Student Loans:
A Trap Built by Wall Street and the Government

Oct 23, 2012

Over the last 10 years, student debt in the U.S. has more than tripled to over a trillion dollars outstanding. The amount of student debt now exceeds debt from credit cards and car loans. A growing share of people pursuing a bachelor’s degree are borrowing, up from 45% in 1993 to 66% today. This includes loans from the federal government and private lenders. The Pew Research Center found that one-fifth of all households had college debt in 2010, double the share in 1989. The average debt for a student going through four years of school was $26,600 in 2011, with 10% owing more than $54,000 and three percent owing more than $100,000.

A great deal of this debt is held by working people for whom some kind of post-secondary education—either some kind of special certification or an associates degree—has become a necessity just to get a job that pays more than minimum wage. Increasingly there are workers with bachelor’s degrees on jobs that used to be considered unskilled, including factory work.

But that education comes with a debt that very often cannot be shaken. One-third of student debt is held by people under 30 years old, but a much bigger proportion of student debt is held by people much older. Many are still making payments on their student loans decades after they left school. Others take on new student debt either to help pay for their children’s or grandchildren’s education or because they themselves go back to school in order to get a job in a shrinking job market. Indicating the sheer magnitude of this problem, two million seniors over 60 years old are still making payments on student loans, thus endangering their means to survive in retirement.

The monumental growth and size of student debt puts the lie to all the old myths about how an education provides opportunity, that higher education is the chance for people to escape to a better life. Workers may get more of an education. But that pursuit of an education very often serves as the bait that catches them in the trap of debt, a kind of indentured servitude. American society has always been and remains a society divided into classes.

The Roots of the Crisis

The roots of the student loan crisis go back almost half a century. Under the pressure of the growing black movement and the revolts in the cities, the Johnson administration introduced the modern student loan program in 1965, as part of his self-proclaimed “Great Society.”

One of the black movement’s demands was to open the doors of the colleges and universities and make them free and available to all, what became known as “open enrollment.” But rather than provide free and open enrollment to college, the Johnson administration came up with a program of government guaranteed loans for students with family incomes of less than $15,000 per year, that is, the working class and poor.

Formally, workers’ children could get a higher education. But the government made no effort to make it cheaper, much less free. Students or their families would still have to pay for their education themselves. And workers’ children still didn’t have the money, but the government did arrange for them to borrow it!

The guarantees and subsidies that the Johnson administration built into the loan program were not for the students, but for the banks and private lenders, which made the student loans. The federal government guaranteed that the banks profited from these loans no matter what. If the former student defaulted, the government reimbursed the lenders for all of the unpaid principal and interest, making the student loans 100% risk-free for the banks.

Johnson might have promised that the student loan initiative would “swing open a new door for the young people of America.” But the “new door” for working class students that Johnson talked about was based on debt—with interest. So working class students graduated with a debt that they had to pay off once they got out of school, while students from the middle and upper class usually graduated debt-free.

Of course, compared to today, the cost of an education was still relatively low, especially for those who attended public colleges. The debt that students took on were not as crushing as the debts of later years, and defaults on student debts were relatively rare. Less than one percent of all the loans that students took out in the 1970s were defaulted on.

Cashing in on Rising Tuition and Student Debt

The big increase in student indebtedness began in the early 1980s, in the midst of the worst recession since the Great Depression. It was a time when corporate profits dropped, many big companies went bankrupt and other companies struggled to stay in business. In response, the government rushed to buttress corporate profits through all kinds of aid and support. The government stepped up defense spending as a way to hand billions over to companies producing for the military, that is, most of the big corporations. It handed out huge tax cuts for big business and the wealthy. To pay for it all, the federal and state governments slashed spending on all the programs that the population needed, including education.

Government slashed its support for public colleges and universities. Those institutions, in turn, boosted their tuition—much faster than the rate of inflation. For students and families to bridge the gap between the skyrocketing increases in the cost to go to college with stagnating or shrinking family incomes, the government simply offered more loans. Congress loosened loan eligibility requirements and added new federal loan programs, such as supplemental loans that the parents of students could take out. As a result, student borrowing went from 1.8 billion dollars in 1977 to 12 billion dollars in 1989.

Big industrial companies—like those in health care, auto, aerospace, energy and agriculture—made greater use of universities for their own research and development, allowing the companies to slash spending on their own research and development. Most of the risk and cost for the research and development was shouldered by the university. But the companies pocketed most of the profits that came out of that work. More of the tuition money—as well as taxpayer money—that the universities received was siphoned off as corporate profits. Thus universities pushed up tuition even more, which forced students to take out even more loans.

