CFPB Sees Student Loans as Housing Crisis Redux

WASHINGTON — Patterns in the private student-lending industry are dangerously similar to those seen in the housing market prior to its collapse, according to a study expected to be released Friday by the Consumer Financial Protection Bureau.

The study, completed with the Department of Education under a mandate in the Dodd-Frank Act, said the private student loan market — fueled by eased underwriting and investors interested in asset-backed securities — grew 185% between 2001 and 2008 to $20 billion. Yet that market then deflated over the next three years, falling below $7 billion in 2011. Outstanding private student loans now total about $150 billion, compared with $864 billion in federal student loan debt.

"Many students have taken out loans from private banks which we know have been issued in a way very similar" to loans "in the subprime lending crisis," Education Secretary Arne Duncan said in a conference call with reporters in advance of the study's release.

The two agencies said private loans have proven riskier for students than federal ones, and borrowers struggling to repay their debt find few workout options. They suggest a potential remedy — a recommendation sure to raise eyebrows in Congress — is to consider allowing student loan borrowers more ways to restructure credit while in bankruptcy.

"Our findings reveal that students were yet another group of consumers that were hurt by the boom and bust of the financial crisis," CFPB Director Richard Cordray said during the call. "Too many student loan borrowers were given loans they could not afford and sometimes for more money than they needed. They're now overwhelmed by debt and regret the decisions they made."

The study included data collected from nine lenders covering more than 5 million loans that were originated between 2005 and 2011. Additionally, five nonprofit lenders also submitted data. The participants included RBS Citizens N.A., Discover Financial Services, The First Marblehead Corp., JPMorgan Chase, PNC Bank, Sallie Mae Inc., SunTrust Banks Inc., U.S. Bank National Association and Wells Fargo Bank, N.A.

The study makes some key recommendations, including that Congress strengthen the role schools play in the origination of private loans, consider making it easier for borrowers to restructure student-loan debt in the bankruptcy process and modernize regulation to "ensure a competitive, fair market where consumers fully understand their debt obligations and lenders have appropriate data to make underwriting decisions."

As loans grew during the boom, the study said, lenders began increasing their direct marketing of loans to students without using schools as an intermediary. Between 2005 and 2007, loans to undergraduate students bypassing school involvement and any verification of students' credit needs increased from 40% to over 70%.

"As a result, many students borrowed more than they needed to finance their education," the study said. "Additionally, during this period, lenders were more likely to originate loans to borrowers with lower credit scores than they had previously been. These trends made private student loans riskier for consumers."

But the report said following the financial crisis, when investor interest declined, underwriting standards appeared to improve. Loans that were co-signed increased from 67% in 2008 to 85% in 2009. Last year, over 90% of private student loans were co-signed. A similar percentage of loans in 2011 required schools to verify how much financing students need. Overall, lending standards have increased, and "nonprime" loans have reduced, the study said.

The study comes as student loans have been a subject of debate in Congress for several years. In addition to the required study in Dodd-Frank, lawmakers a year earlier enacted a bill ending federal subsidies to private student lenders, which many credit with forcing some private lenders to exit the business. In 2005, legislation made it more difficult for student loan borrowers to "discharge" their debt through the bankruptcy process.

Cordray said that 2005 bill has had consequences. The debate over whether to allow bankruptcy-related restructurings mirrors a similar congressional fight over whether judges should be allowed to "cram down" troubled mortgage debt.

"There are striking similarities between stories of the private student loan market and stories of the mortgage market in the years leading up to the financial crisis," Cordray said.

Borrowers who take out federal student loans appear to have more options for dealing with their troubled debt than private loan borrowers, he added.

"Without the ability to discharge their loans, borrowers have looked for other ways to handle their debt. But many borrowers told us their lenders were unable or unwilling to modify or adjust repayment terms even in these tough times, and the borrowers feel they have little leverage to negotiate reduced loan payments with their lenders," Cordray said.

The report found that borrowers did not always understand the differences between federal student loans and private ones, with about 40% of borrowers in the private market having turned to a non-federal lender even though they had not exhausted their financing from the government.

Meanwhile, borrowings to attend for-profit colleges have grown. In 2008, 42% of undergraduates at such schools had taken out a private loan. (The figure for all undergraduates was just 14%.)

The unemployment rate in 2009 for private student loan borrowers, who entered school in the fall of 2003, was 16%. One in 10 recent graduates from a four-year college pay more than a quarter of their income per month for student loans.

In June, the bureau and the department released over 2,000 comments letters they had received from student-loan borrowers as part of the data collection that went into the study. As early as March, CFPB officials were sounding the alarm over the magnitude of outstanding student loan debt — which had exceeded $1 trillion — and suggesting that education costs were impeding the housing recovery. The bureau had also asked state agencies, colleges, consumer advocates and lenders themselves to provide data on existing complaints from private student-loan borrowers.

The agency also alerted borrowers to two online tools available to them to understand repayment options. One is the Student Loan Debt Collection Assistant, which walks borrowers through potential solutions after they have missed monthly payments on either federal or private student loans. An already-existing tool, the Student Debt Repayment Assistant, is a resource on deferments and certain alternative payment programs.