Ever been involved in a conversation where the party who's doing all the talking about one thing inadvertently spills the beans about something way more important?
I felt that way after reading a recent Bloomberg post on securitized student loan debts. The authors of the article, which is provocatively entitled $40 Billion Worth of AAA Student Loans Are at Risk of Becoming Junk, appear to have intended it to be read one of two ways: as a warning to those who have already invested in securities that are collateralized with student loans, or a hot tip about an upcoming opportunity to buy government-guaranteed debt on the cheap.
To me, though, the article is yet another example of how our system of higher-education financing is indeed a toxic concoction of misaligned interests. Here's why.
Bloomberg warns that two rating agencies (Moody's Investors Service and Fitch Ratings) are contemplating downgrading $40 billion worth of securities that represent tens of thousands of student loans. But not because the borrowers have defaulted on their obligations. Rather, it's that an increasing number may actually succeed in restructuring their contracts under the government's various relief programs, much to the chagrin of investors.
That's because investors purchased these higher-ed loans at prices that reflected, in part, a specific duration (10 years, in this instance) and the promise of a government buyback in the event of a borrower's default. Therefore, when the feds provide relief to borrowers by extending the maturity dates for these contracts, or worse, forgiving a portion of the balance, it may very well cause what was a really good investment to morph into one that's akin to the walking dead.
In fact, the Bloomberg authors essentially spell that out when they write, "Bondholders would be faring better if more Americans were actually defaulting, instead of pushing off paying down their debt through a variety of means."
Is it any wonder, then, why the feds are having so much trouble moving troubled loans into one of its many relief programs? The loan-servicing companies that are responsible for the day-to-day administration of these contracts are paid by the lenders and investors that hold the notes. How likely do you think they would be to take actions that run contrary to their benefactors' interests?
The Bloomberg article goes on to note that the problem pertains only to those loans that were transacted prior to 2010 (of which less than $300 billion remains). That's when the Obama administration terminated the Federal Family Education Loan program (where private lenders issued loans that were guaranteed by the federal government) in favor of the less costly Federal Direct program.
Yet the authors neglect to also take into consideration the various state-level higher education lending programs, which often pick up where the government's plans leave off (i.e., when borrowers max out under Federal Direct). Nor do they mention how some of these are actually mini-FFELs, in that they are public-private partnerships where the state guarantees the loans that are held by private-sector lenders and their investors.
Unlike FFEL borrowers, however, those who finance their education in this manner are not eligible for relief under the federal government's programs. Consequently, those who experience financial hardship are fully at the mercy of the noteholders and their loan-servicer agents, just as they are with all other private student lenders.
What's Next for Troubled Student Loans?
Last, the largest heretofore unacknowledged elephant in the room is the $1 trillion (and counting) worth of Federal Direct loans that are currently on the Department of Education's balance sheet.
At some point the ED, which has become the de facto higher-education lender of last resort, will either decide or be compelled to divest all or part of its holdings to make room for more. When that happens—and I'm betting it will, around the time of the next election cycle—the FFEL program may well be reborn, potentially with all these misaligned interests intact, unless:
1. All noteholders — public, private and public-private partnerships — are held equally accountable for any wrongful actions of their subcontractors, including the loan-servicing companies and the collections firms to which severely delinquent and defaulted accounts are transferred. Fining the subcontractors is not enough.
2. Policymakers mandate that all education lenders – that means private lenders and state funding authorities, too — offer relief programs that are comparable with those by the federal government, until lawmakers change the law to allow these loans to become dischargeable in bankruptcy. Not having that as an option encourages private lenders and investors to stonewall struggling debtors when it comes to granting student loan relief.
3. Policymakers craft a plan for the orderly transition of Federal Direct loans into the private sector whereby the Department of Education acts as principal. The government is guaranteeing these debts against default. It should therefore fully control the terms by which the loans are administered.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
More from Credit.com