ANOTHER SHOT AT STUDENT LOAN DEBT

A recent Department of Education initiative has not attracted the public attention that it deserves. But it could have important implications for the federal loans that fuel higher education, including law schools. The Department seeks to create a framework for dealing with the thousands of students who recently filed “defense of repayment” claims.

The Wall Street Journal’s recent summary of the program could strike fear in the hearts of many law school deans and university administrators:

“In the past six months, 7,500 borrowers owing approximately $164 million have applied to have their student debt expunged under an obscure federal law that had been applied in only three instances before last year. The law forgives debt for borrowers who prove their schools used illegal tactics to recruit them, such as lying about their graduates’ earnings.”

But it could get even worse for the schools, as the Journal explains:

“Last week, the department began a months-long negotiation with representatives, schools and lenders to set clear rules, including when the department can go after institutions to claw back tuition money funded by student loans.”

Will the Department’s latest effort to impose meaningful accountability on institutions of higher education fare any better than predecessor techniques that have failed? There have been too many of those.

Lawsuits Haven’t Worked

Law schools have become poster children for the accountability problem and ineffectual efforts to solve it. In 2012 some recent alumni sued their law schools, but they didn’t get very far. The vast majority of courts threw out claims that the schools had misrepresented graduates’ employment opportunities. The winners on motions to dismiss or summary judgment included Thomas M. Cooley (now Western Michigan University Cooley School of Law), Florida Coastal, New York Law School (not to be confused with NYU), DePaul, IIT Chicago-Kent, and John Marshall (Chicago), among others.

Judge Melvin Schweitzer’s March 21, 2012 ruling in favor or New York Law School set a tone that other courts followed: Prospective students “seriously considering law school are a sophisticated subset of education consumers…” In other words, they should have known better. That might be true today, but at the time Judge Schweitzer wrote his opinion, he was wrong. So were the courts who followed his rationale to reach similar results. At a minimum, there were serious factual disputes concerning his conclusory assessment of an entire cohort of prelaw students.

In particular, the plaintiffs in the New York Law School case graduated between 2005 and 2010. Back in 2002 through 2007 — when those undergraduates were contemplating law school — NYLS claimed a 90 to 92 percent employment rate for its most recent graduating classes. But that stratospheric number resulted only because all law schools counted any job for purposes of classifying a graduate as “employed.” A part-time worker in a temporary non-JD-required position counted the same as an assistant U.S. attorney or a first-year associate in a big firm. Only after 2011 did the ABA finally require schools to provide meaningful data about their recent graduates’ actual employment results.

A notable exception to the dismissal of the cases against the law schools was one of the first-filed actions, Alaburda v. Thomas Jefferson School of Law, which is set for trial in March 2016. In that case, Judge Joel Pressman correctly found that a jury should decide the clearly disputed issues of fact. He got it right, but he’s an outlier.

The ABA and the AALS Haven’t Helped

Anyone expecting the profession to put its own house in order continues to wait. The changes requiring greater law school transparency in employment outcomes came about only because the public outcry became overwhelming and Congress threatened to involve itself. When political opposites such as Senators Dianne Feinstein (D-CA) and Chuck Grassley (R-IA) agree to gang up on you, it’s time to wake up.

Since then, the organization has returned to form as a model of regulatory capture. Twice in the last four years, it has punted on the problem of marginal law schools that survive on student loan debt. School that would have closed long ago if forced to operate in a real market continue to exist only because the legal education market is dysfunctional. That is, the suppliers — law schools — have no accountability for their product — far too many graduates who are unable to obtain full-time long-term JD-required employment after incurring the six-figure debt for their degrees.

And while we’re on the subject of regulatory capture, the current president of the AALS has now declared that there is no crisis in legal education. Her interview produced an article titled, “As Law Professors Convene, New Leader Looks to Unite the Profession.” Why all law schools should unite to protect marginal bottom-feeders exploiting the next generation of students remains a question that no one in the academic world is willing to ask, much less answer.

