By Jason Pang Jao, Daily Opinion Columnist
Published January 18, 2012
Many of us have burdens right out of college, including getting a job, moving out of our parents’ house and, of course, paying off our student loans.
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A seemingly manageable task, student loan repayment in 2010 reached 8.8. percent — the highest default rate in history. Federal loans, such as Pell Grants and Leveraging Educational Assistance Partnership grants, support most students, but they can't alone cover the pricey textbooks, costly lectures or the expensive meals at the Hill Dining Center.
According to Sallie Mae’s national study, “How America Pays for College,” the average American student borrows nearly twice as much from outside sources as he or she does from the federal government. These sources include private educational loan originators, credit card companies and other private loan agencies.
This is an attention-worthy subject because a student loan crisis similar to the subprime mortgage crisis of 2008 is looming on the horizon, and the federal and state governments must take actions to avoid it.
Student loans, much like home loans, are securitized and packaged into asset-backed securities. These securities, called student loan asset-backed securities, are then sold to investors on Wall Street, who become the end-collectors of your interest and principle.
Imagine this: Your friend Bob lends you $10 with $2 interest, then sells that loan to his friend Mary, who would receive $11 from you. Bob, the middleman (or the loan originator), collects his commission of $1 through originating the loan to you and securitizing and selling the loan to Mary. Bob walks away with his risk-free commission of $1. Mary walks away with her investment and your interest minus Bob’s commission, totaling $11. And you walk away with a loan deal to pay off school. Everyone wins, right? Wrong.
There is a chance that you could default on your student loan. In the subprime mortgage crisis, homeowners defaulted on their mortgages, and the owners of mortgage-backed securities ceased to receive their payments. The MBS owners — including major investment banks and hedge funds — failed too. Finally, mortgage lenders became insolvent when the demand for MBS dropped to nearly zero and more homeowners were forced to default on their loans. The entire financial system spun out of control at that moment.
Three years after the most tragic recession our country has faced since the Great Depression, the $1 trillion in outstanding student loans in the U.S. face an unprecedented default rate. This time, the stakes are even greater.
Students who fail to make their loan payments — interest or principle — face many direct consequences. The government has the right to offset the defaulted loans by cutting tax refunds, paychecks and even federal benefits such as Social Security, retirement or disability benefits. Public and private loan originators can file suit to collect the uncollected portions of defaulted loans. Unlike home mortgages, defaulted student loans generate an indefinite period during which originators have the right to bring suits against insolvent individuals until the loans are fully recovered. Affected individuals also suffer from indirect consequences, including the lowering of credit ratings and greater difficulty obtaining loans for homes, cars and businesses.
For our economy, a rise in the student loan default rate would, in the short run, reduce dispensable income, depress the housing market and cause private originators of student loans to raise interest rates to reflect the elevated risk. The last act of adjusting rates on newly issued loans would further diminish students’ abilities to pay back interest and loans, elevating the student loan default rate even higher.
Higher tuition and higher rates on student loans mean fewer people can afford a good education. If our governments choose to ignore this issue, a stagnant education system will rid our country of productivity and innovation in the long run. With more than $1 trillion outstanding student loans in the U.S., the impact of a fallen SLABS market would affect every other credit market.
The future of the country is at stake, and the political parties must be united to oppose this ominous threat to the well being of our economy. We need more federal grants and subsidized loans for students to tap into, a simpler loan application process to encourage low-income households to apply and more programs to help distressed households that suffer from the consequences of student loan default.
The U.S. may be coming out of one recession, but the rest of the world is still struggling. We should not take pride in our meager progress. Instead, we must set our objectives for the long run. Education is not merely one of the most important issues — it’s the most important issue of all.
Jason Pang Jao can be reached at firstname.lastname@example.org.