27 September 2017 NEWSLETTER
Education opens many doors, they say. Some doors are already unlocked, some take time, some may be even opened for you, but all of them result in thunderous applause, a piece of paper and a once-worn toga. And in some particular doors, that you can not entirely close behind you, there is something stuck keeps you from leaving the alumni days in the past: student loans.
The issue of student loans and its burden on the pockets of tax-payers became a central issue of the US presidential campaign. The matter of federal and private loans devoted to education is a Damocles’ sword over the Treasury, with figures that can not help but alarm the new administration.
In Italy, the issue of student loans is rarely mentioned. Why? Every year many Italian university students decide to leave their studies prematurely: scarce job opportunities and unappealing courses are just few among the reasons that push the students to leave. 7% of the enrolled students abandons the courses within the first year, while the 19% decides to search for a job after three years of lost academic hopes . In the last decade, the economic problems of the country have affected not only the families in general, but also the academic careers of their offspring. Few students (7%) manage to obtain a full or partial scholarship, which does not cover the entire costs of their studies: tuition fees are not the only expenses that a student have to face, especially if they study far from home. Accommodation, transportation, academic materials implicate expensive costs that students can not sustain without the help of the family or a job. Regarding private loans, the so-called “Honour Loans”, based on merit, are not well known and they rarely manage to cover all the expenses anyway. Among credit institutions, very few of those offer honour or merit loans, and they require high GPA and several guarantees: the available credit does not exceed €25.000-30.000 in total, divided in instalments of about €3.000. Nevertheless, these loans can not provide a full cover for all academic expenses.
Credit institutions do not provide tempting reimbursement plans: right after graduation, students are supposed to repay the loan, with the only option of deferring for a year (in the best case scenario). This condition does not allow the student the necessary time to find a job and reimburse the loan.
Universities and Schools now provide some subsidies for low income students, besides scholarships: income-based tuition fees, free books and subsidized accommodation are the most common solutions, but they are still not enough. According to the data by Eurydice, Italian tuition fees are the most expensive in Europe, and only 12% of Italian students manage to receive some tuition subsidies, comparing with the 35% of French students. In order to create new accessible opportunities, universities and banking institutions must offer adequate options for students. The reality of “Honour Loans” must side with a coherent financial background: financial literacy helps the student avoid useless expenses and establish a reimbursement program that reflects his or her actual economic capacity.
Considering these complex dynamics, it is useful to turn the attention overseas and analyse the problems of student debts across the Atlantic.
Across the Atlantic
In 2016 the student debt has skyrocketed from the mere $240 billion figure of 2003 to $1.3 trillion, an increase explained not only by the expansion of borrowers, but also with the rise in the size of the loans, growing at the rate of 54% since 2011: nowadays, the average borrower enters the workforce after graduation with almost $30,000 in debt . The government caps undergraduate borrowing at $57,500, while there is no limit for graduate borrowers, considered to gain a much higher income and repay the debt.
The increase of 13% in the average tuition fees still does not explain the former figures by itself. The family income distribution, deeply troubled by inequality and global crisis, adds another piece to the big picture, and yet, the understanding is far from being complete.
This phenomenon is quite widespread throughout the country.
In a recent survey conducted by FINRA Investor Education Foundation, student loans are distributed among different age levels: 45% of 18-34 year-olds have loans to pay, 27% for the age 35-54, with a 9% figure for the respondents over 55 years old. for relatives or children.
In 1965, the American government presented its Guaranteed Student Loan program, changed through the years and adapting to the challenges of contemporary finance. This plan later provided credit to graduates, assigning the definition of eligibility, interest rate parameters and default guarantee to the federal government and the Congress itself.
This distinction offered Stafford Loans and Direct Loans: until 2010, the Stafford Loans included a private variable that posed as intermediary, imposing their own interest rates and guarantee options, while the Direct Loans program was solely managed by the public sector. In general, public loans have better repayment solutions, but they can not always cover the entire tuition.
After 2010, the role of the private entity in the Stafford Loans has turned into a merely “consulting” form for monitoring and communication, conferring the management of student debt upon the Department of Education.
Private lenders have now returned to the spotlight, pushed by the recent events in American politics and finance. Private loans are different from federal loans, which maintain their primary competitiveness, as they need a creditworthy cosigner and a good credit record. They do not allow bankruptcy. Nevertheless, the federal government offers subsidized and unsubsidized loans, depending on the condition and repayment capabilities of the borrower. The benefits of subsidized loans include a 0% interest rate during college for students who survive on low income.
