Friday, June 17, 2011

When Freddie Met Sallie: Parallels Between the Mortgage Meltdown and Student Debt

After the the Savings and Loan Crisis, it was widely recognized that the financial bust was the result of control fraud between private industry and government regulators. A few decades later, a similar scenario occurred in the mortgage market giving us the current financial crisis. Now, while we may now all be on alert of another inside job in the mortgage market, another debt crisis is still looms: student loans.

[Richard Mock linocut via old UMass Econ t-shirt]
With the mortgage crisis, plenty of critical economists saw the mortgage bust coming yet went unheard or at least un-listened-to. Likewise with student loans, many in informed, dedicated writers and activists like Alan Collinge, Anya Kamenetz, the filmmakers of Default: The Student Loan Documentary, an others have spent years explicating the extent of student indebtedness, the perverse structure of student lending, the brute force used by debt collectors, and the immense consequences the student lending system has on the livelihoods of graduates.

Similar to the mortgage crisis, which resulted from a disastrous mix of price inflation and unethical lending incentives, the student loan crunch stems from a similarly toxic combination of incentives and institutions breeding a Gresham dynamic marked by deliberate and calculated fraud: exorbitant tuition hikes, usurious lending practices by both the Federal government and private loan companies, financial misinformation from student aid institutions, and an astoundingly blatant lack of basic consumer protections for students and cosigners.   

It is no news that over the past few decades, college tuition has risen dramatically higher than inflation and the real wage has declined. Concurrently, student indebtedness has reached an all-time peak, recently having surpassed credit card debt, for a staggering total of over $919 billion dollars and growing. Like any debt-asset bubble, the uphill price inflation is swiftly followed by its rupture, marked by a steady increase in default.

For years, the student loan default rate has been understated by the Department of Education, leading us to just now see the vast scale of vulnerable student debt being held by recent graduates (note: the students, not the debt, are really the vulnerable ones). Attempting to connect these trends is difficult, with a diverse number of explanations being offered by economists and educators- explanations which often end up blaming students for being irresponsible with their debt and choice of school.  But, the most compelling has been professed by Allan Collinge, founder of the student debtor advocacy group

Collinge’s analysis is strikingly similar to UMKC economics and law Professor William K. Black’s concept of control fraud in financial crisis, in which white-collar criminals control the means and institutions of fraud, giving incentive for pernicious and risky lending and asset price inflation.  Collinge explains how the removal of consumer protections, primarily that ability to discharge student loans in bankruptcy, has given lenders and institutions incentive to bloat college tuition and lobby for further degradation of these fairness standards, even supporting feudal-like methods of debt collection, including wage garnishment and harassment. Loans in forbearance or default, just allow lenders to collect more and more. 

The mortgage crisis grew from a malicious mafioso-eque partnership of bankers, mortgage brokers, derivative insurers, and political lobbying that worked to liberalize financial markets, inflate housing prices to fuel toxic mortgages, and guarantee payouts from complex derivatives. The student loan pyramid scheme relies on colleges and universities willing to hike tuition, government cuts to public higher education, Federal direct and guaranteed student loans, and a political apparatus responsible for removing consumer protections for student borrowers.Meanwhile, the system (mis)educates borrowers through complex, obfuscated names, rules, and regulations. (See this excellent graphic explaining the relationship here.)

As with the mortgage meltdown, the Federal government has served as the base crutch perpetuating the crisis in higher education, by guaranteeing many loans, effectively removing risk, yet still using harsh collection tactics and lacking consumer protections. In fact, some estimates show that for every dollar of recovering defaulted student loans from the Federal Family Education Loan Program, they receive about $1.22 back, a recovery rate much higher than any credit card. With this kind of recovery success, students are the Department of Education‘s (and bailed out private lenders’) new gold mines. (Where does that money go anyway? I'm guessing to more loans, feeding the beast.)

Seemingly friendly, unbiased, benevolent financial literacy services like offer less than clear warnings about the lack of consumer protection for private and Federal loans, while corporations like Sallie Mae and the Massachusetts Educational Financing Authority tout deceptively government-sounding names. These quasi-governmental publically chartered now private entities outright deceive customers, just as Fannie and Freddie did in the mortgage deluge, giving students and cosigners a superficial sense of fairness when weighing the costs of college and taking on Federal or private loans. Maybe, like cigarettes, these toxic (and parasitic) consumer lending products also need a warning label on their websites.

Luckily, the movement for increasing consumer protection for student loans is making some headway. Representative Steve Cohen, along with Senator Dick Durbin and others, has reintroduced a bill that would give bankruptcy protection for some student loans, but for many students bankruptcy would be a last resort. 

“When Freddie met Sallie” sounds less like a romantic comedy starring Meg Ryan, and more like a disaster flick where students and families stand victim to financial kleptocracy.  



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