To keep grads solvent, take the middleman out of student loans
The mounting student debt crisis could cause serious economic damage to the United States. Rising college costs and declining financial aid at both state and federal levels have significantly contributed to the problem. A good deal of responsibility, however, belongs to the financial institutions that service federal student loans, according to a new report.
Millions of students use loans underwritten by the Treasury Department and granted by the Department of Education to help make college a reality. Once the loan is approved, however, borrowers usually deal with third-party servicers — and that’s where the trouble often begins.
In 2010, the Education Department expanded its Direct Loan Program and contracted many for-profit financial institutions to service and administer the loans. Complaints to the department’s Office of Federal Student Aid jumped significantly.
The Consumer Financial Protection Bureau has documented a wide range of complaints, including payments not showing up in payment histories; processing errors that maximize late fees and penalties; misinformation on how payments are applied to multiple loans; misplaced paperwork that results in missed deadlines, and poor customer service that denies borrowers vital information about flexible repayment options.
Borrowers also complain that servicers often make debt management more complicated instead of helping them manage their debt. Servicers, however, are at fault for far more, according to the new report by Eric Fink, associate professor of law at Elon University, and Roland Zullo, an assistant research scientist at the University of Michigan.
Their study shows that servicing firms are playing a major role in the huge increase in student-loan defaults and delinquencies — because the companies have neglected their responsibility to counsel borrowers with distressed loans. By complicating the process and providing misinformation about repayment options, many servicers make paying off student debt an incredibly difficult process.
Since Education Department contracts cap the total revenue a servicer can make on each account, many companies seek higher profits by trying to cut other costs. The result is often a reduced customer-service staff and overall decline in service.
Yet these financial institutions do not shoulder all the blame. The report also blames the Education Department for not providing appropriate oversight and allowing servicers to take on new loans they cannot manage efficiently. Though the department periodically reviews each contractor, the companies are all guaranteed to receive some proportion of new accounts — essentially undermining any demands for performance improvements.
Moreover, because contractors are assessed against each other — rather than against independent standards — the entire floor is lowered with no consequence or penalty for poor performance.
Education Secretary Arne Duncan has recently agreed to conduct an internal investigation of his department’s servicers. But other government agencies have already looked into this — and the results were troubling. The Federal Deposit Insurance Corporation and the Justice Department both investigated one of the largest student-loan servicers, Sallie Mae (as well as Navient, formerly a division of Sallie Mae). The companies were found to be overcharging active-duty soldiers on their federal student loans. The investigation resulted in a large settlement from both companies.
This helps demonstrate the Education Department’s failure to oversee its contractors effectively. Several senators have also called on the Office of Federal Student Aid to address complaints about Sallie Mae. Senator Tom Harkin (D-Iowa), for example, charges that the servicers are being treated as though they’re “too big to fail.”
To rein in servicers, policymakers should move contract monitoring to the Consumer Financial Protection Bureau. It has no stake in the servicers’ performance.
Another way to overhaul the program is to cut out the middle man. Administration of the loans could be taken on fully by the federal government and moved to a government agency better equipped to handle it, with a mandate to insist on responsible servicing rather than revenue maximization. In their report, Fink and Zullo recommend moving oversight to the Treasury Department, the Internal Revenue Service or the United States Postal Service.
Their suggestion dovetails with the Postal Service inspector general’s recent comments about expanding into nonbanking financial services, particularly for people underserved by existing banks and other financial institutions.
The agency is logistically well-positioned for loan servicing with its vast network of offices, many on college and university campuses. It has the personnel and infrastructure to assist borrowers with financial transactions. Unlike current servicers, the Postal Service could offer face-to-face counselors. In addition, the Post Office is already more trusted than banks.
Combating student-loan debt will require reform on many fronts — including tackling college affordability. There are clear, actionable steps, however, that can be taken immediately to ease borrowers’ debt burdens and lessen the resulting drag on our economy.
One crucial missing ingredient, however, is the political will to stop this crisis from getting even worse.
PHOTO (TOP): Occupy Wall Street demonstrators participating in a street-theater production wear signs around their neck representing their student debt during a protest against the rising national student debt in Union Square, in New York, April 25, 2012. REUTERS/Andrew Burton
PHOTO (INSERT 1): Thousands of college students and faculty march at the State Capitol in Sacramento, California, March 14, 2011. REUTERS/Max Whittaker
PHOTO (INSERT 2): U.S. Post Office and Court House in Larado, Texas. Courtesy of LIBRARY OF CONGRESS