An ongoing theme of Student Loan Bubble is the structural similarity to the US housing bubble, such as high-risk loans to individuals with no collateral or credit history, decade-long repayment schedules, and variable interest rates. Given the spectacular collapse of the US housing industry and the level of fraud that was later uncovered, it should not be surprising that some are asking the same questions of the student loan industry.

Between bringing a lawsuit against lending companies and established guilt, a lot of evidence must be presented before the connection is made. Student Loan Bubble is curious to watch this case as it unfolds.

Excerpt from: http://www.businessinsider.com/jpmorgan-citi-charg…

The 285 page suit [...] says Nelnet illegally induced students to apply for federal student loans, paying telemarketers to aggressively push the government product, and used false advertising to get more applications, like promising that students would save thousands of dollars in interest payments by consilidating their loans with Nelnet. They then presented false claims to the Department of Education to receive federal funding.

According to the suit, JPMorgan and Citi alledgely “ratified and/or authorized the wrongful acts of Nelnet and have benefitted from such conduct.”

Without specifying a total amount, the suit asks for triple the U.S. claim payments and other damages, plus civil penalties. It asks for $5,500 to $11,000 for each claim Nelnet presented to the Department of Education between 2004 and 2007 (the number is unclear).

The government could have intervened in the suit, but declined, according to court filings.

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Excerpt from: http://online.wsj.com/article/SB125511860883676713…

“We saw an extension of credit to a much deeper socioeconomic level, and they got access to the same credit instruments as middle-class and mainstream Americans,” says Ronald Mann, a Columbia University law professor. Now, “it will be harder for families at the bottom of the income ladder to get credit cards,” he says.

The financial crisis has forced lenders to be especially cautious with the riskiest borrowers, a category that low-income families often fall into because their debt tends to be higher relative to income and assets. The ratio of credit-card debt to income is 50% higher for the lowest two-fifths of Americans by income than for the top two-fifths, Federal Reserve data show.

Although the tone of the article tends to focus on young people and their consumer behaviors, there is also a glimpse at a much more troubling problem.

Treasury Secretary Timothy Geithner, testifying before Congress in July, said: “We now know that millions of Americans were…unable to evaluate the risks associated with borrowing to support the purchase of a home, a car or an education.”

Student Loan Bubble is curious to hear more about Geithner’s perspective on the inability of Americans to evaluate risk, and if this can be remedied by better information, better financial education, different regulation, or perhaps something else entirely.

Education is an excellent vehicle for elevating one’s socioeconomic status, but The WSJ has identified a major issue for those in greatest need of elevation: disproportionate debt levels, coupled with the previously unheard of suggestion that education might be a risky investment.

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Student Loan Bubble recently discussed one major problem with this figure: new college graduates will only earn $7000 more per year than their high school peers, while shouldering significantly more debt than high school-educated workers. Additionally, high school grads will have at least four years worth of income before college grads even enter the workforce. The take home message from the first Student Loan Bubble article is that recent grads are facing a very real risk that they won’t be able to manage their student loan debt with such a meager income increase, at least during the first few years.

The first article provoked some interesting feedback such as the question, “what happens later in life?” In this article, Student Loan Bubble presents two graphs of lifetime earnings, which were calculated based on median income data from the US Census. The census provides data in 10-year aggregates, so Student Loan Bubble assumed a yearly pay raise that would make yearly earnings consistent with the census aggregates. After determining yearly income, Student Loan Bubble determined the cumulative income between the ages of 21 and 64.

The first graph presents yearly median incomes of High School and College graduates. You can click for a higher resolution version. Notice that the gap is not major while workers are young, and that by age 35, everyone has nearly achieved their maximum earning potential. It is difficult to perceive, but high school workers actually notice a slight pay decline between age 55 and 64.

Next, Student Loan Bubble presents cumulative earnings, and these results might surprise you. By the time workers are 64, college grads will have earned $1,991,574 while high school grads will have earned $1,258,998. These are median figures, which means that 50% of workers will earn less than these amounts. The difference in median lifetime earning is $732,576, which is less than 75% of the fabled $1,000,000.

