The Next Financial Bubble?

The most recent issue of Forbes magazine includes an article entitled "The Great College Hoax." You can find it here:

http://www.forbes.com/forbes/2009/0202/060.html

When I first saw the title on the cover, I thought it would be yet another conservative screed against liberal arts institutions. It wasn't. Instead, the piece has a terrifying discussion of the effects of privatizing student loans. Author Kathy Kristof reports:

A decade ago nearly all student lending was of the low-cost, federally guaranteed variety, most of it with 6% to 8% interest kicking in only after a student left school. As costs outpaced such financing over the past decade, the share of student loans from "private" lenders rose from 7% to 23% of the market, or $20 billion in the 2007--08 academic year.

The rise of private student lending closely paralleled the subprime mortgage boom, which went from 8% of home loan originations in 2003 to 20% in 2006, before the housing meltdown sent that mortgage sector over a cliff. Private student loans resemble subprime mortgages in other ways, too. As banks and brokers did with subprime home loans, colleges and the lenders in cahoots with them commonly market private student loans alongside lower-cost alternatives, blurring the differences.

The key one is cost. Many private lenders tack 10% origination fees onto 18% variable interest rates (there is no legal limit), which begin accruing the moment a loan is funded. That has made private loans more than twice as profitable as government-guaranteed ones . . . .

New York Attorney General Andrew Cuomo has called private lending "the Wild West of the student loan industry." Some problems he notes smack of subprime mortgage lending: lax disclosure requirements, variable interest rates that compound and make paying off the principal a Sisyphean task, and kickback agreements by which lenders pay loan originators--in this case, colleges--a cut of their revenues.

State and federal authorities have taken action to curb the outright bribery. No less illustrious institutions of higher learning than Columbia University, New York University and the University of Pennsylvania paid $1 million-plus each to settle charges of wrongdoing in the student loan market.

Yet investigations still found "troubling, deceptive and often illegal practices . . . involving lenders, educational institutions and financial aid officials," according to Cuomo's office and the Congressional Committee on Education & Labor. Don't count on Washington to provide any more safeguards than it did with housing. Department of Education oversight of the student loan industry has been deemed insufficient by the Government Accountability Office.

Scary news indeed for students and their families. Look at this example cited by Kristof:

Mindy Babbitt entered Davenport University in her mid-20s to study accounting. Unable to cover the costs with her previous earnings as a cosmetologist, she took out a $35,000 student loan at 9% interest, figuring her postgraduate income would cover the cost.

Instead, the entry-level job her bachelor's degree got her barely covered living expenses. Babbitt deferred loan repayments and was then laid off for a time. Now 41 and living in Plainwell, Mich., she is earning $41,000 a year, or about $10,000 more than the average high school graduate makes.

But since she graduated, Babbitt's student loan balance has more than doubled, to $87,000, and she despairs she'll never pay it off.
"Unless I win the lottery or get a job paying a lot more, my student debts are going to follow me to the grave," she says.

In the 1950s, 60s, and 70s, Americans had a commitment to make college an affordable step for students with the ability and desire to make the grade. In the "deregulation" craze of the last quarter century, this became just another way to pad profits at the expense of hard-working men and women trying to make a better life for themselves. As one of Kristof's interviewees put it:

"You can get better interest rates, and better treatment, borrowing from Vito in downtown Brooklyn."

(My apologies to Italian loan sharks in the borough, who are unfairly compared with the college loan lenders in that quote.)

The Obama Administration has a lot on its plate. But making post-secondary education affordable again -- and preventing another lending crisis from erupting -- should be one of the first year goals for the White House and the Department of Education.