how the financial crisis and obamacare improved student loans
Student debt is in the news a lot these days. It currently stands at $1.2 trillion in the U.S., having surpassed credit card debt in 2010. The Occupy movement pushed the issue onto the front pages with its call for debt forgiveness, and since then loans have bounced in and out of the news under headlines like “crisis” and “crippling.”
Of course, there’s always two ways of looking at things. Since the college wage premium (or, more accurately, the noncollege penalty) has increased, plenty of folks have argued that college, loans and all, is still a great deal despite rising tuition, and that many students should actually be borrowing more.
That’s hard to tell an underemployed 24-year-old, but never mind. In general, our shift toward loan-driven higher ed financing is a big problem. But there’s one important, and often overlooked, way in which things have gotten better. Much better.
How can that be, when average debt among borrowers at graduation has hit $30,000?
The answer starts with the financial crisis.
Many of us, looking back at the financial crisis, see it as a huge missed opportunity. Whatever your politics, there’s not a lot of folks who think too-big-to-fail is a good thing, or that finance doesn’t have too much influence in Washington. Dodd-Frank, while better than nothing, is a complicated mess. Even the Consumer Financial Protection Bureau has taken years to actually get off the ground.
But one place the financial crisis did create a big, big shift is in student loans — and hardly anyone noticed.
The politics of federal student loans is one of incrementalism. They started with Sputnik. In 1972, Sallie Mae was launched to be the Fannie Mae of student loans. Over the years eligibility was expanded, caps were increased, loans for parents and graduate students were introduced, and unsubsidized (but government-guaranteed) loans were added to the subsidized originals.
In the 90s banks gained more influence on student loan policy, and financialization began in earnest. Securitization ramped up in the mid-90s, and expansion of the private loan market followed. The really massive increase in loan volume started after 2000 — the analogies with the mortgage crisis are notable. In 1998 government-guaranteed student loans were made (mostly) nonbankruptable, and in 2005 that was expanded to private loans.
In 2008, when the subprime crisis really kicked into gear, credit markets dried up. By the fall, nobody was lending anyone money. But even this didn’t stop the expansion of the student loan market. While private student loans decreased dramatically, the federally guaranteed ones kept increasing. Student loan borrowing peaked in 2010-11, not 2007-08.
Then, it stopped. Okay, it didn’t stop. But it’s been dropping a bit each of the last few years. Not by a lot, but after two decades of constant growth, at a time when public college tuition was increasing dramatically, this is kind of amazing.
Finance and the Politics of Student Loans
So what happened?
The short answer is that the financial crisis finally dislodged the influence of Sallie Mae and the banks, at least a bit.
I mentioned that the financial sector gained clout over loan policy post-1990. Banks pushed for a lot of the changes that came after that: adding unsubsidized federally guaranteed loans, guaranteeing parent loans up to the entire cost of children’s education, increasing government payments to banks that issued loans, and the bankruptcy provisions.
Banks cared so much about student loans because they were the ones issuing them. Until the 1990s, the vast majority of student loans were made directly by banks. The role of government was to cajole banks into lending — through guarantees, subsidies, and the creation of a secondary market. As the market grew, they had a lot at stake.
In the early 90s, the Congressional Research Service estimated that government could save $1 billion a year by lending directly to students, rather than paying intermediaries. But banks didn’t want to lose this subsidized market, and many Republicans (and some Democrats) opposed government taking on this role. George H. W. Bush threatened to veto direct loans, but Bill Clinton pushed them through in 1993 as an alternative to guaranteed loans that did not replace them. By 1997 a third of all federal loans were direct, but as other lending expanded from there the fraction started to decline, and a decade later less than 20% were. (These and subsequent numbers are from the excellent resource Trends in Student Aid.)
By the time of the financial crisis, students were borrowing $94 billion a year, quadruple (in real terms) what they had been fifteen years before. Sallie Mae, now privatized, held $150 billion in loans, and had been accused of benefiting from letting students default. Private loans, with high interest rates and few consumer protections, now made up a quarter of the total. Student loans were almost impossible to discharge through bankruptcy. They made up about 10% of the market for asset-backed securities. And New York State Attorney General Andrew Cuomo uncovered banks paying off colleges and financial aid officers to point students toward their loans.
Why Student Loans Turned Out Differently from Subprime Mortgages
Student loans couldn’t be escaped through bankruptcy, and the government guaranteed them, so they avoided a default crisis like the housing sector experienced. But in many other ways they followed a similar trajectory of government-enabled financialization, with all its attendant problems.
By 2009, even many conservatives had come to think that the federally guaranteed loan system was more crony capitalism than private-sector efficiency. And in March 2010, despite intense lobbying by Sallie Mae and the financial industry, Congress passed legislation eliminating the guaranteed loan program and switching entirely to direct lending, a move the Congressional Budget Office estimated would save $60 billion over a decade.
The bill had other benefits for students as well — notably, an income-based repayment plan that capped payments at 10% of disposable income, with the balance forgiven after 20 years. That’s only come fully into effect this year.
But as significant as income-based repayment is, even more important is cutting banks out of the core business. This not only saves money, but is lowering the volume of loans taken out, and it limits banks’ interest in lobbying around future student aid bills.
Does this fix the student loan problem? No, not at all. But it’s a big step — bigger than a lot of other changes that came out of the financial crisis. And it happened kind of under the radar, before Occupy even drew its attention to student indebtedness.
Why did it go unnoticed? To be sure, it was a fairly technical sort of change. How many people even know the difference between direct student loans and federally guaranteed private ones?
But the biggest reason was timing: the legislation was slipped into Obamacare. That’s right, Obamacare not only expanded healthcare access, it reformed student loans.
So next time you’re feeling depressed about our inability to rein in the financial sector, the spiraling costs of higher education, or the gridlock in Washington, remember this. As intractable as some of these problems seem to be, once in a while things actually do get better.