A Brief History of Student Loans

Whether you agree or disagree with student loan debt forgiveness matters not to me. I just think people should know what caused it. The cause is federal legislation gone wrong, on purpose, once again.?

Back in 2010, the US Government, by way of legislation tied to Obamacare known as the Health Care and Education Reconciliation Act of 2010 nationalized and took over the student loan industry. The US Government now holds over 90 percent of all student loans.

Our federal government has long been involved in the student loan process with most all significant legislation coming after the end of WWII.

Modern student lending really all started in 1972 when the Student Loan Marketing Association (Sallie Mae) was established by Congressional lawmakers. It was designed to provide liquidity to banks for the student loan market by guaranteeing student loans and then serving as servicer and collector.?

The process worked in similar fashion as guaranteed Small Business Administration (SBA) loans, FHA, and VA home loans and selling those originated loans made under exacting underwriting guidelines to the appropriate upstream government agency like the SBA for the small business loans and FHLMC, FNMA, or GNMA for home loans.

Banks would originate the loan following government set standards and guidelines and sell the guaranteed loan to the federal government preserving their liquidity. Colleges and universities prospered under this model.

Twenty years later in 1992 somebody got the bright idea that the federal government should become a direct lender of student loans.?This was conceived as part of a deficit reduction scheme because being a direct lender would cut out the middleman expense. That middleman being cut out would be the banks. A pilot program of direct lending began.

Both the traditional guaranteed student loan program and the 18-year pilot direct from the government student loan program operated in parallel until 2010. That’s when the guaranteed lending program ended for all new loans due to Obamacare related legislation referred to above.

The deficit reduction scheme was justified because the Congressional Budget Office determined that switching to direct lending would save $62 billion over 10 years.

This also eliminated countless of non-bank organizations that were chartered, sometimes as not- for-profit organizations, to assist students seeking loans for college. Students were counseled and guided in the process as to the importance of timeliness of paying their loans after college including credit counseling and the dangers to them in the event of defaulting on their student loans.

These organizations also served as collectors for the federal government.

Banks were allowed to participate in this by buying very short-term, low risk, and liquid participations of student loans and were paid back when the government funded the loans.

And so, it began…a period of easy money not unlike the housing easy money that crashed the housing market. Students could go to any college, community college, university, whatever, apply for student loans without regard to consequences.

Not only did students eat this up, colleges and universities found themselves a cash cow and exploited the situation without regard to the future financial well-being of their students.

My wife witnessed this firsthand when we lived in Arizona. She took a job teaching criminal justice at a for-profit community college. Students would apply for a student loan at the college, be approved rapidly and the proceeds all went directly to the college. The college also provided cool things like laptop computers as part of that loan.

However, there was no accountability or checking of student’s backgrounds for specific courses of study. For example, students would enroll in criminal justice courses with the goal of becoming a policeman or something in law enforcement after graduation. The problem being is that the college was not allowed to ask about criminal records. My wife had many students with felony criminal records that even with their new criminal justice degree would never be allowed in law enforcement.

It is unfair of me to insinuate that all colleges and universities did this. I suspect it was rampant to those colleges and universities that recognized a cash cow when they saw one and exploited the situation.

Another compelling illusion for the complete transition to direct lending was a mistaken concern of limited borrowing opportunities due to periodic and tightening credit around the time of what is now known as the Great Recession.

Since there was a banking crisis going on during the Great Recession, the number of lenders of guaranteed student loans declined by well over 60%. Legislators and their analysts determined that switching the entire system to federal government direct lending would ensure student loans would never again be at risk.

That decision was still made in the face of no actual evidence that students seeking loans lacked access to lenders before or even during the Great Recession. Even though the reduced number of lending institutions, the bank liquidity crisis of The Great Recession, student loans, just like guaranteed mortgage loans, the government, by way of the Department of Education purchased those loans to enable private lenders to continue offering credit either directly to students or through organizations that helped students navigate the process.

Here is what really happened, and I refer to it above. The federal government was just too easy to take money from. Switching to direct lending created greater, easier, and more favorable access and more favorable terms for student borrowers. This included easy repayment plans and easier better terms for loan forgiveness.

Just like the subprime lending practices for home loans, students were highly incentivized to borrow and even borrow more than they should have.

And their college or university profited greatly from it. Colleges and universities quickly embraced to whole program. Money was flooding into their coffers. Their endowment funds became even larger. For profit colleges and universities also proliferated.

And just like that, the federal government became the borrower of choice. Borrowing money to go to college became frictionless.

Just like during the housing crisis from The Big Short, the requirements the federal government places on banks as to credit quality and loan counseling were eliminated. Students did not understand the financial obligation they were taking on nor did they question anything. They just wanted to go to school.

One final fact about the government’s direct lending. The government gave itself the ability to provide relief to student borrowers of its direct lending program. We saw this with the pausing of interest rates and payments during the great covid-19 pandemic and now with the ongoing argument of total loan forgiveness. Student loans made to those under the old, guaranteed student loan programs do not qualify for this kind of relief.

If I dug deep enough, I am quite confident that the projected savings never materialized, and the expense of the program skyrocketed.

Unlike my knowledge of the history of recent banking crises, I am not sure of the real impetus behind the government taking over the student loan business. I am quite confident though that there was some serious lobbying going on in the background for some very self-serving interests.

We are always told that the legislation is well-intended. When it goes bad, not as promised, or even has unintended consequences, we no longer remember the original intention and then wonder why there is more political drama.

That drama distracts from the cause of the problem. Nobody in or outside government will step up say what happened nor address the complete lack of responsibility and accountability on the part of a lot of people in and outside government.

I am reminded of Grey’s Corollary to Clarke’s Third Law – Any sufficiently advanced incompetence is indistinguishable from malice.