The Student Loan Bubble
by Jim Walsh | Posted July 20, 2012
The left-leaning web site ProPublica specializes in long-form journalism — labor-intensive, 3,000-plus-word articles dedicated to serious treatments of big subjects. Think of the long pieces that appeared in The New Yorker during the 1970s and early 1980s and you get the idea. While I find ProPublica’s reflexive and unexamined bias in favor of statist schemes irritating, I do read its articles. They are usually earnest and sometimes worthy efforts.
Lately, a ProPublica article about a semiliterate gardener’s struggles to manage his dead son’s unpaid college loans got some traction in the mainstream media. (While I don’t understand ProPublica’s business model completely, it seems to involve licensing its long stories to other news organizations.)
This gardener’s woes fit neatly into the mainstream media’s narrative that student loans are an evil, evil thing about which Good King Barack needs to do something. And, by “do something,” moronic opinion-shapers mean without saying: subsidize borrowers’ bad choices with capital redistributed from taxpayers.
This proposition is wrong on many levels. It also reflects faulty assumptions and bits of specious logic that are worth some examination — because they explain many of the problems that plague America today.
First, a quick review of ProPublica’s telling of the gardener’s tale.
Francisco Reynoso lives in Palmdale, California — a dusty far suburb, north of Los Angeles. He doesn’t speak much English (though he is a naturalized citizen) and earns about $20,000 a year from his labors. While the story doesn’t offer many details about Reynoso’s work, in southern California “gardener” is often a euphemistic way to describe a causal day laborer — the kind of guys you see milling around Home Depots and such outlets, looking for work.
On this meager income, Reynoso supports his wife and daughter. He used to support a son, too. But, in a tragic turn, that son — Freddy — died in a one-car accident in September 2008.
Freddy had recently graduated from Berklee College of Music, a school in Boston that combines elements of a conservatory with the rigors of a traditional four-year college.
It was a bit strange that a gardener’s son had matriculated to a place like Berklee. It’s no community college . . . or even a state university. Rather, its reputation has long been as a pricey second-tier Julliard. The school’s comprehensive fee is nearly $50,000 each academic year.
A lazy person might describe Freddy’s enrollment at Berklee as a version of “the American Dream.” The son of a laborer enters a world traditionally reserved for the elite, etc. But it sounds like Freddy never really entered that world. In 2005, after he’d been admitted to Berklee, the young man needed to borrow significantly to enroll. Reynoso cosigned on a series of student loans that allowed Freddy to attend. By 2008, when Freddy was finished at Berklee, he moved back to Palmdale and was driving into Los Angeles most days. Trying to find work. According to his family, Freddy was driving back from the city on the night that he ran off the highway, rolled the car, and died.
As a father, perhaps Reynoso should have told Freddy that borrowing hundreds of thousands of dollars to get a degree in music was a bad financial decision.
The principal amount of the money Freddy and his father had borrowed was nearly $170,000. With interest and fees added, the amount they’d have to repay would be closer to $300,000. The lenders didn’t mind much that Reynoso didn’t have the means to repay those amounts because, as we’ll see in more detail later, various government subsidies that support the student-loan market make rigorous underwriting unnecessary.
So, lenders lend. But why do borrowers borrow? Why did a gardener making little more than minimum wage agree to guarantee so much in college loans? His answer: “As a father, you’ll do anything for your child.”
It may not seem sporting to criticize a simple man’s devotion to his son . . . but what if that devotion is ignorant and misguided? According to a survey of music industry salaries produced by Berklee itself (and based — tellingly — in the “Parent Questions” section of its web site), most of the jobs its graduates pursue offer starting pay of less than $25,000 a year. That’s not enough income to support the debt service on nearly $200,000 in student loans.
As a father, perhaps Reynoso should have told Freddy that borrowing hundreds of thousands of dollars to get a degree in music was a bad financial decision. Some people are poor because they make bad financial choices. An unintended consequence of government programs that give material support to such poor people is that they’re free to make more bad choices. In the hands of Francisco Reynoso, Freddy’s government-subsidized student loans were a loaded gun . . . or a hangman’s rope.
A few months after Freddy’s fatal accident, collectors started calling Reynoso to demand payment on the student loans for which he’d cosigned.
The loans that allowed Freddy to attend Berklee fell into several categories — as they do for most borrowing students. There were some direct government loans, which carry the lowest interest rates and most favorable terms for the borrower. In most situations, they don’t require parents to cosign. But there are limits to the amounts available on these favorable terms; in most cases, a student can only get a few thousand dollars each academic year in this “cheap” money.
After that, a borrowing student needs to go to so-called “private” lenders. These are banks and specialized finance companies that offer loans with higher interest rates and less-favorable terms for borrowers. But the “private” loans are still subsidized heavily by the government and share unique traits with the direct government loans — most importantly, the loans cannot be discharged in bankruptcy.
(A personal aside: When my oldest child was getting ready to leave for college, we reviewed her finances and found we were a little short on the cash she would need for her comprehensive fee. She shook off the shortfall as no big deal; the college was happy to help her apply for student loans. I advised her only to borrow as much as was available in direct government loans and to avoid the higher-interest private loans at all costs. She rightly noted this advice was ironic, coming from someone who advocates against such government programs; but she heeded the irony and will graduate next year with a nominal amount of relatively cheap debt to repay.)
