The Most Unfortunate Comment Award to Date

The words seem so innocuous — “federally guaranteed student loans.” But what do they mean when someone actually defaults and the government has to make good on its guarantee? A recent article in The New York Times provides the answer.

A brief review of the business model

This post is the latest in what became my unintended series on the law school business model. It began with The Wall Street Journal’s misrepresentation in a lead op-ed piece. The Journal claimed that Congress made student loans non-dischargeable in 1976 because of widespread abuse. That is, graduates benefited from government loans and then declared bankruptcy on the eve of lucrative careers to avoid their debt. There’s no delicate way to put this: The WSJ was perpetuating a thirty-five-year-old myth.

Then I considered law schools that offer tuition discounts in the form of merit scholarships. There’s no mystery there: a secretive process of awarding money facilitates an individualized approach to pricing that maximizes tuition revenues while enhancing a school’s U.S. News ranking.

Most recently, I turned to yet another element of the current law school business model: raising the list price of tuition while reserving the flexibility to move lower as needed to attract particular candidates.

Follow the money

Now consider the source of all that tuition money. Some people are able to pay their own way, regardless of the cost. But they’re in the minority. Matt Leichter reports that the 44,000 law graduates in the class of 2010 took on $3.6 billion in debt, up sharply from $3.1 billion only two years earlier. The number is climbing as tuition goes up.

The chances that recent graduates will secure a job requiring a law degree are about 50-50. Although others will get non-legal jobs that pay reasonably well, the ranks of new lawyers with loans they can’t afford to repay is growing.

So what?

Students now have an income-based repayment (IBR) option for federal loans; that may afford some relief. But as Professor William Henderson explains in “The Law School Tuition Bubble,” two problems arise. First, dedicating fifteen percent of income for the requisite twenty-five years of a total IBR plan is akin to a permanent tax on the already low incomes of those lawyers. Forget about saving for retirement or funding their own kids’ higher education.

Second, those IBR participants who make it all the way to the end of the twenty-five years will have their remaining loan balances forgiven. That will add more debt that that the federal treasury will bear — for anyone who worries about such things.

Default

For recent graduates with limited job prospects, IBR is better than nothing. But some will default on their loans, just as their predecessors have. This poses no problem for law schools; they’ve already collected their tuition money and don’t have to return it.

Default poses no problem for lenders, either. That’s because educational debt is not dischargeable in bankruptcy, except in rare cases that satisfy the “undue hardship” requirement.

Moreover, the federal guarantee kicks in for private lenders, at which point the government foots the bill. But that’s not the end of the story. As the Times article explains, the newest growth industry is student loan debt collection. Last year, the government paid more than $1.4 billion to debt collection organizations it hired to track down student defaulters.

A Most Unfortunate Comment

For anyone who doubts that this is unapologetic intergenerational exploitation of the young by the old, consider these comments from Jerry Ashton, a consultant for the debt collection industry and the winner of the most Unfortunate Comment Award to date:

“As I wandered around the crowd of NYU students at their rally protesting student debt at the end of February [2011], I couldn’t believe the accumulated wealth they represented – for our industry. It was lip-smacking.”

Ashton included a photograph of several students to which he added these details: “a girl wearing a t-shirt emblazoned with the fine sum of $90,000, another with $65,000, a third with $20,000 and over there a really attractive $120,000 was printed on another shirt.”

Someday this will all come crashing down. I fear that people like Ashton — and merger/acquisitions specialist Mark Russell, who described student loans as the debt collection industry’s “new oil well” — will make money on that event. too. Shame on them. Shame on all of us.

WHEN FACTS GET IN THE WAY

Facts should matter, especially to newspaper editors. On July 25, The Wall Street Journal based its lead editorial on a factually incorrect premise. I happened to notice the Journal’s error because I’m writing a book about the legal profession’s current crises, one of which is exploding law school debt. But the WSJ blunder raises an important question: How often does the truth lose out to editors’ ideological convictions?

You Don’t Owe That” suggested that current bankruptcy law proposals to modify the impact of burdensome student loans would “reverse a hard lesson learned during the 1970s.” The editors claimed that provisions barring the discharge of educational loans in bankruptcy occurred “[a]fter a surge in former students declaring bankruptcy to avoid repaying their loans.” For that reason, the WSJ continued, “Congress acted to protect lenders beginning in 1977.”

