College studentsNew data from the federal government confirms what StudentLoanJustice.org founder Alan Collinge has been saying for years: Defaulted federal student loans don't cost the government.

The Wall Street Journal reports that (subscription required) "After paying the companies that actually collect the loans and other costs, the U.S. Department of Education expects to recover 85% of defaulted federal loan dollars based on current value. The recovery figures are quite generous when compared with other corners of consumer debt. Banks, for example, often retrieve less than 10 cents on the dollar from overdue credit cards."

That sounds like good news. It isn't. Here's why: When lenders don't end up suffering losses on loans that are excessive, they lack any particular incentive to lend responsibly. Why worry about a student borrowing too much for a bachelor's degree when the debt can't be discharged in bankruptcy -- and you can garnish the borrower's wages for the rest of his life while tacking on interest and fees? The result is tragic stories like this one.

Only the Borrowers Pay

Collinge tells DailyFinance that "It's like the Wild West, only it's government-sanctioned." He also takes issue with the 85% figure and says his calculations show that the government is actually making money on defaulted loans. Mark Kantrowitz of FinAid.org notes that the gross recovery amounts are 122.1% for the recently discontinued FFELP federal loan program and 110.6% for the federal direct program -- but that collection costs bring the net recovery rate down to 85%.

He calls the collections costs "very high" and notes that "Collection agencies for student loan debt are all quite profitable, and the government has no real incentive to rein in those costs as they are paid by the borrower, not the government."

Whether it's an 85% recovery rate or north of 100%, the fundamental issues are basically the same. Student lending has developed into a system where no one other than the borrower really loses when people are saddled with excessive debt. Colleges don't care because easily available borrowing smashes the natural ceiling on college affordability -- and allows colleges to continue raising prices at breakneck speed.

How to Lower Tuition

The only way to stop this is to change the bankruptcy laws so that all student loans -- private loans and, more important (because it's a bigger market), federally guaranteed loans -- can be discharged in bankruptcy. Let the banks and the taxpayers take some enormous losses -- and perhaps then reconsider the banks' aggressive underwriting policies. This isn't an ideal solution, but it's the only one that will restore sanity.

What would happen then? Would no one be able to go to college? Would college lecture halls and recently constructed $200,000 per bed dormitories sit vacant? Please. There's no immutable law that says college costs must rise two to three times faster than inflation. Stop the flow of easy credit, and tuition prices will come down. If you don't believe me, Google "housing bubble."

The relationship between increased funding for higher education and increased affordability is not as linear as many would like to think. Economist Richard Vedder recently explained in The New York Times that "exploding student loan programs have contributed to higher tuition charges" and notes that a larger percentage of college students came from low-income backgrounds in 1970 than today -- in spite of the enormous increases in federal student aid.

But until someone other than borrowers suffers from the consequences of excessive student loan debt, this vicious cycle will not stop.

Zac Bissonnette'
s Debt-Free U: How I Paid For An Outstanding College Education Without Loans, Scholarships, Or Mooching Off My Parents was called the "best and most troubling book ever about the college admissions process" by The Washington Post.

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c_sozei@hotmail.com

"perhaps then reconsider the banks' aggressive underwriting policies." The "free market" approach never worked which is why the state and federal governments got involved in the first place. In addition, lenders don’t want to do that underwriting analysis. Performing an individualized, student-by-student underwriting is too labor-intensive, even for types of students you would think would be quite profitable overall.

This also means the much-bandied-about argument that restoring free-wheeling 1970s-style bankruptcy discharge to federal student loans would "put some skin in the game for lenders" is a bogus argument. Even if there were some type of "data model" available to do so, which there is not, lenders would not want to perform the labor intensive person-by-person predictability analysis of who is "likely" to file for bankruptcy and who is not. Student loans are not like auto loans, credit cards or mortgages. It is a volume operation.

There is no way that taxpayers would stand by and allow a reinstatement of bankruptcy provisions for federal student loans. And the longer that borrower advocates willfully ignore the vast consumer protections already available on federal student loans and press for loosening of bankruptcy the less chance there is of achieving implementation of a more logical solution -- a case-by-case write-off application for borrowers who have truly been ripped off by schools, something which is not addressed under the current regulations and procedures.

By the way, there are no "bankers" involved in federal loan volume issuance after 6/30/2010. All new loans come through direct lending. There are still hundreds of billions of dollars of existing loans sitting with lenders. Just no new involvement by lenders. However, they can still make private educational loans, where bankruptcy provisions should actually be reinstated to pre-2006 law.

February 17 2011 at 3:17 AM Report abuse rate up rate down Reply
jlogan2664

Yes it's been 25 years since I graduated from college but whatever happened to limits on guaranteed student loans like we had? If you can't afford to go to college without getting into dept up to your eyeballs, then work and go to school part-time or go to a less expensive college. Students are graduating from college with degrees in underwater basket weaving and are tens of thousands of dollars in debt with no job prospects in sight. Then you have the case of Octomom who used her student loan money for fertility treatments. It's just ridiculous! You borrow the money, you pay it back. End of story.

January 05 2011 at 5:21 PM Report abuse +1 rate up rate down Reply
ajallenky

And the Obummer Administration has now put these loans squarly on the shoulder of the taxpayer because the Federal Gov't NOW guarantees these loans - how's that for change !!!!

January 05 2011 at 4:43 PM Report abuse +1 rate up rate down Reply
2 replies to ajallenky's comment
robsssss

Where have you been aj ? The federal government always guaranteed student loans, even before I started college in 1984. The article speaks to the enhanced enforcement for those student loans guaranteed by the government. But, the article is wrong-headed - let's not put any more expenses on the taxpayer (such as covering defaulted/discharged-in-bankruptcy student loans). All they have to do is substantially lower the amounts of money available and/or guaranteed by those loan programs. This would put less money in the system for the colleges to gobble up - they would have to maintain or lower their tuition costs - and would not place the costs of default upon taxpayers. Even when I was in law school almost 20 years ago, the amounts you could borrow were huge, virtually unlimited. We're still paying a consolidated loan for myself (small loan) and my wife (large loan) - on a 30 year plan (its like a mortgage lol) - I'm not about to complain, until you tell me I have to pay for someone else's defaulted loans. Students who borrow should be chosing to study in areas that will provide the income to pay back the loans, like we did. Maybe they should add a requirement that students attend an educational program about student loans, responsibilities and the likely market trends and demand in their area of study before they are allowed to borrow any money.

January 06 2011 at 2:11 AM Report abuse +1 rate up rate down Reply
thalversonw

The Federal government has guaruntteed these loans since the 70's.

May 16 2011 at 11:47 AM Report abuse rate up rate down Reply
smith65791

Why am I responsible,as a taxpayer for someone wanting to finance their education.Citizen's should not have to bear the burden for someone else's responsibilty. Is this America's current mindset that one's actions are not that persons problems. Buck up and take responsibility for your on actions. Damn people,as someone whose paid his debts I'm tired of bailing every irresponsible individual out of their financial problems!

January 05 2011 at 3:41 PM Report abuse +4 rate up rate down Reply