Graduate Student Loan ‘Horror Stories’ Are the Point

Most of what Jordan Weissmann writes in “A Sign That Washington Might Be Charging Too Much Interest on Their Student Loans,” is correct. Okay, the title should use “Its Student Loans,” but that’s trivial.

Weissmann argues that startups targeting high-income graduate student debtors for student loan refinancing probably aren’t much of a threat to the federal loan program’s profitability (assuming there is any). The example he cites from a Bloomberg article isn’t very inspiring. The debtor has an MBA earns $140,000 per year, and has a scant $45,000 of debt. A 31 year old, the debtor’s 6.55 percent interest rate indicates that he probably has only unsubsidized Stafford loans from back when the interest rates were fixed rather than Grad PLUS loans at a floating rate. He is totally ineligible for income-based repayment. Rhetorically speaking, so far so good.

As for that assumption about that the federal loan program’s profitablity, we’ve already been down that road. (In a related article, Weissmann implies that anyone who disagrees with accrual accounting is a conservative—ha.) The government may have lower borrowing costs, but that doesn’t mean it always lends money wisely. Anyone who disagrees is free to argue why we shouldn’t socialize the entire credit system—and not just postal banking, I mean everything.

Where Weissmann gets tangled up is when he writes, “[W]hile there are certainly plenty of horror stories out there from underemployed and overindebted law grads and Ph.D.s, advanced degree holders are generally high earners who rarely default. Their reliable payments help subsidize lending to low-income undergrads, who are generally far less of a solid bet for the government.”

First of all, graduate debtors’ low default rates are probably due to selection bias, not high incomes. Presumably, highly educated people are savvier, more conscientious, and therefore more likely to contact lenders when they start running into financial problems, so they sign up for hardship deferments rather than default. Now they have IBR. In short, not being in default isn’t the same thing as being in full repayment.

More importantly, however, is that the characterization of law debtors and others as “horror stories” is misleading. In the past I’ve estimated that about 30 percent of Grad PLUS loan dollars go to students at private law schools. More go to public law school debtors. Weissmann should know that a sizeable proportion of these debtors will never repay their loans in full. Even if they’re a minority of graduate debtors, they still owe more than the average, but that’s where the profits are supposed to come from! Consequently, that minority matters quite a bit.

What’s needed is a cross-section of Grad PLUS dollars (not debtors) by degree, then repayment status, and then repayment type. If a minority of debtors owes a greater proportion of the debt and is on IBR because it has a low income, then startups poaching a few MBAs will be the least of ED’s problems.

CBO: IBR/PAYE to Cost Gov’t $39 Billion Over Ten Years

Most people know better than to read through the Congressional Budget Office’s annual “Budget and Economic Outlook,” which was released last week. Not me, though.

Student loans play a subtle roll in these kinds of reports, and this year’s offers an interesting twist. In Appendix A, which concerns the changes since August to the CBO’s baseline projection, on page 113 (pdf 119) it states:

CBO increased its projection of outlays for federal student loans by $39 billion over the 2015–2024 period. That increase is primarily attributable to higher projections of participation in repayment plans that are based on a borrower’s income. Under those plans, the government forgives the loans of borrowers who meet certain criteria, so they cost more than other repayment plans.

Yeeouch.

Don’t worry too much though, the office still believes that there’s an overall negative subsidy to the student loan system thanks to its accrual accounting methodology. I’m a rare liberal who thinks fair-value accounting works better. I think the opponents of FVA confuse the government’s enormous borrowing power with the belief that it never spends money recklessly.

The CBO’s specific estimates of the federal student loan system will be out later, but I suspect this stray statement will be used by Wall Street Journal types to argue that IBR/PAYE is a “debt forgiveness program” for wastrel college students rather than a monthly payment reduction program that it’s largely intended to be. At least people can’t say that it’s a student debtor shakedown to extend standard repayment plans. This whole student loan thing is going to get uglier and not end well. I’m not excited about it.

Shifting gears, another place student debt rears its hideous visage is in household formation. On page 36 (42), the CBO tells us that “[S]tudent loans have rendered some young adults unable or unwilling to obtain a mortgage.” Brookings Institution people, take note.