Not true. There was no such 1970s surge. There was no empirical record of abuse to support the legislative change that began a 30-year slide down a slippery slope, culminating in an even more unfortunate 2005 amendment to the bankruptcy laws.

Perpetuating myths

Old misconceptions die hard. Prior to 1976, all educational debt was dischargeable. That year, Congress amended the Higher Education Act of 1965 to prohibit the discharge of federal educational loans until at least five years had passed since the beginning of the repayment period. Why?

More than 20 years ago, a thorough examination of what some critics characterized as a “loophole” that “allegedly allowed graduating students to discharge their loan obligations through bankruptcy on the eve of lucrative careers” was “more myth and media hype than reality.” More recently, the Congressional Research Service noted that the 1997 Bankruptcy Commission found “no evidence to support the assertion that when student loans were dischargeable the bankruptcy system was ‘systematically abused.’”

Fear and anecdotes — not facts or evidence — resulted in federal student loans joining the same bankruptcy category as child support, overdue taxes and criminal fines. Except for rare exceptions based on undue hardship, a person paid those debts or died, whichever came first.

Bipartisan blame

The Bankruptcy Reform Act of 1978 continued the new five-year rule, even though statistical analyses from the General Accounting Office and a House report confirmed that earlier claims of abuse were “virtually nonexistent.” In 1990, Congress and the first President Bush extended that period to seven years. In 1998, Congress and President Clinton decreed that debtors would never discharge their federal educational loans. In 2005, Congress and the second President Bush extended that protection to private lenders as well.

The recent Journal editorial worries about those private lenders. No one has been able to identify the author of the 2005 amendment giving financial institutions that huge break. It also gave them something else: a new incentive to lend money with less concern for how debtors would repay it.

Framing the question

The WSJ position seems somewhat paradoxical for the otherwise libertarian-leaning newspaper. On the one hand, personal responsibility is an easy argument to make when focusing on young people who incur debt: “They should be careful and make better choices.”

On the other hand, what entitles such students’ older, wiser and more knowledgeable bankers to put the government’s heavy thumb (in the form of granting special creditor status to lenders) on the scale?  For some law school graduates, the result is enormous educational debt for degrees that won’t lead to jobs necessary for repayment. Shouldn’t lenders feel the consequences of their poor decisions? Might everyone be better off if lenders sat down with pre-law students and asked them what they planned to do with their J.D. degrees before approving loans for tuition?

Moreover, from the debtor’s perspective, the underlying issue involves the exercise of a constitutional right. Against the backdrop of eighteenth century debtors’ prisons, the founders empowered Congress to enact uniform national bankruptcy laws so that a debtor didn’t risk losing all assets in one state only to be thrown in jail for not paying debts in another.

Accountability

Perhaps questions of accountability and personal responsibility turn on the characterization of the issue — and who should be accountable to whom. The Wall Street Journal is accountable to more than two million daily readers. Those readers assume the honesty of editors who include purported facts in an op-ed piece on important policy questions.

This time, readers got what an important newspaper’s editors would like the facts to be, instead of what they are. Even worse, most of them will never know it.

THE NEXT DEBT CRISIS

One of the next big bubbles is educational debt. A recent article in The New York Times notes that it exceeds one trillion dollars — more than total consumer credit card debt. Meanwhile, according to The Wall Street Journalthe Federal Reserve Bank of New York reports that for those aged 40 to 49, the percentage of educational debt on which no payment has been made for at least 90 days has risen to almost 12 percent. Sadly, history will view these as the good old days.

Middle-aged education debt blues

Growing delinquencies among middle-aged debtors result from two phenomena. First, some people took out loans for their own education, such as the 50-year-old who woman told the WSJ that she got her bachelor’s degree in 2008. The recession pushed many newly unemployed workers into higher education as a way of reinventing themselves. For some, the strategy worked.

A second group consists of parents who took out loans to fund their kids’ education. A related Department of Education program is, according to the Journal, “among the fastest-growing of the government’s education loan programs.”

Now extrapolate

For anyone who thinks this problem is bad now, wait until today’s twenty-somethings who went to law school and can’t get jobs reach their forties. Indiana University Maurer School of Law Professor William Henderson has analyzed the origins and long-run implications of current trends. His article with Rachel Zahorsky, “The Law School Bubble,” describes them in thoughtful detail.

