Private Loans

Last week, we identified our favorite and least favorite provisions in the mammoth Higher Education Act reauthorization legislation that Congress overwhelmingly approved on Thursday. Neither list, however, included sections of the bill that target the types of "pay for play" conflicts of interest in the student loan programs that Higher Ed Watch helped expose last year. That's because, frankly, we had mixed feelings about the provisions.

The legislation certainly takes some positive steps to safeguard students. It, for example, bars colleges from entering into revenue-sharing arrangements, in which colleges get a cut of each loan their students take out. Colleges are also forbidden from entering into "opportunity loan" deals with lenders -- arrangements in which loan companies waive or loosen credit requirements on private student loans in exchange for becoming the exclusive provider of Federal Family Education Loans (FFEL) on a campus.

The legislation also prohibits colleges from allowing lenders to staff their financial aid offices or to run the call centers that students depend upon to answer their questions about student aid. And it forbids schools from assigning first-time borrowers' federal loans to a particular lender through award packaging or other methods. This should put a stop to some colleges' particularly deceptive practice of providing pre-filled out master promissory notes to incoming students in order to shepherd them toward favored lenders.

By Ben Miller, Stephen Burd, and Sara Mead

A decade after its last reauthorization and five years since an updated version was due, a new version of the Higher Education Act is finally ready for Congressional passage. With both chambers set to vote on the bill this week, Higher Ed Watch will take a closer look at various parts of the legislation over the next two days. Today, we praise lawmakers for doing the following:

• Putting Teeth Into Loan Auctions

Last year, Congress created a groundbreaking pilot auction program that uses market forces to set student loan subsidy rates for lenders making federal PLUS loans to parents and graduate students. With about a year left to enact the pilot project, lawmakers have added penalties for lenders who win an auction and then back out. The bill allows the Education Secretary to punish lenders that violate the terms of the auction agreement by one of the following methods: fining the lender for any additional costs needed to find and subsidize a replacement PLUS loan lender; banning the offending lender from future auctions; or, kicking them out of the Federal Family Education Loan (FFEL) program entirely. We particularly like the fact that the Secretary can retrieve the fine by reducing subsidies paid to the lenders on other FFEL loans or having another federal agency garnish other subsidies the lender might receive. While we have some complaints about the language (it doesn't, for example, address the PLUS loan auction bidding cap, which needs to be more flexible to encourage robust bidding in a range of financial market conditions), overall, we believe that this provision is an important step forward in getting this pilot program off the ground.

Yesterday, Sen. Barack Obama (D-Ill.) unveiled plans to rewrite federal bankruptcy laws to make it easier for financially-strapped senior citizens, military families, and individuals suffering medical emergencies to get relief from debilitating debts. While we are pleased that the presumptive Democratic presidential nominee is proposing to overhaul the 2005 bankruptcy bill, which was a glaring example of politicians putting corporate interests over regular people, we urge him not to forget another group who desperately needs help -- borrowers who have taken on unmanageable levels of private student debt and now find themselves in severe financial distress.

As we have noted previously, Congress tucked a provision into that bankruptcy bill making it extremely difficult for borrowers to discharge private student loans. That special provision was added in a secret conference committee, without any public debate or notice.

For most unsecured debt, a borrower who runs into difficulty can file for Chapter 7 liquidation or Chapter 13 reorganization, so a judge can sort out the appropriate treatment of various loans. But there is a short list of debts that the law subjects to a different status, allowing discharge in only the most extreme circumstances. The government, for example, makes it nearly impossible for people to escape child support responsibilities, overdue taxes, and criminal fines.

Federal student loans also can't be discharged. There's at least some justification for providing federal loans that status since they are backed by taxpayer dollars and come with borrower protections in cases of economic hardship, unemployment, death, and disability. But there is no good reason for private loans to be accorded the harshest bankruptcy status.

For a long time we have known that KeyBank has played a leading role in aiding and abetting the efforts of sham for-profit trade schools to scam vulnerable students. What we didn't realize, however, was the integral role that KeyBank played in fueling the growth of Silver State Helicopters, an unlicensed and unaccredited Nevada-based flight-school chain that left its 2,500 students in the lurch when it shut its doors without warning on Super Bowl Sunday and filed for bankruptcy liquidation. Most of these students are now stuck having to repay nearly $70,000 in high-cost private loan debt for training they did not receive.