But for some reason the CBO thinks household formation will surge ahead.

CBO Household Formation Projection

The CBO’s only reason for optimism is “better prospects for jobs” and easier access to mortgages, yet it concedes that in recent years household formation has not been linked to employment gains as it has been in the past.

Looking at the employment-population ratio for 25-54-year-old Americans, there’s but slim reason to be hopeful. It’s risen two percentage points since October 2011, but it needs to go up five more points to return to its 2000 peak. I don’t think the current trajectory is compatible with rapid growth in household formation. On the other hand, two percentage points is probably more than I would’ve predicted a couple years ago.

Civilian Employment-Working Age Population Ratio

Without new households, vacancy rates will stay high (though there are regional variations I’ll not speculate on at this time), so expectations of higher future land values will stay suppressed. This doesn’t bode well.

Less Debt, Fewer Defaults, and More IBR

…Is everything you needed to know about last week in the world of federal student loans.

We have The Wall Street Journal‘s Morning Editorial Report … um … editorializing on the “Surge in Student Debt Forgiveness.” The whole article is subscription required, but it appears the WSJ is continuing its biased reporting on IBR by sloppily characterizing it as a loan-forgiveness program rather than a program whose intended purpose is to reduce monthly payments. That’s not to say I don’t think IBR will cost the government a lot of money or that the average amount borrowed is high enough to indicate that a lot of these debtors borrowed Grad PLUS loans, but this is pretty shrill. Like, how dare an income-based repayment program base people’s repayments on their incomes? What’s next Social Security securing society from old people starving to death in the streets??

On the other hand, we have The Washington Post, which does a much better job of pondering why student loan defaults are dropping. IBR is part of it, as is slightly better job outcomes for graduates. It even concedes that college graduates are finding jobs that don’t require their degrees. Clearly the author has not gotten the memo on occupations.

Finally we have an article by … me. This very post you’re reading. Recently, the Department of Education released its fourth quarter report of total student loan volumes by institution. The slightly good news is that last year the aggregate disbursement fell below $100 billion.

Aggregate Federal Loans Disbursed (Current $)

The bulk (43 percent) of the $5.9 billion decline is in unsubsidized Stafford loans to undergraduates, and 37 percent were due to subsidized Stafford loans (which now go only to undergraduates). The rest (1/4th) is due to unsubsidized Staffords to graduate students. Grad PLUS loan disbursements grew by half a percent. Can’t win ’em all, I guess.

As for the amount disbursed per recipient (in current dollars, for loan limits aren’t inflation-adjusted and that’s the benchmark to measure changes against), most of the loan types saw negligible declines, indicating that either fewer people are taking out federal loans or fewer Americans are going to college.

Meanwhile, since the Internet tells us that Thomas Jefferson School of Law is in trouble, I figure it’s time to check in on those freestanding private law schools. TJSL isn’t alone, it just hasn’t managed to find a public university to socialize it yet (see WSJ, there’s your Social Security quip!). Western State fused into Argosy University two years ago, but I heard that was a long time coming. Texas Wesleyan is now Texas A&M, and some of the formers’ graduates want diplomas that say they went to the more reputable latter. Chalk one more up for the signaling hypothesis. Finally, the University of New Hampshire (formerly Franklin Pierce Law Center) is in fact now the University of New Hampshire. Go figure.

Oh, and how could I forget: Thomas M. Cooley is now affiliated with Western Michigan University.

I’ve heard rumors of other mergers going on among the FSP law schools, but that’s four that are adapting to the new world. TJSL just happens to be dealing with its fiscal problems by having a fiscal crisis.

There’s more to be said on this, but I figured I’d leave you with a chart comparing the average amount borrowed per recipient of federal loans at each of these law schools to their total costs for full-time students according to the Official Guide.

Average Amounts Borrowed Over Full-Time Costs at FSP Law Schools (2013-14)

I draw your attention to the fact that at none of these schools can a full-time law student cover his or her tuition with just unsubsidized Stafford loans. (Also, it seems that some law students are cleverly borrowing more than the annual loan limit allows. Hm.) At the average FSP law school last year, 87 percent of students took out Stafford loans; 70 percent borrowed Grad PLUS loans.

Fin.

PAYE for All!