Consider, too, that it not unusual to pay $120,000 to attend a private university for 4 years, and the earning difference drops to approximately $600,000. Once interest expenses are included in this figure, and accounting for the very real risk of penalties for late payments, the earning difference will be reduced even further. It should be reiterated again that these are all median data, which are a robust measure that is not affected by high-earning outliers.

It is plainly evident from these graphs that college graduates can expect to earn more with their degree, but the exact amount of this earning difference deserves to be scrutinized. The next step is to examine the upper and lower quartiles to see how the relationship looks. Student Loan Bubble predicts that the earnings gap for the 25th percentile will be somewhat lower than the median difference, and that the 75th percentile will show a much larger income difference.

It is the conclusion of Student Loan Bubble that the $1,000,000 lifetime earning difference truly is a myth that is not supported by the median income data. In the case that this myth has been used to justify excessive student debt liabilities, it is possible that some students will be seriously disappointed by their lifetime earning potential.

Supplement: A CSV file is available to download here, for anyone who wishes to give these data a closer look.
student-loan-bubble-lifetime-median-income.csv

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There is at least one element missing from the video, which is mentioned but not expanded upon: Credit Default Swaps (CDS), which explain how insurance companies are also included in the flowchart. The Collateralized Debt Obligations (CDOs) are partially insured by CDSes, which is a guarantee that if the CDO stops earning money, the insurance company will pay the difference. Because the CDO market was actually the business of reselling housing mortgages (and we all know how that went) the CDS contracts are now in effect. Now, insurance companies must pay out sums of money that are a large portion of the total mortgage defaults.

Nevertheless, this video is fantastic, and it is a useful tool for learning more about the student loan bubble. In the same way that bankers created CDOs out of mortgages, student loan debt has also been packaged and resold to other bankers and investors. Unlike mortgages, students are not able to default on their loan repayments.

Excerpt from: http://vimeo.com/3261363

The goal of giving form to a complex situation like the credit crisis is to quickly supply the essence of the situation to those unfamiliar and uninitiated. This project was completed as part of my thesis work in the Media Design Program, a graduate studio at the Art Center College of Design in Pasadena, California.

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For its lending and collection businesses, SLM Corporation enjoys unprecedented legal advantages that are not shared by any other class of financing, including many unique techniques for retrieving repayment from students who have defaulted. As a result, the repayment rate for student loans is currently 95%, which is significantly higher than in the past, and is higher than other industries. Stahl interviews several experts to figure out how SLM Corporation came to be, and uncovers a fascinating story of amazing profits and questionable expenses.

RTFA: http://www.cbsnews.com/stories/2006/05/05/60minute…

“It may be called ‘private’ by the people in the system. But it’s not private at all,” says Michael Dannenberg, who analyzes student loan policy at the New America Foundation, a non-partisan think tank.

“What do you call it?” Stahl asks.

“Frankly, it’s a socialist-like system,” he says. “It’s not as if this private entity is assuming any risks. No, no, no. The law makes sure that this so-called private entity has virtually no risk.”

On top of that, Sallie Mae also owns some of the biggest collection agencies in the country. Once a student borrower goes into default, the government pays Sallie Mae all the principle and compounded interest that have accrued.

The loan then passes into the collection phase. If Sallie Mae is the collector, it gets to keep up to 25 percent of whatever is recovered. In 2005, nearly a fifth of its revenue came from its collection business.

“Sallie Mae makes money if you pay back on time. And Sallie Mae makes money if you don’t pay back on time,” says Elizabeth Warren, a professor of bankruptcy law at Harvard Law School.

Warren says it’s a mistake to allow Sallie Mae to be both a lender and a collector.

“It shouldn’t be the case that Sallie Mae gets to play every hand at the poker table while the government is the one that keeps anteing up the money,” Warren tells Stahl. “But let’s be clear. That by itself isn’t enough. We have to decide collectively as a country: do we want to encourage the young people who are trying to get college diplomas? And if the answer to that is yes, the way to encourage them is not to double and triple the amount that they owe when they get into financial troubles.”

By law, private lenders must offer payment options, but that usually means the loans just balloon. So even though 95 percent do pay up over time, many are burdened with heavy debt. In a statement, Sallie Mae told 60 Minutes it makes far more money from those who pay on time, than from those who default

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It is very common to read criticisms of students who have taken on more debt than they can handle, and if this film is able to speak to those criticisms, it will be a significant accomplishment. This challenge involves convincing a wide audience including people who dutifully paid all of their student loan debt, those who required no debt to begin with, those who compromised in order to avoid debt, and those who didn’t go to school at all. With an audience like that, Default might be a very difficult sell.

