As the presidential primaries rumble on, the candidates — especially Bernie Sanders and Hillary Clinton — have debated college affordability and Wall Street greed. Unfortunately, no one is confronting the links between the two.
More than 40 million Americans have student debt, totaling at least $1.2 trillion. On average, borrowers out of school owe $36,000, with a monthly payment of $680. Roughly 11 percent of borrowers are in default. Overall, indebtedness discourages people from starting degrees, families and businesses, dragging everyone down.
Or almost everyone. One person’s debt is another person’s asset. What some owe, others own. And student debtors don’t just cut checks to lenders. Our money flows to third parties — including investors.
One rarely discussed feature of the “student loan industrial complex” is the $200 billion market for student loan asset-backed securities (SLABS). This is a circular business, involving lenders like Sallie Mae and big banks like Wells Fargo and Bank of America. Like mortgages, student loans get pooled and repackaged into new financial products (securities). The lenders then sell the securities to investors. Investors receive the reward of monthly loan payments, plus interest. They can hold the securities themselves, trade them or bet on them. In turn, lenders receive quick cash, including fees and commissions, and push the risk of the underlying loans onto investors. This shift allows lenders to make more, and larger, loans.
In theory, more loans means the securitization process benefits borrowers.
But reality suggests otherwise. Student debt is special, as borrowers shoulder most consequences of non-payment. As such, SLABS players gain from an increasing supply of student debtors saddled with heavy, almost inescapable burdens.
Absent the most extreme circumstances, borrowers can’t declare bankruptcy and have their student loans forgiven like other debts. The threshold for relief is so high, and lawyers are so expensive, that fewer than 1,000 borrowers even try each year. For most loans, if borrowers don’t pay on time, the government can dip into wages, unemployment benefits, tax refunds and even Social Security checks. Unlike mortgage borrowers, who can hand over their keys and walk away, student debtors can’t return their diplomas. Overall, these constraints for borrowers make SLABS uniquely safe investments. As one corporate attorney explained in the Wall Street Journal last year, SLABS are attractive primarily because of harsh bankruptcy legislation.
Most SLABS investors also benefit from government insurance. From 1965 to 2010, both public and private lenders made loans with 97 to100 percent of their value insured by the federal government. Of the outstanding volume of SLABS, $160 billion worth (roughly 80 percent) are backed by these government-insured loans. This means even if borrowers default, and investors have to wait for their money, they’re still guaranteed to get it.
You’d think a surefire bailout would decrease resistance to debtor relief. But investors want timely payments; they fear federal relief programs might slow cash flow from an otherwise “bulletproof asset class.” This creates twisted incentives, especially for SLABS players involved in loan servicing: They often have a stake in borrowers defaulting rather than paying smaller amounts over a longer period of time.