Recent graduates in particular know where this is going because many are already there: Lots of debt — averaging $100,000 for recent classes — and limited prospects of employment with which to repay it. Meanwhile, the nation’s law schools are turning out more than twice the number of lawyers as there are law jobs.

The problem is growing, but so is denial. Recent headlines proclaimed that a drop in law school applications must be a sign that the market is self-correcting. After all, first-year enrollment fell by seven percent — from 52,500 in 2010 to 48,700 in 2011. Now for some context: The current number is about the same as total one-L enrollment was each year from 2002 to 2006.

How are law schools responding to this continuing crisis? Some better than others.

Law school reactions

Deans at George Washington University, Hastings and Northwestern recently announced that they were considering plans to reduce enrollments. Meanwhile, Thomas M. Cooley Law School opened a new campus in Tampa where it has signed up 104 students — double the number it initially expected. Last month the WSJ quoted Cooley’s Associate Dean James Robb, who said that the school “isn’t interested in reducing the size of its entering class on the basis of the perceived benefit to society.”

All right, let society take care of itself. But how about the school’s students? Two weeks after the Journal article, the ABA reported recent law school graduate employment data that, for the first time, refined one category of “employed” to include only jobs requiring a J.D. degree. For that group, Cooley’s “full-time long-term” rate for the class of 2011 nine months after graduation was 37.5%. Remarkably, more than two dozen law schools did even worse.

I wonder how those who run Cooley — and many other law schools — would feel if they had to bear the risk that some of their alumni might default on their educational loans. For now, we’ll never know because: 1) the federal government backs the vast majority of those loans, and 2) even bankruptcy can’t discharge them.

Meanwhile, a court recently dismissed Cooley alumni’s complaint alleging that the school’s employment statistics misled them into attending. The most revealing line of Senior Judge Gordon Quist’s ruling is the conclusion:

“The bottom line is that the statistics provided by Cooley and other law schools in a format required by the ABA were so vague and incomplete as to be meaningless and could not reasonably be relied upon.”

Too bad for those who did. In some ways, the profession is a terrible mess — and it’s just the beginning.

A PLUTOCRAT’S PITTANCE

Recently on ABC’s “This Week with George Stephanopoulos,” the usually thoughtful George Will practically jumped from his seat at the prospect that the interest rate on student loans might continue at 3.4 percent (based on a federal subsidy that President George W. Bush signed in 2007), rather than move up to 6.8 percent. He was — for him — apoplectic at the idea of creating what he was sure would become yet another “entitlement.”

Will opposes such relief because the average college student graduates with around $30,000 in loans and, over a lifetime of earning superiority over non-college graduates, he says, “that’s a pittance.” One man’s pittance is another man’s fortune, I guess. Then again, Will has a much different opinion about a slightly greater amount — $36,900 — when it’s the additional tax he’d pay on a million dollars of annual income if the Bush tax cuts expire.

But rather than search for consistency that can’t be found, put Will’s comment next to Mitt Romney’s related suggestion that young people should do everything they can to attend college, even “borrow from your parents.” If only all college-bound students had parents who could float them six-figure loans for however long it might take to repay them.

About those big salary differences

That leads to the point that Will sidestepped: repayment could take a while. Will’s “pittance” argument relies on studies showing that a college degree produces better lifetime earnings for those who obtain them. Historically, that’s been true. But it ignores what’s been happening to the newest college graduates. The NY Times recently reported  how unemployed graduates have been flocking to unpaid internships. Sadly, two years ago it ran a similar piece. Meanwhile, the Times also reports, they and their families are buried in debt.

Ultimately, many who get degrees will fare better than their non-degree counterparts. But at the moment there are more unemployed and underemployed recent college graduates than ever. Studies show that their delayed entry into the labor market will likely translate into huge lifetime earnings losses. As baby boomers defer retirement because the Great Recession wiped out their savings, the plight of young people worsens.

How about lawyers?

Among the most burdened in the youngest generation of debt holders are new attorneys. Their average law school debt exceeds $100,000 — and it’s climbing. So is their reported unemployment rate, especially now that law schools have to start disclosing the truth about their graduates. If you’re wondering why all of those students went to law school when there are legal jobs for, at most, half of them, deceptive deans have been a big contributor.

