The Consumer Financial Protection Bureau’s (CFPB) recent annual student loan ombudsman report aims to help those falling behind with private lenders. However, its reactive approach would simply stifle flames rather than prevent their initial burst by proposing shortsighted policies that could lead vulnerable students to take on more debt.
CFPB Student Loan Ombudsman Rohit Chopra announced the report’s release with a dire warning: “This is something we’re taking very seriously, and we do not want to see a repeat of what happened in mortgages happen here.” The comparison is appropriate, but probably not in the way Chopra intended.
The report identifies an increase in the number of complaints filed with the CFPB related to companies offering private student loans—some 5,300 in the past year, a 38 percent increase from the previous year.
Source: Consumer Financial Protection Bureau
The CFPB points out that in 2005, the bankruptcy code was amended to exempt all loans made for a qualified education expense from discharge in bankruptcy without “undue hardship” to the debtor. The agency essentially blames lenders for the rise in complaints, saying “the expected present value of payments in a modified payment plan, less any one-time costs with modifying the loan, may be less than the expected present value of a borrower self-curing or through recovery by third-party debt collectors and litigation.”
While not explicitly calling for a complete rollback of the 2005 changes, the CFPB report recommends changes that would allow more borrowers to discharge their debt. This is the wrong approach to dealing with consumer credit problems and could lead to the unintended consequence of more unprepared students taking on even more debt.
It would also undo the modest reform that’s been achieved. The 2005 policy change was meant to offer lenders greater protection in exchange for offering loans to less creditworthy borrowers—and that’s what evidence suggests happened.
Seen this way, Chopra’s analogy with the subprime mortgage crisis is fitting: government policies to promote homeownership (such as the Community Reinvestment Act) forced lenders to extend housing loans to less qualified borrowers. The ensuing lending binge triggered a domino effect with global repercussions. Lender greed may have played a role, but the underlying problems were insufficient consumer education, lack of preemptive risk mitigation, and government-driven loosening of lending standards. Encouraging more risky lending for student debt would have similar results.
Counterintuitively, as American Enterprise Institute scholar Andrew Kelly points out, students with lower debt burdens are the ones most likely to default. Students with the highest burdens are the best equipped to pay them back since they typically have the greatest post-collegiate earnings. Defaults are most common among students attending community colleges and for-profit colleges, according to a recent Moody’s Investors Service report.
These students are clearly the ones most in need of financial counseling. And it’s no wonder that so many of them are woefully unprepared to grasp the risks they are undertaking. In 2014, just 16 states require high school students get tested in economic principles, while a mere six states mandate personal finance testing, according to the Council for Economic Education (CEE). Laxer repayment policies, such as Chopra calls for, would merely subsidizing unsustainable consumer behavior.
Contra Chopra’s warning, overall student loan defaults are on the decline. A June 2014 Brookings Institution study finds:
[T]he monthly payment burden faced by student loan borrowers has stayed about the same or even lessened over the past two decades. The median borrower has consistently spent three to four percent of their monthly income on student loan payments since 1992, and the mean payment-to-income ratio has fallen significantly, from 15 to 7 percent. The average repayment term for student loans increased over this period, allowing borrowers to shoulder increased debt loads without larger monthly payments.
As the Brookings study also notes, some students take on private student loans before they have tapped out their eligibility for federal debt, a huge mistake since private loans tend to have higher interest rates and fewer borrower protections.
Shortsightedly, the CFPB report fails to call for empowering policies and education that would ensure students conduct a robust analysis of the expected present value of their education vis-a-vis the cost and risk. Chopra’s Band-Aid prescriptions fall under what Harvard professor Ronald Heifetz calls cheap, “technical” fixes for “adaptive “challenges.
Rather than taking lenders to the woodshed and expanding a culture of reckless lending, the CFPB should proactively push for better consumer education prior to loan creation. This would put student borrowers on a long-term path of sustainable financial choices.