The Student Debt Business: A Way Forward

Credit.com

My daughter works for a nonprofit organization. The pay’s not great but she loves what she does. So much so that she’s now ready to take the next step in her personal career development plan — graduate school. As it turns out, though, there’s only one university nearby that offers the curriculum she needs, and there are two big problems with its program.

To start, it requires a full-time commitment, which means she’d have to give up the job she’s held for three years, along with the benefits package that comes with it. The program also costs more than $90,000 to complete — $90,000! — on top of her $200,000 undergrad degree, and for a position that’ll likely pay less than $50,000 per year.

Coincidentally, I ran into a former student who’s at the other end of the scholastic timeline. He was finishing his graduate work and needed advice on a serious matter.

My student was the first in his family to go to college. His mom and dad weren’t wealthy nor were they financially savvy. However, they managed to save a little money for his schooling, but not nearly enough to cover all the costs. So they left it up to him to work out the details with the school’s financial aid office. Six years later, he has more than $100,000 of student loan debt and too little cash flow to cover the monthly payments.

With these and other similarly disturbing stories in mind, it’s hard not to conclude that higher education’s more students equals more revenues business model isn’t just broken, it’s dead.

Costs are too high, curricula have relevancy and structural issues, and the mechanisms for delivering educational content are out of step with the needs and expectations of today’s learner-consumers. In business school-speak: it’s a valueless proposition.

The financial markets have also taken notice.

The Larger Issue

Recently, Moody’s Investors Service ascribed a negative outlook to the higher education sector, attributing its problems to the weak economy’s impact on family income and household net worth.

Frankly, it’s more serious than that.

Higher education’s future prospects are inexorably linked to its past — the legacy of financial hardship many college graduates are left to endure — as well as to the actions the schools continue (or not) to take today.

For example:

  • College enrollments are poised to decline. But instead of responding by fundamentally rethinking program structure, content and delivery, not to mention systematically right-sizing the expense sides of their operations in the process, many schools appear only to be pushing at the edges of their profit and loss statements by curtailing discretionary spending, instituting tuition price-hikes that continue to outpace the rate of inflation, pitching (hopefully) lucrative corporate sponsorships and, when all else fails, tapping endowment funds, all in an effort to bridge their budgetary shortfalls.
  • The most recent Federal Reserve Bank of New York report indicates that roughly 17% of total student loans are more than 90 days past due. This is in addition to the more than 8% of borrowers who became delinquent for the first time during the last quarter, in addition to the payments that continue to be 30 and 60 days past due. Moreover, if you were to consider the fact that less than half of total student loans are actually in repayment mode, you’d realize that in truth about a third of that segment are indeed one or more months past due. To put this point into even sharper focus — recall a similar delinquent-payment run-up to the subprime mortgage fiasco we’re still working to resolve and you’ll understand the cause for alarm.
  • Fewer than five months remain before this past summer’s deal to extend the government’s subsidized student loan rate is set to expire. And yet, we’ve heard nothing about how Congress proposes to address a problem that seems to have been little more than a political contrivance. Meanwhile, according to the U.S. Census Bureau, there are 20 million students attending some form of college at this time, with roughly two-thirds of all undergrads depending on student loans in order to continue their education.

Look, it’s not just the economy. Believing that only encourages us to pin our hopes on better times ahead instead of motivating us to take the necessary steps to ensure that they actually come to pass. So let’s begin by focusing on the student loan problem.

The easy money policies adopted by the government and financial services industry have led students and families to over-borrow their way into unmanageable levels of debt. These policies have also made it possible for the schools to over-spend on overhead as well as for projects that distract from the institutions’ core academic missions, which fueled the upward movement in tuition prices.

The debt debacle is an issue that’s national in scope. As such, it deserves an equally expansive response — a national workout plan, if you will — one that extracts concessions from each of the parties that have benefited from the excesses over the years.

Help for the Indebted

To start, I believe the government’s recently implemented Pay as You Earn Repayment plan (PAYER), which calculates payment affordability at 10% of discretionary income and caps the repayment duration at 20 years, should be expanded to include all student loans regardless of:

  • Origination channel and type (i.e., government, private, previously consolidated, etc.)
  • Initial loan draw-down date (i.e., including loans taken out prior to 2007)
  • Borrower type (i.e., students and parents)
  • Payment status (i.e., loans that are current as well as those that are past due)

The PAYER plan should also address the “cancellation of debt”  tax liability that borrowers face when their loan balances are forgiven before they’re fully paid off.

Once the government opens the door for all education loans to be included in the PAYER plan, the private lenders should then be mandated to facilitate their unimpeded transfer into it — in other words, without the assessment of arbitrary fees on the way out.

