Will the CFPB save us from the student loan crisis?
by Anastasia Wilson
Last year student debt ballooned to $1 Trillion. Months earlier in the previous year, it surpassed outstanding credit debt in total, making it a substantial part of the American household debt portfolio. This year, policy discussion is finally taking place to tackle both ends of the problem: Federal and private student loan debts.
As the so-called student loan crisis loomed, the Obama administration began to make small patches to the Federal side of the problem. The reforms that came packaged with health care legislation established an income-based repayment option (IBR) for Federal student loans and consolidated lending and services practices. IBR allows Federal loans to be repaid on a sliding scale based on a percentage of yearly earnings. The repayment schedule is roughly 10% of income, or lower for those near the poverty line, and is applied to the principal of the loan. Interest may continue to accrue, however after 25 years of qualifying payments under IBR, the remaining balance is forgiven. In the future, all Federal loans will be serviced directly by the government instead of using corporations such as Sallie Mae as intermediaries. With the important exception of IBR which can be applied for with outstanding loans, most of the new practices will only apply to loans originated after 2014. Baby steps, but in the right direction.
While the IBR program is meant to offer relief to borrowers, the policy itself may suffer from framing problems, making it underutilized by those who need it. The Roosevelt Institute Campus Network recently published a series of student essays called “A New Deal for Students”. Their first proposal was automatic enrollment in IBR for Federal loans. Behavioral economists have used experiments to show that even when some money or stress saving option exists, having to go through the process of enrollment often shies people away from enrolling in a program, even if it makes them much better off. The Roosevelt essay by UCLA student Razmig Sarkissian explains concisely:
“Many borrowers are either unaware that the IBR program exists or are deterred by a complicated application process. In a June 2012, President Obama acknowledged this problem, “Too few borrowers are aware of the options available to them to help manage their student loan debt, including reducing their monthly payment through IBR,” Obama wrote. “Additionally, too many borrowers have had difficulties navigating and completing the IBR application process once they have started it.”(6)”
In other words, the transactions cost of dealing with IBR enrollment makes it, in the moment, not worth it or impossible to deal with for many. By making IBR the default option, this could relieve a number of borrowers who would ordinarily end up in default or delinquencies. Making IBR the default option would prevent loan defaults.
But what about the rest of student loan borrowers, who are cash strapped by payments for private student loans?
The Consumer Financial Protections Agency (CFPB) may have a solution. Private student loans represent a fast growing segment of all student loans, and of personal household debt in general. With a 25% annual growth rate, private loans will eventually eclipse Federal loan totals, as Federal loan amounts get maxed out and tuitions continue to rise. Private loans, like their Federal counterpart, cannot be discharged under bankruptcy, yet unlike Federal loans they offer little flexibility in repayment. These loans are often funded by corporate bond offerings from financial industry players like Sallie Mae Corporation, which just recently sold $1.1 billion in student loan asset backed securities (SLABS). These SLABS, which remain a hot go-to safe asset on bond markets, bear an eerie resemblance to the MBSs that took down the financial system (and the rest of the economy with it) back in 2008. Here’s another form of private debt, rebundled for financial profit, except unlike a mortgage foreclosure is not an option. For private student loans, payment negotiation also remains difficult.
So what’s the solution? The CFPB has announced its support for IBR for private student loans. Like the mortgage modification policy that helped relieve some borrowers from financial stress, IBR and refinancing of private student loans would ease the crunch. Instead of waiting for the crisis to happen though, the CFPB is recommending this more pro-active approach, with director Richard Chopra stating, “”If you think everything in this market is hunky-dory, you’re missing the warning signs. Waiting any longer is just not an option.” Let’s hope the government policy-makers hear the warning signals this time.
The CFPB will be taking public comments on Student Loan Affordability policy until April 8, 2013.