The Real Student Debt Problem

This fall, those calling for reform of student aid have had a lot to celebrate. Last month, President Bush signed the College Cost Reduction and Access Act. Championed by Democrats George Miller and Nancy Pelosi, the package cut $21 billion in excessive subsidies to student lenders and shifted the money to increase Pell Grants (the largest need-based student grant) and cut interest rates on federal student loans.

The significant subsidy cut, along with other turmoil in the credit markets, scotched a private equity takeover of Sallie Mae, the largest student lender. This averted the specter of a company which holds $153 billion in student loans, and which was created as a government-sponsored enterprise, becoming privately held with no obligation even to make SEC filings. Sallie Mae is currently suing their cold-feet suitors.

More important, by reforming repayment rules, the bill takes steps toward restoring the premise championed in our country from the creation of the land-grant universities: Higher education is a public good, not just an individual investment. The bill creates a range of loan repayment programs for graduates who choose to enter public service and introduces Fair Payment Assurance, which allows borrowers to limit student loan payments to a percentage of income, and cancels the debt after 25 years. "The College Cost Reduction and Access Act is the most meaningful higher education reform in more than 15 years," said Luke Swarthout, a higher education advocate for US PIRG. "This legislation is an example of Congress getting policy making right."

Emboldened by these successes, advocates see momentum growing for even broader reform which could offer meaningful relief to students by reining in the excesses of an ethically dubious industry. But no serious remedy is on offer for the elephant in the room: tuition increases themselves.

Currently, student loan debt, like child support and tax liens, but unlike all other unsecured debt, cannot be discharged (forgiven) in bankruptcy. Bankruptcy reforms in 1998 made federally subsidized student loans nondischargeable, and the notorious 2005 Bankruptcy Abuse Prevention and Consumer Protection Act excluded private, unsubsidized student loans as well.

The amount of federal student loans a student can borrow is capped at $23,000 for undergraduates, at interest rates of 6.8 percent. Private or "alternative" education loans, which receive no government subsidies, have no effective limits. Students may borrow $200,000 or more at rates anywhere from 9 to 19 percent. As tuition soars more than twice as fast as inflation, these expensive private loans are filling in the gaps. The volume of private student loans grew a staggering 894 percent in the past 10 years, in constant dollars, to one-quarter of all student loans.

Private loans are handled by large banks like Citibank and federal lenders like Sallie Mae, but some of the worst abuses occur with lower-profile outfits that make only education loans. Recently, New York City attorney general Andrew Cuomo singled out three lenders -- Elite Financial Group, Academic Loan Group, and Erie Processing. He alleged that they marketed their loans deceptively and aggressively, online and directly to students. Elite sent solicitation letters marked "Federal Loan Division," that sported an eagle seal.

The evidence is mounting that families are confused by such tactics and by the myriad financial aid choices available. A simple policy change by Barnard College this past year showed that contrary to the claims of lenders, many families are borrowing far more than they need to in private loans. Before certifying to a private lender that a student was enrolled, Barnard began requiring that the student or family talk with a college financial aid officer. This simple conversation, making families aware of the high cost of private loans and of other available options, led to a 73 percent decrease in private loan volume.

Furthermore, private lenders often partner with for-profit and career colleges that target the least experienced students with programs that are more expensive than, but similar in quality to, public community colleges. At these schools, financial aid officers may sign up students for private loans even when they are eligible for federal aid. Similarly, students in film school, culinary school, and other high-cost programs are graduating with six figures of high interest private loan debt and low or unpredictable incomes.

In June, Senator Dick Durbin introduced a bill that would restore bankruptcy protection for these unsecured private loans. Giving borrowers the right to get out from under these loans may make private lenders more cautious -- and that's a good thing. With no risk of losing profits to bankruptcy, private student lenders now have little incentive to try to determine students' ability to repay these loans. Yet as exciting as these reforms are, some of the toughest work is still ahead. Progressives who care about meritocracy, opportunity and global competitiveness need to ask broader questions about the future of higher education in American society, and how much we are willing to pay for that future.

Educational access, persistence, and completion are about more than economic assistance. But the way we choose to distribute higher education aid can influence access. Right now, college financial aid offices package various sources of aid -- federal, state, and institutional grants and federal or private loans -- for individual students through an opaque aid award process. Schools receive Pell Grant and other funds directly from the government to distribute among students according to federal formulas. Students receive their award letters from college financial aid officers -- not directly from the government -- with the combination of Pell Grant, state scholarships, college awards, work-study, and loans that will allow them to afford school.

Jon Oberg, a former official with the Department of Education, points out that federal Pell Grants are just about the only federal funding that come without a matching requirement on the part of institutions. The federal government has one explicit goal with its taxpayer-supplied funds: increase access for all qualified students regardless of ability to pay.

Individual colleges, however, have a very different mandate: to attract a mix of the brightest, most highly qualified students while meeting various internal criteria. We know they give special consideration to minorities, athletes, and children of alumni. Colleges also have a clear mandate to attract some students who can pay full tuition; otherwise raising tuition wouldn't effectively raise operating funds for the college.

At the state and individual college level, merit-based aid has been growing faster than need-based aid. Several states have accelerated this process with programs that offer full scholarships to in-state high school graduates with top grades; studies show that these programs are disproportionately taken advantage of by middle-class families who can afford to pay some tuition, rather than the poorer but qualified students for whom this scholarship would make the difference in their being able to attend a four-year college at all. The same upper-middle-class skew is true of education tax benefits.

Therefore, for all the Pell Grant money we're giving out, we're not seeing improvements in the percentage of qualified low-income students able to attend four-year colleges. To take an example: Let's say a school costs $10,000 and has one $1,000 scholarship to give out. One poor applicant qualifies for a $4000 Pell Grant, but he needs $1,000 more to pay for books. A middle-class student qualifies for no federal aid, but the school gives her the $1,000 scholarship to make the school a more attractive choice. The result is that the middle-class student enrolls and the poor student cannot afford to.

Right now the maximum Pell Grant pays for about one-third of the average cost of a public university, or $4,050 of a bill that is $13,589 this year. To make college accessible for families earning less than the median household income of about $48,000, more state and institutional aid should be required to be distributed according to the same need-based rules as the Pell Grant.

As we can see, resolving the access dilemma requires engaging colleges directly, and challenging their policies. Same goes for tuition itself. Since the early 1990s, college sticker prices have soared faster than both inflation and family income. There are lots of reasons for this. One is the US News rankings effect: pressure to provide expanded services like wi-fi dorms in a newly nationally competitive market for students. Increased costs have been shifted to both families and the federal government through annual tuition increases of 7 percent or more.

No matter how fast we increase federal grants and student loan limits, tuition increases are eating up the gains. It's appropriate for families and students to share the cost of education, but the growth of tuition and resulting student loan debt is not sustainable. In one scenario, lower-cost degrees proliferate, meaning more students of lesser means heading to two-year and online programs. Or, if states and the federal government believe in expanding access to the liberal arts and preserving a true meritocracy, they will work directly with universities using a carrot-and-stick approach to keep tuition increases under control and get aid to those who need it most. The College Cost Reduction and Access Act is a great step, but there is more work to be done to truly cut the cost of college.