What Else the Government Can Do

However, shifting to the government — and by extension, to the taxpayers — the totality of a financial headache so many parties were complicit in creating, should not take place without consequence. That’s why it would make sense for the feds to also establish a student loan trust (SLT) that provides for the value of unrecoverable defaults that occur as well as the loan obligations the government ultimately forgives via the PAYER plan.

The SLT would be additionally supported by contributions from the private lenders and schools.

As it pertains to the lenders’ part, it’s worth considering an amount that’s equal to the economic value of the interest rate differential for the loans that move into the government’s program. For example, suppose a student owes $30,000 in private loans that charge an average 10% interest. The monthly payment for that debt would be $396.45 for 10 years. However, if the same loans were rolled into the standard 6.8% government program (the PAYER modification would be determined after the fact), the monthly payment would drop to $345.24, or 13% less. Therefore, the private lender’s contribution to the SLT would be determined by multiplying that 13% discount by the value of the underlying debt.

Think of it this way: the math says that when a student borrows money at 10% for 10 years, it’s as if he or she were borrowing nearly 15% more at 6.8%. This calculation helps to level the playing field. It also encourages more affordable private loan pricing practices going forward.

As for the schools, they too share fault by virtue of tuition prices that, according to the U.S. Census Bureau and National Center for Education Statistics, now represent more than 40% of median household income (versus less than half that amount 30 ago), not to mention a graduation rate that hovers at the 55% level, with widely varying results for sub-sector institutions.

That’s why it makes sense for the schools to contribute to SLT’s funding at an amount that’s equal to a percentage of the value of the loans that constitute the college’s unique cohort default rate — the loans that have been defaulted upon by their former students. This would effectively hold schools financially accountable for their academic outcomes.

Bankruptcy Isn’t the Only Answer

As for the borrowers, as long as the government agrees to loosen its PAYER plan eligibility standards and relax its refinancing protocols, and as long as the private lenders are prohibited from interfering with the transfer of these loans into the government’s program, education loan borrowers should then have a reasonable chance of repaying all or most of their debts over time. Consequently, it’s hard to rationalize revising the bankruptcy code to permit the discharge of these loans, because doing so would encourage borrowers to declare bankruptcy instead of rolling their private loans into the government’s less expensive program.

However, should these changes not be enacted, the code should then be modified so that all student loan debt — government and private alike — becomes fully dischargeable in bankruptcy.

What More Schools Need to Do

Earlier, I talked about the measures schools are employing to bridge their budgetary gaps. I also discussed how they’ve strayed from their core academic missions. These days, in addition to delivering educational content, colleges are also in the real estate, food services, sports and entertainment businesses. Consider the vast tracts of land these institutions own and the dormitories, libraries, classrooms, administrative buildings, dining halls and sports facilities they’ve constructed on them.

With all that in mind, here are three questions worth pondering:

  • To what extent is developing additional sources of revenue (such as through commercial-sector partnerships, sponsorships and non-academic real estate development projects) or tapping endowment funds a better way to go than fundamentally attacking cost structures from the ground up?
  • To what extent can higher education as a whole rationalize a system of vast redundancies, where a dozen midrange private colleges in a given state are each supporting their own administrative and technological infrastructures?
  • To what extent should the schools be in all these sideline businesses at a time when the need to develop and deliver higher quality educational content—both online and in classroom settings—conflicts with the economic realities of declining enrollments and increasing demands for financial assistance?

Higher education would become more competitive if in-market academic alliances and intra-sector consolidations were to occur, and the schools would also benefit by divesting their sideline businesses to those who specialize in the field (such as hospitality companies, REITs, and so forth) in favor of generating the investment capital that’s needed to revitalize educational content and upgrade the technology required to deliver it. All these actions would drive down overhead costs and tuition prices in the process.

As for the revenue side of the equation, some schools are experimenting with stackable credentialing. As the authors of a recent McGraw-Hill Research Foundation paper suggest, deconstructing academic majors into clusters of targeted educational content permits consumer-learners with specific interests and limited resources (time and money) to acquire the education they need for the work they do or the careers they aspire to attain. The schools also stand to benefit from this buffet-style approach to learning via a broadening of the revenue base. What’s more, the “stackable” feature of the individual certifications encourages learners to view them as pathways toward formal degrees.

Education is an integral component of the American dream. It represents a way out for the disadvantaged as much as it does a way up for us all. That’s because an educated populace makes for a more prosperous and globally competitive nation. With what’s at stake here, we cannot afford to continue taking such an inadequately incremental approach to solving so extensive a problem.


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