Now Comes the Fun Part

Ignoring problems does not make them go away. As the profession refuses to acknowledge a bad situation, it loses the opportunity to influence the discussion. Which takes us to the recent Department of Education activity relating to criteria for applying the burgeoning volume of “defense of repayment” applications.

Special interests are likely to resist meaningful change. From institutions of higher education to debt collectors who have made student loan debt collection a multi-billion dollar business, lobbyists will swamp the process. Still, attention seems assured for marginal schools exploiting a dysfunctional market. That’s a good thing.

As the disinfecting qualities of sunlight intensify, someday the ABA and the AALS may realize that an old adage is apt: If you’re not part of the solution, you’re part of the problem. Perhaps another round of bipartisan congressional interest will help them see the light.

10 thoughts on “ANOTHER SHOT AT STUDENT LOAN DEBT

  1. As a new adjunct professor who talks to a lot with students about jobs, and a former regional managing partner of a national law firm who hired a lot of lawyers and a finance lawyer, this student debt situation has always intrigued me. A lot of debt is securitized through structured finance transactions. And it kind of reminds me of subprime loans. Debt from some of the schools who have poor real graduation rates (and high default rates) should be put in a higher yield trust which pays higher interest rates on its tranches AND be purchased from the schools at a greater discount. Schools with high real graduation rates (lower default rates) could be placed in lower risk, lower interest, lower discount trusts for investors. Why should the student debt which has been securitized be expunged? Why not let the lenders have a clawback against the schools (not the students) which have placed the defaulted debt. And if the kids have defaulted, let them have a cause of action or counter claim against the school, especially the private schools which have no gov’t immunity. So let the market place determine the financing? I know this is somewhat sophomoric but perhaps the market place in part can determine it better than gov’t.

    • @Bob,

      Since 2010, graduate students can finance 100% of their cost of graduate education directly through the Department of Education. No private loans, no securitization (Student Loan Asset-Backed Securities). Of course, there is every indication that private lenders are salivating to recapture the lucrative graduate & professional student segment of the student loan market. Demand for private SLABS (as opposed to older FFEL SLABS) is growing. And the ABA accredited law schools themselves actually own a (non-profit) private student lender, Access Group. Seriously.

      I like your ideas re: clawback on the schools and cause of action. Law schools need skin in the game.

    • Bob and Steven, Even graduated lawyers who have had some probability and statistics are not likely to consider the probability models applied by actuarial scientists using portfolio theory. Since markets did not make student loans absent government guarantees and favorable treatment in bankruptcy the historical and statistical evidence should show that student loan portfolios are not sound on an actuarial basis. This means sophisticated investors and loan portfolio managers expect a net loss on any large pool of loans where interest rates cannot go high enough to offset the expected loss. I make this case in my paper on SSRN, How Honest But Unfortunate Student Borrowers Became Scapegoats in Bankruptcy: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2508974.

      When Congress formed Sallie Mae (SLMA) around 1973 it was to provide liquidity in the student loan markets in addition to the creditor cash flow guarantees that had been created by Congress over the period 1965-1969. SLMA effectively had a line of credit to Treasury via the Federal Finance Bank (FFB) so its liabilities were subsidized while its assets were guaranteed by ED. As I’m sure you know in a pure private scheme the default loss is an expense that reduces the growth rate of capital in a sound portfolio but which would result in a persistent net loss or drain of capital in an unsound portfolio, so private markets should not generate unsound loan portfolios. When SLMA purchased student loans from lenders and a loan would default then SLMA collected from ED on the default claim and ED put the defaulted loan on its books similar to a direct loan. If ED writes off a defaulted loan or direct loan it has no capital to expense, so the net worth of the government goes down, and ED incurs debt to Treasury inside the govt. To make it appear that ED is not in perpetual debt to Treasury it must impose charges on defaulted loans, inflating the collection balance, and not allow defaulted borrowers to obtain a write-off. Apparently the politics of Congress do not permit a tax to cover the loss at ED so honest but unfortunate student borrowers and sometimes their extended families became scapegoats in bankruptcy.

