CARES Doesn’t Care Enough about Student Loans

The COVID-19–driven financial collapse has exposed an ugly underbelly of economic truths, not least of which the severity of the student loan crisis, which the recently enacted Coronavirus Aid, Relief, and Economic Security (CARES) Act does not alleviate.

Under CARES, Federal Direct student loan borrowers may suspend remittances through September 30 without incurring penalties, late fees or negative amortization (in which the unpaid interest is added to the loan balance).

Although six months of payment moratorium is better than nothing, it certainly doesn’t amount to a whole lot of something. Not when the remittances on more than 20% of all student loans currently in repayment (as opposed to in deferment because the borrower is still in school) are delinquent — and god knows how many more are in forbearance, restructured (temporarily or permanently) under the government’s various loan relief plans, in default or have otherwise slipped through the cracks because the data for that is unavailable.

Related Article: A Fearsome Financial Freight Train

No matter how you slice it, this is by far the worst performing segment of consumer credit. Ever. It also represents the most striking example of how not to structure loans in the first place. But should all these debts be forgiven, as some have vociferously advocated on the campaign trail? I’m not so sure.

Clearly, loans that were deliberately designed to deceive should be challenged and the perpetrators held to account. As to the rest of the student loan portfolio, I worry what blanket amnesty would do the availability of credit, the existence of which hinges on trust: I trust that if I loan you money, you — not someone else, not the government — will pay me back. I am equally troubled by the inequity of loan forgiveness granted to current borrowers at the expense of those who’ve repaid their debts. Shouldn’t they get their money back too?

As improperly structured as the Federal Student Loan Program is, borrowers willingly entered into those agreements. Sure, one can make a reasonable case for their doing so without due consideration or adequate preparation, but that’s not reason enough to challenge the legitimacy of these contracts.

The federal government has, to its credit, taken the tact of funneling financially distressed borrowers into income-based repayment (IBR) plans, granting temporary forbearances and providing other forms of relief. The problem is that none of this is permanent. It is, for example, incumbent upon IBR plan borrowers to annually recertify their eligibility, which, according to the most recent Consumer Financial Protection Bureau report, roughly one third of these borrowers fail to do.

There is a better way to deal with this problem: Restructure the Federal Direct student loan portfolio in its entirety so durations are doubled and payments are consequentially reduced — an outcome that is not all that different from that which would likely result when an IBR borrower never leaves the program.

Apart from the instantaneous payment relief that education borrowers would realize from such a move, the federal government also stands to gain.

At roughly $1.2 trillion in loans on the Department of Education’s balance sheet, and a comparable level of agency borrowings to support those assets (which, by the way, is additive to an already skyrocketing federal deficit), the obvious question is: Should this tree be permitted to grow to the sky?

Perhaps not.

Once these loans have been properly restructured and the financial markets restored to normalcy, the government may well be in a position divest all or part of its holdings to the private sector and, with the resultant proceeds, retire the underlying debt, dollar for dollar.

There is, however, a significant danger in proceeding along this course, even after the payment schedule is restructured.

Absent explicit consumer protections, Federal Direct student loan borrowers could find themselves subjected to the same well-documented abusive loan-servicing and collections practices as those who struggle to repay their Federal Family Education Loans (FFEL). That’s because these loans are owned and controlled by the private sector, as are non-federally sponsored (eg, bank and fintech) debts.

It is therefore critically important for Congress to remedy the matter by including all education-related debts under the recently enacted legislation, and additionally mandate:

1. The restructuring of all education-related debts so loan durations — whether or not these are currently in repayment, in deferment or newly originated — are doubled in length
2. The option for borrowers to accelerate repayment — in whole or in part — without penalty
3. A standardized process for adjudicating relief requests from financially distressed borrowers that also includes an option to make interest-only payments — which fall someplace in between full and no-payments — to prevent the negative amortization that is attendant to forbearance, and
4. A standardized protocol for the servicing of education loans that holds accountable all parties that have a financial interest in these loans, including lenders, investors and loan administrators.

Related Article: An Opportunity for Action on Student Loans

That said, it is likely that the private sector will resist these changes, but not because lenders and investors are unaware of the crisis that we face as a nation. Rather, it’s because a good portion (if not most) of the FFEL and non-government-sponsored loans these entities hold have been securitized (or financed in some other structured manner), much like a substantial portion of residential and commercial mortgages. The contractual terms of these transactions incorporate certain event triggers that call for their dissolution. These include high levels of nonpayment, which CARES authorizes for a long enough period to trip that control.

As such, it is not enough for Congress to mandate industry-wide compliance for the benefit of distressed borrowers. The underlying structured finance agreements among the lenders and investors must also be amended to accommodate these changes — a remedy that will also likely require legislation to effect because the securities are so widely held. Failure to do so risks a systemic meltdown for this class of loans and all the others that are similarly financed behind-the-scenes.

COVID-19 has significantly disrupted our lives in so many ways. But that doesn’t mean that we shouldn’t take this time to reconsider the suitability, value and fairness of the financial instruments that we have so cleverly devised, which we now realize have the potential of making matters so much worse.

Mitchell D. Weiss is a financial services industry executive and entrepreneur. He is also an Executive-in-Residence at the University of Hartford, co-founder of the university’s Center for Personal Financial Responsibility and adjunct faculty at Rutgers University. His most recent text, Practical Finance — A Straightforward Guide to Personal and Entrepreneurial Finance, is the basis for the course he developed and teaches at both institutions.