Thanks to a class-action lawsuit filed by several former Silver State students in California, we recently learned that KeyBank was Silver State's exclusive private student loan provider from 2002 to 2005, a time when the flight-school chain grew by "an astounding 2,786 percent." KeyBank appears to have severed its ties to Silver State in 2005, forcing the flight-school chain to find other lenders to provide private loan funds to its students. As we previously reported, Silver State then forged an exclusive arrangement with the infamous Student Loan Xpress and the Pennsylvania Higher Education Assistance Agency (PHEAA), to make and service the loans.

At Higher Ed Watch, we hear regularly from financially-distressed borrowers with private student loans who believe they have been victimized by lenders' predatory practices. Much of that feedback comes in the way comments we continue to receive on blog posts that ran more than a year ago.

At a time when the federal government is providing a major bailout of the student loan industry, we think it is important to highlight the experiences of borrowers who are struggling with unmanageable levels of high-cost, private student loan debt. Surely borrowers such as these could use a helping hand too.

The Career College Association continues to breathlessly proclaim that the decision by some major lenders to stop providing subprime private loans to students attending for-profit trade schools of dubious quality is leading to a major college access crisis.

"In career colleges across the country, college plans are coming unraveled," Harris Miller, the association's president wrote in a recent column in the newspaper Politico. "The academic equivalent of foreclose signs are going up across the land."

Sounds scary. But if you listen to what the leaders of some of the largest chains of for-profit higher education companies are telling investors, you get an entirely different story.

For months, some trade school chains, such as Capella University, Devry Inc., Strayer College, and the University of Phoenix, have been going out of their way to assure Wall Street that the credit crunch has had little to no effect on students attending their institutions. "We are really not seeing any impact on our business," Stephen Shank, Capella's chief executive officer, told The New York Times in February.

We have written a lot recently about Silver State Helicopters, a Nevada-based company that left the 2,500 students who attended its flight academies in the lurch when it shut its doors without warning on Super Bowl Sunday and filed for bankruptcy liquidation.

As we noted yesterday, Silver States' entire existence depended on the willingness of loan companies -- in this case, the infamous Student Loan Xpress and the Pennsylvania Higher Education Assistance Agency (PHEAA) through its national brand American Education Services -- to make and service high-cost private loans to help students cover the $70,000 cost that they were required to pay up front to attend the unlicensed and unaccredited flight schools. Unfortunately, Silver State students are now stuck repaying these private loans for training they did not ultimately receive.

Silver State is hardly an isolated case.

With calls from student loan providers for a bailout growing louder every day, it's worth remembering that the lenders have brought a good part of these problems onto themselves. Investors are wary of purchasing student loan asset back securities, and, and least when it comes to those made up of private loans, they have good reason. Lenders have dumped lots of bad loans made to subprime borrowers going to dubious schools onto the marketplace, knowing full well that much of this debt was likely to go into default.

Case in point: as we noted last week, there has been in recent years a proliferation of unlicensed, unaccredited trade schools that do not participate in the federal student aid programs and therefore go largely unregulated. The growth of these schools of dubious quality has been fueled by student loan companies that have willingly and irresponsibly "partnered" with these institutions to provide high-cost private loans to often at-risk students that these schools tend to attract. The lenders have then turned around and, like subprime mortgage lenders, securitized the loans, shifting the risk of the loans onto unsuspecting investors.

After Tuesday's surprisingly one-sided hearing before the Senate Banking Committee on the credit crunch, it's clear that Congress is prepared to take steps to add liquidity to the student loan marketplace. But as lawmakers move forward with plans to bailout student loan giants like Sallie Mae, they shouldn't forget about the financially-distressed borrowers who have been victimized by the lenders' predatory private loan practices. Surely, they deserve a helping hand too.

Over the last two years, we at Higher Ed Watch have written extensively about how loan companies' aggressive marketing practices and cozy relationships with colleges have pushed students to take on unnecessarily high levels of expensive private student-loan debt, often before they have exhausted their lower-cost federal loan eligibility. In fact, at least one in five private student loan borrowers take out a private loan before they exhaust safer, cheaper federal Stafford loan options.

If you want to know the dangers of taking out private student loans, just ask the 2,500 students who were, until early this year, enrolled at flight academies across the country owned by Silver State Helicopters.

As recounted by The San Diego Union-Tribune, these students were "left in the lurch" when the Nevada-based company, without warning, shut its doors on Super Bowl Sunday and filed for bankruptcy liquidation. Because the schools did not have the proper accreditation to qualify to participate in the federal student aid programs, the company directed students to take out high-cost private student loans to cover the $70,000 tuition that they were required to pay up front. Unfortunately, these students may be stuck repaying these loans for training they did not ultimately receive.