On their promotional websites, law schools routinely reported more than 90 percent of their graduates as employed. But they didn’t mention that the number included those with part-time jobs, non-lawyer positions (like working at Starbucks), or temporary employment by the law school itself for just long enough to count in their U.S. News ranking.

A compromise

Tavis Smiley responded to Will’s position with this: Wall Street bankers got zero-interest rate loans from the government; why can’t students get a break on theirs? That’s not a bad question. However, not all students need relief from their student loans. Families like the ones Mitt Romney had in mind sure don’t, but many others do. The Wall Street Journal recently profiled one — a 34-year old unemployed attorney with more than $200,000 in educational loans, mostly from law school:  “It’s a noose around my neck that I see no way out of.”

Here’s a compromise: get rid of the noose by returning to pre-1976 bankruptcy rules. In those days, any baby boomer who wanted out of even federal student loan debt could get it. Filing for bankruptcy was an extreme step and few did it. In fact, there was never empirical support for changing the rule. There was even less reason for the added protection against discharge that private lenders received in 2005 — a change that no legislator is currently willing to admit sponsoring.

Those who cry “moral hazard” should prove it — not simply list a theoretical parade of horribles that never happened under the old rule. If the bankruptcy option was good enough for baby boomers, it should be good enough for their kids.

DEBT, DECEPTION, AND THE ABA

The ABA kicked the can down the road again. When law schools classify their most recent graduates as “employed” in 2012, they still won’t have to disclose whether the jobs are part-time or require passing the bar. Anything and everything counts — which leads to this question:

Q: When are some law schools like for-profit colleges?

A: Every day.

Both groups are under increasing scrutiny for similar tactics. The Wall Street Journal doesn’t like the new efforts to hold for-profit colleges accountable. Recently, it used those initiatives to bludgeon a favored target:

“Where there’s money, there are trial lawyers…”

After the many WSJ articles about the rise of corporate big law’s multi-millionaires, such special disdain for greedy, non-corporate trial lawyers seems somewhat disingenuous. But I digress.

The editorial criticizes the government’s intervention in a whistleblower’s False Claims Act case against a for-profit college system and concludes with this non-sequitur:

“If the government thinks such schools are unfairly benefitting from federal subsidies, then it should cut off grants to all college students.”

Whoa, Nelly!

The Journal sidesteps the most important questions that the False Claims Act cases raise and that apply equally to many law schools: How do institutions of higher education recruit students and what happens after they sign up? When colleges are accused of “a boiler-room style sales culture,” it’s no answer to say “a recruiter’s job is to recruit.” Surely, the Journal‘s editorial board understands the importance of truthful information to the proper functioning of free markets.

For example, here’s information that for-profit colleges are loathe to emphasize: their student drop-out rate is over 50 percent. According to one report, only 38 percent graduate within six years (compared to 53 and 64 percent for public and private non-profit institutions, respectively). Another report of the ten largest for-profit schools puts their graduation rate at 22 percent.

Law schools don’t have those stunning drop-out rates, but two other criticisms apply to many of them:

Encouraging students to take on debt that can’t be repaid. Bloomberg News reports that for-profit colleges enroll 12 percent of all undergraduates, receive 25 percent of all student loan dollars, and account for almost half of all defaults. Only a day after its editorial, the Journal reported that the for-profit default rate had soared to 15 percent, compared to non-profit rates of 7.2 and 4.6 for public and private schools, respectively.

Ironically, the same edition running the editorial attacking efforts to increase for-profit college accountability also contained a small item on the front page: “Vital Signs” — a graph with this accompanying description:

“Americans are borrowing more for student loans. In July, consumers owed the government about $386 billion, largely for student loans, up from $139 billion two years earlier. However, during the same period of time, consumers pulled back on other types of borrowing, such as credit cards and loans for automobiles.” [emphasis supplied]

Evidently, a standard hot-button topic for the Journal‘s editors — “wealth redistribution” — isn’t so bad when the redistribution is from students to their schools.

Law schools? Almost half of their graduates incur more than $100,000 in educational loans. But the real tragedy that the ABA continues to facilitate involves ongoing deception about the prospects for getting jobs needed to repay them.

