then no one will pay for college and our taxes would sky rocket. You people complaining about paying YOUR bills need to grow up. It's called adulthood, don't like it, go back home to mommy and daddys house.

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