In this period of burgeoning government-guaranteed loans in the 1980s, many owners of smaller for-profit career colleges, vocational and correspondence schools saw the loan program as an opportunity to try to enrich themselves. In order to get hold of federal loan money, these schools promised working people and the unemployed training and certification in things like secretarial work, cosmetology, travel agents and truck driving. But the students got no useful training, could not find jobs afterward and were soon forced to default on their loans.

The federal government eventually closed down most of these schools. But defaults were rising, not just from loans to students at the fly-by-night, for-profit schools, but for loans to students at other schools as well. This rise in defaults should have been a big red flag about the rapidly increasing cost of college and the size of the debt that students were taking on. But Congress chose to ignore it. There were no proposals to increase funding to education, or to prevent universities from using tuition money on other things, like research and development for the profit of big business. Instead, in 1990 Congress extended the period from five to seven years during which a former student was required to pay down on their loans, before they could use bankruptcy to discharge the rest of their debt.

Money to Be Made...

Nonetheless, the increasing number of defaults was gobbling up three to four billion dollars of government funds a year, or 10 to 15% of the Department of Education budget. To help recover some of that cost, in 1992 Congress set up a government program to make loans directly to students. The government claimed that this so-called reform would increase competition in lending, reduce costs and provide some relief to the growing burden of student debt. Not true! The federal government’s direct loans were no cheaper than those of private lenders. The interest rates and terms were exactly the same. Instead, the government plowed the profits from the new federal direct student loans back into the government’s own coffers in order to help replace the billions in guarantees that the Department of Education was paying to the banks. The private lenders had nothing to complain about since the government continued to contract with them to service the direct federal government loans.

The government allowed the private lenders to keep close to 80% of the student loan market—and the profits—for the next 15 years. And that market was growing. From 1992 to 2001, the volume of new student loans more than doubled from 19 billion dollars to 40 billion dollars. Five years later, it increased by another 20 billion dollars.

In the 1990s, the nation’s biggest banks had garnered the lions’ share of the profits. The five top student lenders were Citibank, Bank of America, Wells Fargo Bank, Bank One and J.P. Morgan Chase. But in the following decade, a Government Sponsored Enterprise, the Student Loan Marketing Association (Sallie Mae), overtook these banks and emerged as the dominant student lender. Created in 1972 by the federal government to buy up student loans from the banks, Sallie Mae at first played the same kind of role for the banks in the student loan market as Fannie Mae and Freddie Mac played for the banks that issued mortgage debt. As the student loan market expanded, Sallie Mae grew extremely profitable and powerful. In 1996, the federal government fully privatized Sallie Mae. Sallie Mae began to market loans directly to students through the financial aid offices of the universities and colleges. Sallie Mae soon established a presence in every college, university and educational institution in the United States. It aggressively bought up other companies which originate and service loans, including debt collection companies, dominating every aspect of the student loan business.

Student loans produced so much wealth, Wall Street investors were greedily trying to get a piece of the action by buying up Sallie Mae stock. They pushed Sallie Mae’s stock price up by 1,900% in less than a decade after the company had been privatized. The money made off of student loans represented an inexhaustible gold mine for Wall Street.

For-Profit Colleges: Education be Damned!

Wall Street, looking for places to put its money, realized that there were other ways to profit from the ever expanding availability of government-guaranteed student loans: for-profit colleges.

This move by Wall Street was spearheaded by the University of Phoenix. In the first 15 years after it was created in 1976, Phoenix serviced business needs, providing training and degree programs for companies’ middle managers and professional staff. With about 7,000 students, Phoenix had just about saturated that market. Seeking to expand quickly in order to please its Wall Street investors, Phoenix began to offer two and four-year courses for students who were not prepared for college, for the most part students from the working class and poor. It also offered various technical programs in computers, health care, law enforcement and teaching, geared to those looking to get a better job. Effectively, Phoenix’s rapid growth was funded by the federal government through federal grants, veterans’ benefits and federally guaranteed student loans.

Phoenix was a replay of what the small fly-by-night, for-profit colleges had done a few years before, but on a far vaster scale. Phoenix is owned by the Apollo Group, a financial company. Pretty soon, The Washington Post bought Kaplan Higher Education and Goldman Sachs teamed up with a hedge fund to buy up Education Management Corporation. This sector is dominated by 30 big for-profit college companies, owned by big financial companies. Between 1998 and 2008, enrollment in this sector increased 225%, with approximately 2.4 million students attending a for-profit college in 2008.

These colleges make it very easy to enroll. Students don’t have to wait until the next semester starts in three months. They could start on Monday. The colleges walk the students right through all the various forms and help them get financial aid and loans, a very easy and smooth process. They offer convenient class locations and schedules, the ability to stop and start course work. They make course work highly structured, meaning students progress from one class to the next without having to consider which elective to take or worrying about fulfilling credit requirements in various disciplines.

