The Student Loan Crisis

A consistent pattern in American politics and culture is that an endless stream of social problems are offloaded onto the education system. In the world of American higher education, this pattern manifests itself when various institutions and actors treat college and graduate/professional school as a kind of magic bullet that will make our society fairer, less unequal, less class-ridden, etc.

More concretely, the idea that it’s a good thing to make it as easy as possible for families and individuals to borrow government money to go to college is something that has resulted in, at present, about $1.6 trillion in federal educational loan debt, with that number projected to nearly double over the course of the next decade.

How much of this money is going to get paid back? Betsey DeVos’s Education Department hired JP Morgan to study that question, and the resulting report was not encouraging:

Mr. Courtney’s calculation was one of several supporting the disclosure in a Journal article last fall that taxpayers could ultimately be on the hook for roughly a third of the $1.6 trillion federal student loan portfolio. This could amount to more than $500 billion, exceeding what taxpayers lost on the saving-and-loan crisis 30 years ago.

If Mr. Courtney is right, there are big implications for taxpayers and families alike. While defaulted student loans can’t cause the federal government to go bankrupt the way bad mortgage lending upended banks during the financial crisis, they expose a similar problem: Billions of dollars lent based on flawed assumptions about whether the money can be repaid.

Were his model to be adopted, watchdogs such as the Congressional Budget Office could force the federal government to recognize the losses, deepening deficits and adding hundreds of billions of dollars to the national debt. That would put pressure on the government to take action to narrow the losses. Some government officials and advocates of student loans fear it would create pressure to curtail the program.

Of course anything coming out of a Trump administration agency needs to be taken with a pillar of salt, but the JPM report points to what appears to be a lot of accounting legerdemain reminiscent of the monkey business during the 2007-08 mortgage crisis:

The assumption that all this student lending would mean growing profits for the federal government and savings for taxpayers has been consistently off the mark.

The federal government extended $1.3 trillion in student loans from 2002 through 2017. On paper, these would earn it a $112 billion in profit.

But student repayment plummeted. In response, the government revised the projected profit down 36%, to $71.5 billion. The revision would have been bigger except for the fall in interest rates that let the U.S. borrow inexpensively to fund loans.

The phenomenon is worsening in recent years. For the fiscal year ended September 2013, the government projected it would earn 20 cents on each dollar of new student loans. For fiscal 2019, it projected it would lose 4 cents on each dollar of new loans, federal records show.

Congress approves the student loan program each year, doing so based on a profit assumption. Then, in subsequent years, it revises those profit estimates based on the repayments that actually arrive.

If repayments come in lower than expectations—as has happened successively in recent years—the Treasury Department fills the gap with cash infusions to the Education Department.

This process takes place outside of the budget review and outside of congressional oversight. Ever-larger cash infusions from the Treasury have been needed.

And then we have this kind of thing, which sounds all too familiar to anyone who has looked at the details of the 2007-08 crash:

In 2018, more than a year after Mrs. DeVos became education secretary, she looked for someone to sort through this, and JPMorgan’s Mr. Dimon recommended Mr. Courtney, who had just retired from the bank after heading its private student-loan branch. He joined the administration and started going through documents.

According to his report a year later, students who took out federal loans in the 1990s had repaid, on average, 105% of the original balance a decade later, including interest. Since 2006, they had repaid an average of just 73% of their original balance after a decade.

He looked into why government projections seemed so far off. One thing he found was that Education Department budget officials didn’t look at basics such as borrowers’ credit scores to estimate the likelihood they would repay. Not checking credit would be unthinkable in the private sector.

With the help of a contractor that does statistical modeling, FI Consulting of Arlington, Va., he ran some numbers. The credit scores of four in 10 borrowers would qualify them as “distressed”—double the rate on all types of private consumer loans, his analysis found.

He also saw that when borrowers defaulted, the government continued to charge interest, allowing balances to keep rising, which also differs from private lenders’ practice.

Then, the government typically put those defaulting borrowers into new loans, and the accrued interest was wrapped into a new balance. The borrowers’ loans were no longer “nonperforming.”

A substantial number of borrowers go on to default on these new loans, according to Mr. Courtney’s report, which was part of why he estimated so much lower a recovery of defaulted amounts.

Another source of what he considered faulty projections: Borrowers unable to make regular monthly payments sometimes lowered them by switching to income-based repayment. President Barack Obama made this move widely available, which his administration could do by itself on the understanding it wouldn’t widen the deficit.

The accrual of unpaid interest caused loan principals to rise instead of decline, making the loans appear more profitable to the government, even though the accrual stemmed from borrowers’ difficulty in repaying.

Mr. Courtney’s conclusions, outlined in a presentation to Mrs. DeVos in May 2019, also said Education Department budget officials overestimated how much borrowers would earn and thus be able to pay back. The department is blocked by law from reviewing individual borrowers’ tax records. Its estimates of how much borrowers’ incomes would rise were consistently wrong, he concluded.

All told, his analysis led to his estimate that taxpayers would be left with the bill for around a third of all outstanding loans when they reach the end of their repayment cycles.

A huge issue, mentioned in passing at the very end of the WSJ’s long analysis, is that federal educational loans have very high interest rates — five and six percentage points over prime — which means that in recent years a whole lot of the most solvent borrowers have been skimmed off by private lenders, who offer to refinance the loans at much lower rates, leaving the government holding loans that are far more likely to default than those in the original cohort.

Again, all this relates back to a lot of culture-wide magical thinking about how higher education is always a good investment, if not literally priceless. I saw this rhetoric play out first hand a decade ago in what I believe a JPM consultant might call “the legal education space,” and my proudest professional accomplishment remains helping kill off a quiver of scam law schools, that had been feeding peacefully at the GRADPLUS loan trough.

The gathering student loan crisis is a testament to the belief that sending ever-larger percentages of the population to college and graduate school is the solution to all sorts of problems that actually have little or nothing to do with how many people go or don’t go to college. But a lot of people remain literally invested in remaining blind to that.