This is the major reason why the “private” student-loan lenders don’t bother with rigorous underwriting. Since the loans can’t be discharged in bankruptcy, the lenders or their agents can hound borrowers and cosigners for repayment endlessly.
In Freddy’s case, he borrowed about $8,000 in private money from Bank of America and about $160,000 from a company called Education Finance Partners. Neither lender kept the loans for long; as is typical in the market, the “loan originators” sold Freddy’s paper to other firms that focus on servicing debt or bundling it with other student loans and “securitizing” those bundles.
According to ProPublica, Bank of America sold the loan it made to Freddy to a student-loan financing specialist called First Marblehead Corp.; Education Finance Partners, which has since declared bankruptcy, sold the loans it made to Freddy to a unit of the Swiss banking giant UBS.
The loans purchased by UBS may have been sold, in turn, to the Swiss National Bank (analogous to the U.S. Federal Reserve) when the National Bank made a Fed-style bailout of UBS in 2009. Details are sketchy because of Swiss privacy laws.
So, if the ownership of the debt was unclear, who were the collectors calling Reynoso for repayment? A separate company, called ACS Education Services, which owns some student debt and contracts with other lenders to manage and collect on their loans for a fee. ACS is a unit of Xerox Corp. and one of the bigger players in the student-loan servicing market.
But Freddy was dead — and one might think that that fact would have an effect on the lenders’ collection efforts. Some student loan companies have a policy of canceling loan balances when a borrower dies. (Direct student loans from the government are generally cancelled if the borrower dies.) But, since Reynoso had cosigned for his son’s “private” loans, the lenders have the legal right to pursue payment from him.
A fundamental fraud lies beneath all this do-gooder claptrap. And that fraud may eventually destroy the foundations of many schools.
It’s easy — and emotionally satisfying, perhaps — to focus outrage at lenders like Bank of America and Education Finance Partners, or behind-the-scenes operators like First Marblehead or ACS Education Services. The establishment Left and media outlets like ProPublica certainly focus on them.
But these lenders and finance outfits are really just service providers, working the levers of government to find ways to make a few points here or there while helping to facilitate state-sponsored transactions.
The core transaction in the ProPublica story was between Freddy Reynoso and the Berklee College of Music. Freddy was pursuing a dream of being a professional musician and Berklee was selling an expensive credential that might help in that pursuit.
Freddy died. But Berklee is doing well. It has an endowment of nearly $200 million and is in the midst of an ambitious expansion of its campus — which at present comprises of some 21 buildings in the Back Bay area of Boston. The College’s website described the opening of one new building in this way:
Adorned with bright colors, the unique and hip space has an industrial feel, in step with Berklee’s cutting-edge sensibility. The building also houses the Berklee Writing Center, Berklee’s English as a Second Language Program, an Africana Studies Room, conference and seminar rooms, and a café.
More hip space in the Back Bay is in development. And Berklee has recently opened a satellite campus in Valencia, Spain.
According to a September 2011 report from the Center for Social Philanthropy and the Tellus Institute, Berklee President Roger H. Brown makes more than $550,000 a year. And five other senior administrators make more than $300,000 a year. It’s good money — although, by elite college standards, it’s not that much.
President Brown’s official biography recounts sanctimoniously the work that he’s done in places like Thailand and the Sudan for various humanitarian outfits (some connected with United Nations). It boasts about the big child-daycare company he started with his wife, but it doesn’t mention the years he spent working for Bain & Co.
I’m sure Mitt Romney will understand.
Of course, the bio focuses on the efforts Brown has made to move Berklee closer to the first-tier of private colleges:
In 2007, Brown launched the college’s first capital campaign with a goal of raising $50 million. He has initiated Berklee’s Presidential Scholars and Africa Scholars programs that provide full-ride scholarships to give top musicians around the globe a Berklee education. He has overseen the expansion of the City Music Program beyond Boston in an effort to provide educational opportunities for talented but economically disadvantaged urban youth. . . . Brown worked with the city of Valencia, Spain, and the Generalitat Valenciana to create a Berklee campus in Valencia.
He’s the very model of a modern major-general. Working the levers of government in Spain to set up a ritzy international campus. Overseeing the expansion of programs to provide for the disadvantaged. Initiating programs to give scholarships to top musicians around the globe.
But a fundamental fraud lies beneath all this do-gooder claptrap. And that fraud may eventually destroy the foundations of schools like Berklee College of Music.
For decades, striving institutions of higher education have been working the levers of government — and, specifically, the student loan market — to redistribute capital from the lower and middle classes into their self-styled “elite” pockets. A regressive racket if ever there was one.
The pieces are all present in Freddy Reynoso’s story. Nearly $200,000 was taken from people who can’t afford it, facilitated by banks and the federal government, and transferred into the coffers of a music college already sitting on an endowment of several hundred million. If the sanctimonious Roger H. Brown really wanted to help disadvantaged youth, he should have given Freddy Reynoso a free ride. But why should he do that? Uncle Sam is willing to arrange for Berklee the pretense of high-minded altruism and the profit margins of a payday lender.
Roger H. Brown won’t stop this deal. So Uncle Sam needs to.
Jim Walsh owns Silver Lake Publishing, which has recently published Seven Principles of Good Government — Gary Johnson’s 2012 presidential campaign book.
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