The schools do everything but provide an education. They maximize their profits by devoting as little as possible to instruction and student services, such as career counseling. The level of instruction is so low that when students try to transfer credits to another college, like public colleges, most of them can’t do it.

In fact, the schools are a costly trap. The for-profit colleges are designed to rope students into paying tuition that is three or four times higher than that of public institutions. Students are stuck with debts of more than $30,000 on average at high interest rates.

The opening for the rapid growth of these for-profit schools was provided by the government. Since the early 1980s, the government has cut funding for all levels of post-secondary education, including adult education, community colleges, public colleges and universities. As a result, tuition at public colleges is now close to 400% higher than three decades ago—after inflation. The cost of tuition has risen twice as fast as even the increase in the cost of health care. At the same time, the availability of classes has not kept up with the rapid increase in demand, especially of working people. Still worse, because of much bigger budget cuts over the last several years, public institutions have been cutting the number of classes that they offer. For example, community colleges in California have cut 25% of their classes in three years.

So, when the rapacious for-profit colleges deploy armies of thousands of recruiters and advertize incessantly on television, radio, billboards and the internet, they easily find millions of people hungry for the education and training that public institutions have stopped providing.

Government in the Service of the Capitalists

It is obvious that the government should make a post-secondary education free and available for everyone, that it is a necessity in the modern world. But it has done the exact opposite. For close to half a century, the government has presided over the exponential growth of student debt. The government’s entire policy has aimed at nurturing and safeguarding not just the growth of that debt, but the power of the lenders to collect on it.

The government has removed all consumer protections from student loans. It also removed all protection against usury, that is, excessive interest. This leaves the door open for private lenders to hook students onto the equivalent of subprime loans, with exploding interest rates and debt payments.

The government certainly did not require truth-in-lending information on student loans. The lenders are not required to make clear how big the loan is, what are its terms, and how much interest the student will have to pay over the life of the loan. The government requires this on car loans and credit card debt, but not for student loans. In the worst instances, schools don’t distinguish between federal grants, scholarships and loans, calling them all “financial aid,” thus deliberately tricking students into believing that they are not taking out any loans at all! In the best of circumstances, the schools blandly reassure students that the size of their debt won’t be a problem after they graduate.

The only thing the government did—after enabling the lenders to trick young people into a mountain of debt they had no idea they were getting into—was to make it increasingly impossible for those students with debt to declare bankruptcy to get out from under the debt. In 1978, Congress passed a Bankruptcy Reform Act that specified that former students would have to make payments for five years on their student loans before they could declare bankruptcy and get rid of those loans. In 1990, Congress extended the period to seven years. In 1998, Congress closed the door completely on discharging all federally guaranteed loans and federal direct loans in bankruptcy. Finally, in 2005, Congress amended the Bankruptcy Code to extend this prohibition to privately issued student loans.

Thus, Congress made education loans the only type of loan that has this federal “no escape” clause. All student loans, government and private, are almost impossible to discharge. Only a small fraction of people even try.

With tuition soaring and the amount of student debt soaring, of course the default rate has gone up. It is now 10%, according to the latest data, double what it was five years. Once a loan goes into default, the lenders can extort not just the original principal and interest, but also tens of thousands of dollars in penalties, fees and collection costs—all with the government’s blessing.

To collect that money the government turns to debt collectors, giving them “power that would make a mobster envious,” as Elizabeth Warren told 60 Minutes in 2010, while she was the Chair of the TARP Congressional Oversight Panel. The government pays these collection agencies as much as 20% of the debt they recover. These companies unleash a small army of debt collectors, who are under pressure to either produce or get fired. The employees operate in a high-pressure “boiler-room” environment, which rewards ruthlessness in hounding and tricking people in order to maximize what they get from the borrowers. One indication of the lengths these companies have gone is that within the past 17 months, three companies working for the Department of Education—including one that is majority owned by JP Morgan Chase’s private-equity arm—settled federal and state allegations of abusive debt collections for a slap on the wrist.

The debt collectors go after everything they can get their hands on. They seize tax refunds. They garnishee paychecks. They even garnishee Social Security and disability payments. Overall, the government recoups about 80 cents for every dollar that goes into default—an astounding rate, considering that most lenders are lucky to recover 20 cents on the dollar on defaulted credit cards.

Acting like common gangsters, the banks, lenders, debt collectors and government agencies rob and plunder the working population, the young, the elderly, the disabled. In the effort to get an education and training, people instead are buried in a mountain of debt, and then squeezed for every nickel.

The trillion-dollar student debt is a mark of the government’s entire policy for higher education. As with every other sector in the economy and society, from health care to housing, the government has turned higher education into just another avenue for the capitalist class, the big lenders and Wall Street investors to extort as much money and wealth from the working population as possible.

For many people, tricked into student loan debt, the so-called “American Dream” has become their very own nightmare.

October 23, 2012.