Misleading employment stats. For-profit schools’ recent battle over federal “gainful employment ” regulations mirrors the controversy over the way many law schools report employment data. Prospective students read about graduates who are “employed,” even though they’re performing tasks that don’t require the degrees that schools are trying to sell them. Likewise, law schools can call their graduates employed, even if they’re greeters at Wal-Mart.

Overwhelming educational debt is one of many terrible things happening to the next generation under the guise of “letting the markets decide” — however imperfect or distorted those markets may be. Whether for-profit or, like most law schools, run as if they were, educational institutions that pursue the myopic short-term mission of filling classrooms with tuition-paying bodies do their students a disservice. As the cycle of deception-debt-no jobs produces a bubble that is already beginning to burst, the resulting damage to the country will become increasingly obvious, too. Some of the “Occupy Wall Street” protesters are already making that abundantly clear.

DEBT LOADING

The University of Virginia Law School has offered its unemployed 3Ls stipends to defray the cost of bar application fees ($500) and bar exam prep courses ($1500). This follows a protest during admitted students weekend when some UVA students wore (and sold) T-shirts saying, “$40,000 a year and no jobs.” Of course, such public turmoil is the tip of a mammoth iceberg that isn’t limited to UVA.

The absence of jobs — even for graduates of top schools — is especially dire because repayment of educational loans typically begins when higher education ends. The collateral damage of such debt can persist for generations. As one analyst recently told the NY Times, “A lot of people will still be paying off their student loans when it’s time for their kids to go to college.” According to the same Times article, last year’s college graduates left school with $24,000 in debt.

For those moving on to law school, $24,000 soon looks like the good old days. The 2009 Law School Survey of Student Engagement reported this stunner:

“The percentage of full-time U.S. students expecting to graduate owing more than $120,000 is up notably in 2009…29% of students expect to graduate with this level of debt.” Almost half of all law students expect to cross the $100,000 debt threshold before getting their degrees.

Here’s the disconnect: according to the Bureau of Labor Statistics, the median salary for all lawyers nine months after graduation is $68,500. Try servicing $120,000+ debt on that budget. Average compensation for all attorneys in the United States is $129,000 a year.

Why the gap between investment and reward? A better question is, why not? The BLS numbers don’t appear in law school recruiting brochures that are more likely to tout big law’s $160,000 starting salaries. Nor do they disclose the downside that comes with those high-paying jobs.

Likewise, most schools don’t report meaningful employment data, either. When they collectively tell U.S. News that the most recent average employment rate nine months after graduation is 93%, something is amiss — like the fact that employed can mean being a greeter at Wal-Mart or flipping burgers at McDonald’s. In an insightful new article, Professor Paul Campos calculates the true rate — graduates with full-time legal jobs nine months out — to be well under 50%.

Revealing the truth would almost certainly drive down applications, compromise U.S. News rankings, and threaten law schools’ bottom lines. That might force many deans to reconsider what they’re doing to their own students. Too many administrators hide behind rhetoric — “free choice,” “markets work,” and “students should take personal responsibility” — as excuses to disregard their own roles as the profession’s most important fiduciaries. When ignorance and misinformation reign, choices are distorted and markets don’t work. I often wonder if law school deans who have kids the same age as those they’re duping behave differently from the rest. Or do they fault students’  “failure to take responsibility,” too?

My article, “Great Expectations Meet Painful Realities,” appearing in the current issue of the Seventh Circuit Bar Association’s semi-annual publication, Circuit Rider has more on this (starting at page 24).

Fraud can be overt — by commission — or it can occur by omission when there’s a duty to speak. Revealing good facts can create an obligation to disclose the bad ones. Greater candor won’t stop the flow of talented applicants to law schools. Nor should it. The legal profession is still a noble calling. But it has also become a way for some educational institutions improperly to persuade the next generation to mortgage its own future — literally.

Some call it the next big bubble. If it bursts, I’m not sure what that will mean. Because of statutory revisions in 2005, bankruptcy doesn’t discharge student loan debt unless the difficult “undue hardship” test is met. The era of big bailouts has passed, so that’s an unlikely solution as well.

Perhaps we’ll see a new growth industry in the revival of an ancient concept: debtors prisons. Law school deans who lost sight of their true obligations to their students and their profession should run them — without pay.