Since 2013 with the Student Loan Certainty Act, interest rates have reflected the Federal 10-year Treasury bond rate at the time the loan was issued, fixed over the life of the entire loan. A higher interest rate can ensure an incentive to responsibility and academic effort, but on the other hand lower interest rates would allow manageable payments and less defaults. An interest subsidy is an expensive and disorganized tool to reduce default, but small steps are made to the right direction.
Repayment plans vary from public to private issuers, but they all suffer the decisions of policy-makers and the markets. Most of the borrowers have signed for federal loans, but 22% reported to have both private and public loans, with different methods of repayment for a period of 10-20 years. Only 51% of the borrowers have paid regularly, while the remaining individuals encounter several difficulties: student loan holders belonging to minorities have more troubles with the payments, with the highest rate (and chance) to default. Recent numbers show 8 million Americans in default, although the Obama Administration has taken credits for its decrease through the introduction of income-driven repayment programs. A 9% difference divides women and men regarding the ability and the concern to pay off the loan, a figure too little to prove any discrepancy and pattern . The problem lies in the mismatch between the cost and benefits of education (Dynarski, 2014): the loan holder should pay back the loan as soon as he or she graduates from college, in a moment when he or she is most vulnerable and looking for liquidity.
Few borrowers know or have considered income-based repayment, an interesting solution that needs further development and improvement. During Obama’s administration the Pay As You Earn program limits payments at 10% of income over 20 years, but it does not adjust automatically with changes in the earning and the borrower’s eligibility must be verified annually. Income-based repayments are used by almost 5.3 million people in US for different kinds of debts, from credit cards to mortgages, owing about $269 billion. It is also the most suggested by the Department of Education, only if the standard payment is higher than the income-based option.
This system has raised criticism: if the repayment plan is linked to the future income, the borrower could be encouraged to rise the amount of the loan, creating a huge loss for the tax-payer at the end of the 20 year-term. Bigger borrowers will in fact be forgiven for a bigger amount at the end of the term than smaller loan holders, who include the majority of the students in debt. Another aspect that raises concerns in Washington deals with the similar incentive for colleges to raise the tuition fees. According to the Government Accountability Office (GAO), the income-based repayment program is chosen by post-graduates (lawyers, for example) who would not have problems repaying it through the standard method. On the other hand, college dropouts (with less than $10,000 in debt) tend to chose the latter, pushing themselves closer to default.
The GAO extensive research has shown that the government is about to forgive $137 billion ($108 billion forgiven and $29 billion because of death and disability) for income-driven payments in the future, considering only the fiscal year of 2016. The government also expects lower revenues than the ones predicted by the program. It has also strongly criticized how the Education Department has failed to adjust inflation for borrowers’ income while portraying the positive picture of the program in the future.
Among these concerns and opportunities, students in the US look at the newly elected President to understand his position regarding the issue.
The new budget plan, issued in May 2017, does not seem to reassure: alongside with the Secretary of Education, Betsy DeVos, Trump has submitted a series of cuts for student loans that has alarmed not only students, but the public administration.
The Department of Education’s budget will lose $9.2 billion through these cuts, inevitably leading to considerable consequences to the system of federal loans. The most bewildering news is the complete cut of subsidised loans that the government used to offer at 0% interest rate during the academic years: this option was vastly used by low-income students, who could focus on their studies without worrying of accumulating more debt.
If the budget plan is accepted by the Congress, other incentives dedicated to low-income students will be eliminated: the fund for part-time working students, which helped students to sustain the costs of post-graduate and PhD education, is among the promised cuts.
Even public servants are going to be slashed by Trump’s sword: the budget plan intends to remove the Public Service Loan Forgiveness Program, established in 2007, that allowed public, government or NGO servants to be forgiven of their debt after 10 years of reimbursement. Without this option, public servants will have to repay their debts accordingly to the standard options, set by the Department of Education or the private contractor.
Trump intends to burn the bridges with the past: his repayment plan moves from the Obama’s 10% over 20 years to 12,5% of the borrower’s income for 15 years. Although he did not define the fiscal parameters of the measure nor the costs, he ensured that colleges will be forced to lower tuition fees: by cutting “unnecessary costs of colleges’ compliance with federal regulations”, the colleges will have more money to spend on their students, while keeping their tax-exemption status and fiscal benefits.
In the mist of all these worrisome manoeuvres, the Pell Grant, a financial aid program for low-income students, will be extended to the full academic year. Even though it is a considerable step forward, it is not enough to compensate for the imminent loss of all the other programs.
