05 Oct Student Loans and Subprime Mortgages: The Resemblance is Multifaceted
Many newspapers carried a lengthy Associated Press Article this week on student loans which ought to give borrowers and investors pause. Much of it deals with aspects of the student loan problem which have already attracted national attention: the explosion in college costs and student indebtedness in general, the plight of individual borrowers caught in a debt trap, the huge increase in high cost private loans with onerous repayment terms, and the questionable deals between colleges and private lenders. Midway through, it introduces another ominous note. According to no less an authority than New York Attorney General Andrew Cuomo, the private student loan market bears an uncanny resemblance to the subprime mortgage market. Should private student loans suffer the same sort of failure as subprime mortgages, as students graduate or drop out and find themselves unable to pay, we will do serious damage not only to the lives of many students but also to the economic and social fabric of our country, one person interviewed concluded.
Not mentioned in the article is the extent to which both subprime mortgages and costly private student loans rely on a save your cake and eat it too philosophy of lending. That is, the lender justifies the high interest rate and other onerous terms of a loan based upon the poor credit history and presumed high default rate of the borrower while at the same time insulating itself against losses through default. In the case of subprime loans, that insulation consisted of rapid appreciation in property values. When property values declined, these mortgages became genuinely risky, and their value in an investment portfolio plummeted.
Originators of high-interest private student loans rely upon the non-dischargeability of student loans in bankruptcy to reduce risk. The laws as they stand now grant holders of student loans collection rights that put them ahead of virtually every other creditor, for the entire lifetime of the loan, allowing them to garnish wages and squeeze those high interest rates out of people in very straightened financial circumstances. However, as more and more loans carry repayment terms which cannot realistically be met, that insulation wears thin. Such loans will eventually default. Recognizing this, prudent investors will avoid securities backed by student loans, curtailing the availability of money for additional loans.
The article also points to the effects of student indebtedness on the economy as a whole. For many young people, those interest payments require foregoing purchasing a home and otherwise curtailing all but the most necessary consumer purchases. Like the sudden spike in adjustable rate home mortgages, this siphoning off significant chunks of people’s wages into the loan industry has a chilling effect on consumer spending. With repayment terms of 20 or 30 years, this effect is going to last for a significant fraction of a graduate’s working life and for much of the minority of her children.
Government-guaranteed and subsidized student loans are not immune to these problems. When these loans default, the public picks up the tab. Lenders appear to be using the law to postpone default as long as possible in order to rack up additional interest and fees chargeable to the government. Raising the cap on guaranteed loans from the current $23,000 for four years, as has been proposed by various spokespeople for the education industry, might curb the proliferation of high-cost private loans, but would not change the bottom line: large numbers of people burdened with loans they cannot repay, and a public debt concealed as a private obligation.
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