From the Associated Press, “Obama to Announce Expansion of Student Loan Repayment Program.”

Obama on Monday will announce he’s expanding his “Pay As You Earn” program that lets borrowers pay no more than 10 percent of their monthly income in loan payments, the White House said. Currently, the program is only available to those who started borrowing after October 2007 and kept borrowing after October 2011. Obama plans to start allowing those who borrowed earlier to participate, potentially extending the benefit to millions more borrowers.

I didn’t realize Obama could do this via executive action, but there you have it. In fact, IBR was planned to transform into PAYE by 2014 by law all along. IBR as you’ve known it will be gone for good. RIP I guess.

“At a time when college has never been more important, it’s also never been more expensive,” Obama said in his weekly radio and Internet address released Saturday.

We can also expect a larger aggregate amount of student debt to be written off in the next couple of decades.

Obama also plans to announce he’s directing the government to renegotiate contracts with federal student loan servicers to encourage them to make it easier for borrowers to avoid defaulting on their loans. And he will ask the Treasury and Education departments to work with major tax preparers, including H&R Block and the makers of TurboTax, to increase awareness about tuition tax credits and flexible repayment options available to borrowers.

This is unobjectionable. Beyond that, though, the president voiced his support for Sen. Elizabeth Warren’s proposed student loan refinancing scheme, which would allow debtors to take advantage of the low overnight rates the Fed offers banks. Yes, it’s apples-to-oranges because student debts are paid within 10 years or more and not overnight, but it’s a little strange because the reason Congress abolished the guaranteed loan program under the Affordable Care Act was that it would use student loan repayments to pay for health care. With easily refinanced interest rates, that’s unlikely to happen.

The president will continue the push Tuesday in an online question-and-answer session hosted by Tumblr.

Maybe you can ask him how much student debt the OMB expects to be forgiven. I doubt it’s even pondered the question.

Senate Republican leader Mitch McConnell of Kentucky in a statement criticized the Democratic bill for failing to address college costs.

“This bill doesn’t make college more affordable, reduce the amount of money students will have to borrow, or do anything about the lack of jobs grads face in the Obama economy,” he said.

Pretty much.

CBO Projects Additional $1.3 Trillion in Student Loan Debt by 2024

…And that’s just the government loans.

Forget Erwin Chemerinsky’s and Carrie Menkel-Meadow’s NYT op-ed, the real news is the Congressional Budget Office’s baseline projection of the federal student loan program for FY 2014-2024. Notably, it thinks that over the next 11 years the government will lend out another $1.3 trillion in direct loans and that it’ll even make $1.10 per dollar lent. $115 billion of that will be Grad PLUS loans (9 percent).

Federal law requires the CBO to account for student loans by comparing the net present value of federal loans to investing in government debt. It doesn’t make a lick of sense, and the CBO would rather use fair-value accounting to evaluate the loan risk, so its hands are tied behind its back.

…But that doesn’t mean we can’t laugh at its absurd projections for Grad PLUS loans, about 30 percent of which go to ABA law school law students.

For one, the CBO believes that the government will make more than $1.30 on the dollar from Grad PLUS loans.

2014 Student Loan Baseline Projections (2)

(Click to Enlarge)

In the real world, most people who take out large balances of Grad PLUS loans will use IBR and then cancel their loans after 20 years. I’d be very surprised if non-law graduate and professional students counterbalance the losses the government will take on these loans. Another prediction I don’t think will pan out is the increase in the average amount borrowed and the number of borrowers.

The other fantasy is subtler: The CBO expects interest rates to spike over the next few years. By 2018, students will be borrowing at the maximum legal interest rates because either the economy will recover magnificently, or the bond vigilantes will finally come and stop lending the government money. (Then, of course, there would be a run on the dollar, export demand will spike, and we’ll return to full employment, but that’s off-topic.)

2014 Student Loan Baseline Projections (5)(Click to Enlarge)

If you do the math, on a 10-year repayment plan (which is used for calculating 20-year IBR monthly payments), law students entering today will pay a maximum additional 5.3 percent in interest for their 3L Grad PLUS loans over their 1L ones this fall. In other words, the CBO predicts law school’s costs will increase even as schools flatten or cut tuition.