Trump’s aim seems to be directed upon the removal of all lending programs from the government, leaving the management to private institutions. Nowadays, federal loans offer more repayment options with lower interest rates. Private loans, on the other hand, are subject to the flow of the market. Banks and universities together will have the shared duty to evaluate the eligibility of a candidate, based on his or her real repayment capabilities. This process could ultimately shrink the tendency to contract more debt than necessary.
Republicans have always pursued deregulation, and now they have a clearer path to privatization, incentivized by the upcoming Reauthorization of the Higher Education Act. Threatening to lower federal spending on colleges that do not limit their tuition fees could backfire into an increase in private donations and support, that will finally downsize or eliminate the useful institution of the Department of Education.
The Trump effect on this Game of Loans extends its wave all the way to the government-sponsored enterprises Fannie Mae and Freddie Mac. Right before the election, the former has announced a new joint plan “Student Loan Payoff ReFi” with SoFi Lending Corp., a student loan servicer. It allows people to pay their student loan by disbursing payment directly to the services by refinancing their mortgage at a lower rate. Fannie Mae stock value rose at November 8th from 1.650 to 3.080 in 20 days, envisioning a future increase in their loan requests.
The other institution taken into consideration is Freddie Mac which suffered greatly under Obama’s indifference to Wall Street requests and several lawsuits in 2014. Along with Fannie Mae, it allows to use student loans as mortgage qualification. The stock value skyrocketed after the election, as did Sallie Mae’s, one of the biggest student loan provider in America. Furthermore, the steeply increase of stock values belonging to for-profit operators’ (DeVry Education Group and Apollo Education Group among them) after the election comes with no surprise.
The disruptive behaviour of the new President-Elect, from his complete disregard to diplomacy to his post-election compromises, makes the verdict on student loans very unpredictable. Expecting Trump to keep his promises could backfire in the markets, as well as for the future student loan holders. Markets could lead investors towards certain financial products that likely follow the new President’s assurances: while the words of former Presidents were taken as gold from the masses, Trump’s speeches must be analytically computed and formalized. In this atmosphere of uncertainty, what could the market’s anchor be? The answer is paradoxically education itself, in two different notions.
First, the field of education should be reconstructed. If the decisions at the White House are misguided, then institutions and schools should take the lead to solve the problem. Without falling into the limited side of fiscal conservatives and higher education bubble theorists, it is no doubt that education leads to better jobs, better wages, and ultimately boosts the economy. Nevertheless, the system (as usual) is unevenly distributed. Some degrees are known to have higher wages turnouts than others, but schools charge the same tuition. Furthermore, many fields are overvalued or undervalued in terms of future income. The loans that students take to pursue such careers are not adjusted to these endogenous conditions. Therefore, schools should take into consideration the real potential of some degrees and change accordingly. Markets will therefore offer predictable flows and lower-risk products, finally boosting the overall economic trend. Even if this idea seems quite far-fetched, it is a small step to make institutions accountable not only for the academic path, but also for their alumni’s future and performance.
Leaving the institutional concept of education, the second notion relies on the need for financial education of the students themselves. Economics students seem to be the only ones with even a basic knowledge of finance, which they gain solely through their major, and after they have taken the loan. Financial education should be taught much earlier, as the children first approach the world of part-time jobs and money-managing. Although it is unlikely for a student to save enough for college, it is important for the same to be able to discern and contemplate all the different options that credit institutions offer. The surveys conducted nowadays show an alarming portrait of ignorance and miscalculation at the time of the contract. If students could make their borrowing decisions all over again, 53% of them will take a different path. Most of them did not know about income-based repayments, or thought to find a suitable employment right after graduation.
Education, therefore, in its most intrinsic meaning, is the key. High school students with a first financial understanding are more likely to choose a credit path that is most adequate at their real repayment possibilities. With Trump’s words scattered around the campaign, future students will tend to take advantage of the new repayment options, with little concern of the true impact on interest rates, credit ratio and national debt. The private factor, that the new President seems to have particularly at heart, is even more concerning. Credit agencies, until now tied and monitored by the federal government, will have carte blanche to rewrite the rules of the Game of Loans. Nothing stands in the way of these companies to become the sharks of the education system, to mutually adjust with tuitions and promote their own interests. In this dark picture, the light of financial literacy is prominent now more than ever, to ensure that everyone can reach their goals with the best possible options and understanding.
Global Thinking Foundation
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