The following trailer is about 5 minutes long.

Excerpt from: http://www.defaultmovie.com/?page_id=2

Default: The Student Loan Documentary is a feature-length documentary chronicling the stories of borrowers from different backgrounds affected by the private student lending industry and their struggles to change the system.

In 2005 private student loans were exempted of ALL consumer protections. No matter when their loans were taken, many borrowers now find themselves in a paralyzing predicament of repaying two, three or multiple times the original amount borrowed, with no bankruptcy protection, no cap on fees and penalties and no recourse to the law. The consequences are dire, with stories of borrowers in financial and emotional ruin.

Beyond these personal accounts, DEFAULT will explain the differences between federal and private student loans, a subject often overlooked by colleges and high school counselors. It will also give detail on the rise of the private lending industry and of college debt.

While the media has focused on the disaster that sub-prime mortgages have turned out to be, only superficial attention has been given to financial giants which have been profiting by approving loans to low-income students with variable interest rates up to 25%.

As The National Consumer Law Center concluded in their March 2008 report titled “Paying The Price: The High Cost of Private Student Loans and the Dangers for Student Borrowers”, there are ominous signs that “the student loan market is headed for the same fate as the subprime mortgage industry .”

Default is directed by Aurora Meneghello and produced by Serge Bakalian. Keep an eye on the official website, which is www.defaultmovie.com. Student Loan Bubble will keep you posted as this story develops.

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Vedder and Gillen draw a parallel to the housing bubble by observing the similar financing practices that drove both bubbles. From the Student Loan Bubble perspective, the inverse observation is that the prospects for future growth in career income justified the risk of taking on student loans. This wager on future earnings downplayed the threat that young professionals might not be able to repay their debts, unless they truly earned more money through their career.

Both descriptions converge on the similarities to the housing bubble, but the conclusion is ultimately unsettling. Whereas over-extended home debtors are able to default on their mortgages, students have no home-like asset that can be repossessed by the bank. Vedder and Gillen suggest a somewhat bizarre strategy, whereby colleges purchase equity in students’ future earnings, financed by the college endowment. The suggestion is either deeply unsettling, or simply another way of saying that students will go into debt for the eduction, making repayments to the school instead of a bank. In all, it makes for an interesting read.

Excerpt from: http://www.insidehighered.com/views/2008/05/02/ved…

The 61 percent increase in inflation-adjusted federal loans over the last decade leaves virtually all their students capable of paying more in tuition. The schools can either raise tuition, using the additional money to help build a better (more prestigious) college , or could leave tuition unchanged in an inflation-adjusted sense. The decision they made is obvious from U.S. Department of Education data. Over the last 10 years, after adjusting for inflation, tuition is up 48% at public schools and 24% at private schools.

Giving schools more money to build better institutions may not seem like a bad idea, but keep in mind that their goal is to increase prestige. This means that they will not necessarily use the money to improve the education their students receive. For example, Inside Higher Ed recently reported that less than half of employees at America’s institutions of higher education are faculty, information reinforced by a new study released this week. Today’s universities are congested with vast bureaucracies that stifle innovation and waste resources. Princeton University recently constructed a fancy dorm that cost $70,000 more per bed than the median home price. This unnecessary largess should show that what increases prestige may have very little effect on the education of students. Moreover, much of the extra money for schools ultimately comes from the students, who have seen the average debt upon graduation steadily increase to over $20,000 last year.

The analogy to the housing bubble is nearly perfect. Low interest rates arising from expansionary Federal Reserve policies led to rising housing demand, rising home prices, and excessive lending to individuals with dubious credit worthiness. Similar things have happened with student loans. The federal government has provided subsidized, low interest credit, often to students whose prospects for graduating from college are marginal and whose credit histories are non-existent. Student loan defaults are rising along with tuition fees. Already, some private lenders are exiting the market and federal officials are starting to become increasingly worried about the availability of student loans. The government-induced housing bubble is paralleled by what could be thought of as a tuition-loan bubble.

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