      • “Since markets did not make student loans absent government guarantees ”

        Ah, but they did. Do not conflate FFEL loans (loans with government guarantees) with private loans (loans with no government guarantees). Or to put it another way, the FFEL program has been dead for more than half a decade. Sallie Mae still originated ~$4.3 billion in private student loans last year. From what I have read in the financial press, the asset-backed securities made from private loans are more desirable at the moment than the FFEL asset-backed securities, since many FFEL loan holders are now on an income-based repayment plan like IBR or PSLF and that is reducing the revenue stream to investors.

      • Anyone who wants to understand how honest but unfortunate student borrowers became scapegoats in bankruptcy can read my paper on the subject and also do a keyword search “Lessons Learned from the Privatization of Sallie Mae.” One of the lessons learned is that Sallie Mae had government subsidies on both sides of its balance sheet and pioneered the SLABS industry in the 1990s. If one goes back to 1957, the Soviets launched Sputnik satelites, and governments in the United States sought to increase finance for higher education, because, apparently, communism would beat capitalism in technology development and growth of human capital if the governments did not arrange finances for education. Markets like to “cherry pick” the human capital after it is paid for either via taxes or increasing the float of government insured savings accounts which include Treasury securities sold to finance direct federal loans or to repay loan guarantees. I agree since the 1990s private loans have exploded in part because an executive can make a fortune without any claw back of compensation if the portfolio explodes on someone else in the future or after “passing the trash” to some other investors.

  2. Prospective students “seriously considering law school are a sophisticated subset of education consumers…”

    I dated one of these so called “sophisticated” consumers. She had ADHD, was on a steady diet of amphetamines, drank a bottle of cheap wine every night, couldn’t pay her bills on time and for the love of God could not understand why the world was conspiring against her. Could never hold a steady relationship, and after $160,000 in student loans and “higher education”, she finally decided that becoming a prostitute was her best option. Sophisticated my ass.

  3. What intrigues me, in the various Court’s analyses, is the (unintended?) implication that students who were scammed by technical colleges, trade colleges, chef schools, etc. are therefore “unsophisticated consumers” deserving of protection. The law has rallied to the side of these students, whose schools were engaging in the EXACT SAME PRACTICES as law schools.

    It is difficult, however, to be a dispassionate, third-party observer when the case hits too close to home – even for Judges. Human nature, I guess.

  4. “Schools that would have closed long ago if forced to operate in a real market continue to exist only because the legal education market is dysfunctional. ”

    I must disagree. Let’s not forget that unlimited federal GradPLUS have only been around since 2006. Law school tuition got out of hand long before that, and it was wild west lending standards in the private student lending industry (let’s also not forget that these loans had bankruptcy protections until nearly the end of 2005). The catalyst, just like it was in mortgages, was rolling these private loans into asset-backed securities, selling them – in doing so taking the risk off your books – and then generally getting a nice contract from the purchasers to service them. Even despite GradPLUS coming along, private loan originations exploded after bankruptcy protections were taken away, because now those securities were much more appealing to investors. Inescapable debts and all that.

    The point is nothing has happened in the interim that would make private lenders like Sallie Mae wary of throwing $100k or $200k to anyone to attend any law school. Nondischargeability + securitization + the ABA-accredited law schools OWN a private student lender (Access) = absolutely no need for due diligence.

    • Fair points. But I would say we actually agree because you’ve identified some of the ways that the legal education market is dysfunctional — i.e., no law school accountability for poor graduate employment outcomes. That is the result, in large part, of non-dischargability of any student loan debt in bankruptcy and federal guarantees. If law schools had to worry about unemployed grads filing clawback actions and could not hide behind non-dischargeability and federal guarantees, I think their risk calculus would be different.

      • Sadly, such consequences for law schools would be unlikely even if Democrats hold the presidency, retake Congress, and pack the USSC.

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