I wonder if law professors writing op-eds agree.

GUEST POST—Don’t Go to Law School (Unless) (Flow Chart Edition)

(Connecticut attorney Samuel Browning obtained permission from Paul Campos to create a flow chart version of the book Don’t Go to Law School (Unless). Mr. Browning’s herculean effort is displayed here as a single graphic taken from his spreadsheet with only some proofreading on my part. I have not read the book, so any unclear points and errors are the author’s own.)

Browning--DGTLSU Flow Chart (2.0)

**********

CFPB’s Math on Student Loans Ain’t Pretty

Rohit Chopra, “A closer look at the trillion,” CFPB.

I’m not a fan of the three-year cohort default rate as the metric for the vitality of the student loan program. It’s about as unhelpful as the unemployment rate, which can hide people who left the labor force, are underemployed, left the jurisdiction, etc. Just as the definition of “unemployed” is slippery (like, any job search activity in the previous four weeks), so too is “default,” which is no payments whatsoever over the previous 270 days. The CFPB has released, to my recollection, the first ever breakdown of federal student loans by repayment status (billions of dollars):

In-school Grace Repayment Deferment Forbearance Default Other Total
Direct 133.8 (24%) 40.4 (7%) 237.4 (42%) 75.6 (13%) 48.3 (8%) 30.5 (5%) 3.2 (1%) 569.2 (100%)
FFEL 12.2 (3%) 6.6 (2%) 256.3 (60%) 46.5 (11%) 42.8 (10%) 58.8 (14%) 6.3 (1%) 429.5 (100%)

I get 30 percent of all federal student loan dollars in deferment, forbearance, or default. Only 49 percent of the total are in active repayment. I’d love to see a comparison to credit cards, but aside from class concerns, I think it’d tell us that the federal loan program has been a spectacular, embarrassing failure.

Here’s the same thing for borrowers (millions):

In-school Grace Repayment Deferment Forbearance Default Other Total
Direct 7.9 (28%) 1.9 (7%) 10.8 (39%) 3.2 (12%) 1.8 (6%) 2.1 (8%) 0.1 (0%) 27.8 (100%)
FFEL 0.9 (4%) 0.5 (2%) 12.9 (56%) 2.3 (10%) 1.6 (7%) 4.4 (19%) 0.3 (1%) 22.9 (100%)

I’m not going to do the same calculation because there’s certain to be some overlap between DLP and FFELP borrowers, but I direct your attention to the FFELP’s default rate: 19 percent. That’s a better long-term indicator of where the DLP is headed, and remember, once you’re in default, there is no IBR. People in those circumstances will have to negotiate with their lenders, but my guess is that debtors who are old enough can beg for mercy from bankruptcy judges (and federal court judges dealing with the inevitable appeals).

Another interesting factoid is that the average balance by repayment status table (omitted) shows that the average amount owed by people who are in default is less than $15,000 for both DLP loans and FFELP loans. I expected the figure to be much higher based on the belief that people would default when their loan balances are hopelessly high. It’s probably weighted-down by people who borrowed a small amount of money to go to a for-profit and then dropped out or couldn’t find a decent-paying job.

The CFPB also gives a table of repayment plan choices for direct loan borrowers (not FFELP):

Outstanding balance
Billions of dollars
Recipients
Millions of recipients
Average balance
Thousands of dollars
Standard 10-year plan 139.9 9.84 14.2
Plans based on income 72.3 1.58 45.8
Income-contingent repayment 20.1 0.63 31.9
Income-based repayment 50.9 0.91 55.9
Pay as you earn 1.3 0.04 32.5
Plans not based on income 107.4 3.35 32.1
Extended repayment 62.1 1.63 38.1
Graduated repayment 27.8 1.27 21.9
Extended graduated repayment 17.5 0.45 38.9
Other alternative repayment plan 4.4 0.23 19.1
Total of loans in these plans 324 15 21.6

Note that the average balance for the 910,000 people on IBR is $55,900. This is certainly a bellwether for law school debt and other graduate or professional school programs that rely heavily on Grad PLUS loans. Going forward, student loan debtors, including undergraduates, will be on the better-publicized PAYE, which will reduce the average amount borrowed.

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