A $150 Billion Burden: What to Do About Subprime Student Loans

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Today, the Obama administration offered us some very bad news and some very good news about the America's student debt burden.

First, the bad news. Thanks in part to grossly loose lending standards during the last decade, the Consumer Financial Protection Bureau (CFPB) says the country is now sitting atop a $150 billion mound of private student loans, which lack the flexible repayment options of federal loans and tend to be more expensive to pay off. The government also found that at least $8.1 billion worth of private student debt issued between 1999 and 2011 had entered default. Loosely speaking, we had a subprime student loan boom. 

Now the good news: Since the financial crisis, lenders such as Wells Fargo and Sallie Mae have become more responsible. They've tightened up their underwriting practices substantially and are now handing out fewer loans (as shown in the graph below) and picking more qualified borrowers.  

Private_Student_Loans.PNG

In light of this new data, the CFPB is urging to Congress to take a couple of steps. The first should be completely uncontroversial: it would require educational institutions to take a more proactive role guiding students through the borrowing process. Right, far too many students are a simply ill-informed about their options. Twelve percent of those who took out private debt didn't even apply for a federal loan. 

Their second recommendation, though, could run into some headwinds. It would make it easier for students to discharge their private student loans in bankruptcy, which is near impossible to do under current law. Federal loans would not be affected by the change. 

As the WSJ noted today, private lenders are arguing that the change could drive up interest rates further and that many students would simply choose to walk away from their debt. After all, nobody can repossess your diploma if you default.

These are not persuasive objections. First, as the CFPB notes, there's no evidence that students were abusing the bankruptcy process before 2005, when changes to the law made discharging college debt more difficult. Moreover, 90 percent of private loans are now cosigned, compared to a little more than half in 2005 -- and cosigners with good credit are much less likely to default than a student with few assets. It's conceivable that, rather than up interest rates, banks might just require even more loans to be cosigned. I don't think that would be a tragedy.

And frankly, nor would marginally higher interest rates. Low interest federal loans play a crucial role making college available to students who might not be able to afford it, and making it possible for low-income students to focus on their educations rather than working full time to afford tuition. But undergraduate students can take out as much as $31,000 over four years in unsubsidized Stafford loans. There's no reason to incentivize even higher, potentially irresponsible levels of borrowing. 

The CFPB's report today showed us that, in many ways, the worst excesses within the student loan industry may be behind us. We'll probably continue to feel the hangover from that borrowing binge for several more years. Changing the bankruptcy code could help many of those borrowers now. And as far as the future goes, the more the private student loans resemble any other kind of consumer debt, the better. 

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Jordan Weissmann is a senior associate editor at The Atlantic.

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