Why federal student loans need new protections on debt collection
Democrats have harshly criticized President Trump for aggressively using his executive powers and, of course, the president has repeatedly examined the limits of his constitutional powers. However, in one area they are raising the president and urging Joe Biden, if elected, to cut up to $ 50,000 in student loan debt for millions of borrowers.
Blanket debt relief would be an extremely aggressive use of the president's power under the Higher Education Act, which appears to focus the powers to “waive or release” debt on troubled borrowers. Given the $ 1.5 trillion student debt burden on our economy, this can be justified. At the very least, this executive agency should be used to provide relief to badly distressed borrowers and to better align government debt practices with those of regulated bank lenders.
When granting unsecured consumer credit, banks must assess whether a borrower will be able to make principal and interest payments on their loan as soon as it becomes due, and provide standardized information on borrowing costs and repayment terms. When a loan defaults, government regulators generally require banks to write off the loans once they are 120 days past due. While banks can continue to apply for recoveries after the debt is written off, such collection efforts are subject to government statutes of limitations (SOL) and the Law on Fair Collection Practices. National lenders often resort to the most conservative government SOL and stop debt collection efforts after three years. Private lenders are also subject to various state and federal restrictions on "negative depreciation," the practice of adding unpaid fees and interest payments to amounts owed. This can lead to distressed borrowers having debts that are multiples of the amount originally borrowed and are frowned upon by bank auditors.
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In contrast, the government is making no effort to determine whether student loans are affordable, and borrowers are not provided with standardized information about loan terms and estimated loan repayments. In addition, government accounting does not require amortization of cumbersome student loans. This may be because there are no federal restrictions on student loan collection and the government can resort to collection tactics that are illegal in the private sector, including garnishment of social security and other state benefits. Consumer protection against abusive collection tactics does not apply to the government or to state statutes of limitations. The government regularly garnishes the wages of defaulting borrowers, which charge a whopping 20% per payment. Repayment plans are also used, which set the minimum payments below the minimum payments required to cover the interest, which significantly increases the overall obligations of borrowers over time due to negative depreciation. In some cases, the government even charges interest on a borrower's unpaid interest. After all, student debt is generally unsettled in bankruptcy, which means the government can and does follow a defaulting borrower to their deathbed.
In order to better align the practice of the federal government with that of private lenders, collections for defaulting borrowers should be limited in time. Three years would be compatible with the most conservative state SOL. The limit should not exceed five years. Research shows that after this point, collection efforts are unlikely to be successful, costing taxpayers unnecessary administrative costs and creating stress for borrowers.
Standard Exit Rates as calculated by the American Enterprise Institute.
To counter the detrimental effects of negative amortization, a student's total repayment obligation (including fees) should be limited to a reasonable multiple of the amount originally borrowed, possibly 1.5 times for college students, with a higher multiple for graduates and vocational students. the loans take out more, but also higher incomes. Canceling the debts of those who have been in arrears for more than 3 to 5 years, as well as debts in excess of 1.5 times the amount originally borrowed, would eliminate the worst abuse of government debt collection.
Such steps would be particularly beneficial for low-income color borrowers, including African American borrowers. Research shows that black borrowers are overrepresented among borrowers when they default on payments over several years and are more likely to have rising credit balances due to negative write-offs. Those who cannot finish their education have high levels of debt and no degree.
Progress in repaying student debt by race. (JPMorgan Chase Institute)
It's also more likely that black borrowers have been attacked by a for-profit college graduate mill. And they are hardest hit in major economic crises, including this pandemic.
Bank auditors have a name for banks that try to "extend and pretend" troubled borrowers in "repayment plans" in the hope that one day they will be able to repay their debt obligations.
Such a practice not only obscures a bank's true financial strength, but is also bad for the economy. Banks maintain balance sheets that are burdened with bad debt instead of writing off the losses and moving on. Most importantly, the debt overhang caused by expansion and pretense is holding back consumer spending as borrowers are never entirely released from their past obligations. The ability to secure a fresh start is why we have a consumer bankruptcy process but it is denied to borrowers by student borrowers.
During the great financial crisis, the resistance to the repayment of government-secured mortgage debts, which could not be paid even in bankruptcy, put a lasting strain on our economy. Given the government's persistent reluctance to cancel the student debts of even the most heavily burdened borrowers, we repeat the same mistake. Much more needs to be done to reform the student loan system. I have long argued that the government should get rid of debt in favor of income share agreements. But at least let the government stick to the same standards that it expects from private lenders.
We do not allow banks to extend and simulate loan commitments that are clearly unaffordable for borrowers. We should at least ask the same of our government.
Sheila Bair is the former FDIC Chairperson and has held senior appointments in both Republican and Democratic administrations. She is currently a board member or advisor to several companies and a founding member of the Volcker Alliance, a not-for-profit organization created to restore trust in government.
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