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The Economic Downturn and Student Loans: Some Practical Advice for Borrowers

Today's post is from Alan Michael Collinge, author of The Student Loan Scam: The Most Oppressive Debt in U.S. History—and How We Can Fight Back and founder of StudentLoanJustice.Org, a grassroots organization, and political action committee.

Book Cover for The Student Loan Scam, links to Beacon Press page for book Student loan companies will soon be lined up at the Federal Treasury, seeking loans against bundles of high interest, private loans that they made to students, often with their parents as co-signors. Meanwhile, hundreds of thousands of students and their families see their livelihoods wracked by student loans in ways worse, even, than defaulting home mortgage borrowers. As we progress through this economic downturn, there is a strong potential for increased predatory activities by the student lending industry, and borrowers need to be prepared to take extra steps to protect themselves.

A bit of history: federally guaranteed student loans have been largely impossible to discharge in bankruptcy for the past decade. The federal guarantee on these loans was used as the reason for removing this basic protection. It was a very weak argument—no other loans, federally guaranteed or not, have special exemptions from bankruptcy protections. In practice, this unique lack of bankruptcy protection has given the green light to lenders to attach penalties and fees onto debt without fear of the borrower. The largest lender in the country, Sallie Mae, saw its fee income increase by 228% between 2000-2005 (its loan portfolio grew by only 87% during this time), and their CEO bragged to shareholders in their 2003 annual report that their record earnings that year were attributable to collections on defaulted loans. So, no bankruptcy protection for the borrower means free money for the lenders, and lots of it!

Removing bankruptcy and other protections from federal loans wasn't enough for the student loan industry, however: in 2005, student loan giants Sallie Mae, Citibank, and others lobbied Congress successfully to remove bankruptcy protections, as part of the 2005 Bankruptcy Bill, for private student loans as well. No one seems to be able to find out who inserted this language into the bill—no Congressman can be found who is willing to claim credit. Nonetheless, it happened. That the student loan companies were able to get this passed was shocking to unbiased experts and analysts of this industry.

The student loan companies claimed at the time that by eliminating bankruptcy options for borrowers, the industry would be able to make loans to people with lower credit scores. After passage of the bill, however, it was shown conclusively that lenders did not follow through on their promise. Students with low or marginal credit scores received loans at roughly the same rate as before the legislation was passed.

What the industry did do was pile as much of this private loan debt on the students as possible, often with credit card-like interest rates, and at hugely unfavorable terms (Bethany McLean at Fortune Magazine, for example, found a student who had been stuck with a 28% annual percentage rate).

Unlike home mortgage borrowers, who at least have standard bankruptcy protections on their side as a worst, last option, student loan debtors are stuck with principal, interest, and massive penalties and fees. Students across the country are discovering, typically after the fact, that they've been paralyzed by an insurmountable debt, often with interest that exceeds their monthly earnings. Co-signing parents and other relatives forced to step in sometimes must liquidate the equity in their homes in order to pay.

The Student Loan lobbying machine has been very successful in putting down attempts to reverse this ridiculous legislation, most notably efforts led by Sen. Dick Durbin (D-IL), and Rep. Danny Davis (D-IL). In a leaked Sallie Mae strategy memo from 2006, the second priority listed was to "protect private credit economics (including bankruptcy)." Even with a new Congress in 2007, the industry was somehow able to convince the Blue Dog Democrats to kill the Davis legislation.

Academia has been largely unwilling to speak out for the borrowers on the bankruptcy issue, as their financial interests lie with the lenders. Student loans are again being called upon to make up for budget shortfalls—this time, owing to large endowment losses. Tuition at our nation's colleges continues to increase dramatically, even as the economy slows.

The Fed's bailout action potentially lays the groundwork for the promulgation of bad lending onto a new generation of borrowers unless Congress acts swiftly to protect them. Come January 20, President Obama should work with the new Congress to immediately reinstate bankruptcy protections for private student loans. The bailout loans will be given "haircuts" that will serve to mitigate taxpayer losses on these assets, and the lending industry will have to make do with this basic consumer protection. Of equal importance is the need for the next Congress and presidential administration to work towards the reinstatement of a much broader set of consumer protections for federally guaranteed loans.

I urge those now in repayment on their loans to be very vigilant. The name of the game in the student loan industry is in attaching every penalty and fee possible onto delinquent and defaulted debt, and we can expect this trend to only intensify during times of economic uncertainty. For federal loans, the industry actually has a perverse incentive to default loans in many instances, and borrowers should guard against this at all costs. For example, don't assume that deferment and forbearance requests will be acknowledged by the lenders without contacting them personally to verify receipt. Also, make sure that your payments are posted in a timely fashion by your lender, and that you aren't hit with late fees that can persist for months after a later payment (another clever ploy by the industry). We may be hopeful for change in the form of meaningful legislative action, but in the meantime, students, former students, and their co-signors will have to fend for themselves.

You might also be interested in Nan Mooney's post about weathering the financial storm or Victor Tan Chen's post on Obamanomics for the missing class. You can also join the Student Loan Scam Facebook group.