Michael Tanney
PAF9103
September 17, 2014
Problem Memorandum
TO:
FROM:
RE:
DATE:
College Candidates and their Parents/Legal Guardians
Michael Tanney
Student Loan Delinquency Rate
September 16, 2014
Executive Summary
Students and families are finding it more difficult to be smart consumers when it comes to evaluating
colleges and their associated costs. According to a study from the Department of Education, the overall
default rate on taxpayer-funded student loans rose nationally from 12.8% to 13.5% percent in 2013 and
the effective default rate (calculated by excluding loans to students who are still in school or not expected
to make payments currently) rose to 21.9%.1 These figures are camouflaged by the large number of
borrowers who are either in deferment or grace periods and the true delinquency rate is believed to be
much closer to 33%. As a result of these staggering figures, many student borrowers and their families
are forced to delay major life decisions such as buying a home, starting or extending a family, and saving
for the future. On a national scale, the economic repercussions for such impedance in growth have
longer term negative economic implications. This memo seeks to share the history of the Federal student
loan program, illustrate the recent rapid growth of student loans, and identify the major causes of
delinquency rates on such student loans.
If afforded the opportunity, future correspondence will present and evaluate policy ideas to mitigate and
prevent an increase in delinquency rates of student loans.
History of the Federal Student Loan Program
The Federal Student Loan program was first conceived by President Dwight Eisenhower through the
National Defense Education Act of 1958 as an answer to increased scientific and technological pressures
faced by the country as a result of the Cold War. In 1965 President Lyndon Johnson signed the Higher
Education Act expanding the student loan program and removing the government from its role of financer.
In remarks made at Southwest Texas State College upon signing the act, President Johnson said of the
act:
“It means that a high school senior anywhere in this great land of ours can apply to any college or any
university in any of the 50 States and not be turned away because his family is poor… So to thousands of
young people education will be available. And it is a truism that education is no longer a luxury. Education in
this day and age is a necessity...Tell [your children] that the truth is here for them to seek. And tell them that
we have opened the road and we have pulled the gates down and the way is open, and we expect them to
travel it….Tell them that the leadership of your country believes it is the obligation of your Nation to provide
and permit and assist every child born in these borders to receive all the education that he can take.” 2
Section 343 [20 U.S.C. 1066b] subsection (a) of the Higher Education Act authorized the government to
“…enter into insurance agreements to provide financial insurance to guarantee the full payment of
principal and interest on qualified bonds.” 3 The government assumed the role of insurer while the private
lenders were assigned the role of the student loan originators. This mutually beneficial arrangement
enabled private lenders (predominately banks) to earn money risk-free and the government to remove
outstanding loans from its balance sheet, thus portraying to the public a healthier financial institution.
By 1972, President Richard Nixon introduced the Student Loan Marketing Association. The governmentsponsored enterprise was commonly known as Sallie Mae and recently changed its name to Navient.4
The law code stated “[t]he Secretary of the Treasury is authorized and directed to purchase any notes
and other obligations issued hereunder…”,5 which freed private lenders to use their capital for other
areas of insurance and business development. Not surprisingly, over the next 36 years, private lenders
Michael Tanney
PAF9103
September 17, 2014
continued to provide student loans aggressively, competing with lesser known governmental programs,
all while having the insurance of payment by the government.
In 2008 Congress authorized the Education Department to “dramatically expand its role as a direct lender
to fill the void created by an exodus of private-sector lenders, due primarily to the credit crisis.”6 As the
severity of the recession became clearer, in 2010 Congress approved President Barack Obama’s plan to
remove all private lenders and return the program exclusively to the government. To disincentive private
lenders involvement in student loans, the assurance for any missed payments would no longer be
provided by the government.7 Positive outcomes from the new schematic included better student loan
rates, greater flexibility of payment schedules, discount or forgiveness plans based on post-graduation
careers, and in specific circumstances, the freezing of interest accrual for the duration the student is
matriculated. The primary negative outcome was greater student exposure to political maneuvering and
bickering.
Recent Rapid Growth of Student Loans
From 2004 through 2012, the total student debt in the United States nearly tripled from $364 billion to
$966 billion.8 Approximately two-thirds of this debt was owed by borrowers under 40 and the remainder
owned by borrowers under 30. More telling was that during the last severe economic downturn, all types
of household debt (mortgages, credit cards, auto loans, etc.) decreased, while student debt continued to
climb. By 2012, student debt surpassed credit card as the second largest form of household debt behind
mortgages. Students at private, for-profit colleges accounted for 10% of the nation’s college enrollment
but, according to the Department of Education (DOE), accounted for almost 50% of all student loan
defaults.9
In this period of rapid student debt growth, the total number of borrowers increased by 70% and the
average amount of debt per person increased by 40%. 8 It is important to note that student debt is unique
and is not normally dischargeable in the event of personal bankruptcy.9 Thus the delinquency rate may
continue to increase even if the number of borrowers who become newly delinquent stay constant.
Major Causes of Student Loan Delinquency
The majority of student loan delinquencies are a result of the four causes cited below. However, it would
be improper for the author not to acknowledge that individual and family circumstances are dynamic and
include unforeseen shocks that may cause delinquency to occur. Although important to recognize, these
unforeseen shocks are not addressed as causes in this memorandum.
The growing cost of tuition across all levels of school (undergraduate and graduate) is a major contributor
to the growth of student loan delinquency. A report by the St. Louis Federal Reserve suggested that high
levels of student debt were correlated with higher tuition and fees. From 1993 to 2011 education costs
increased 165%. In comparison, during the same period, broad inflation was up 56%.10 If an extra
decade of data is incorporated, one will find that the education costs increased 559%.11 While there are
efforts by individual colleges to minimize tuition increases, the most common unspoken justifications are:
1- research universities are spending too much money, 2- public universities are replacing lost money as
a result of budget cuts, and 3- universities are making up for declining donations.
Another major cause of student loan delinquency is the arduous process and inconvenient timing that
current and prospective students face when completing the Free Application for Federal Student Aid
(better known as FASFA) form. The 100 page form is completed to determine eligibility for student aid on
an annual basis after a candidate has already applied to a college.12 In June 2014, Senators Lamar
Alexander of Tennessee and Michael Bennet of Colorado introduced the “Financial Aid Simplification and
Transparency Act.” This act was described by Senator Alexander as:
Michael Tanney
PAF9103
September 17, 2014
"Every year, 20 million students waste millions of hours and countless dollars on a 100-question application
form that only needs to be the size of a postcard…This bill would cut more than 100 questions down to
two…the two questions would capture the necessary data for about 95 percent of students….helping
families get aid information sooner while protecting taxpayers from lending more money to students than
they’re able to repay…”12
The lack of information available to aid in students and their parent’s decision making processes has
been cited in a report from the Bill & Melinda Gates Foundation's Reimagining Aid Design and Delivery
project as a major cause for student loan delinquency. According to the report, “most students focus on
being accepted by a college, it is often only after having been accepted that they realize they may not be
able to afford the cost….The lack of upfront information about costs can set successful applicants up for a
devastating dose of reality.”13 From the perspective of the student only, a study by the Young Invincibles
Project (also funded by the Bill & Melinda Gates Foundation) found that “students overwhelmingly lack
information and strong counseling about federal loans…About 40 percent of high debt borrowers
responding to a survey reported never receiving federally mandated loan counseling.” 14
Lastly, once student loans are issued, the repayment rate is low primarily because many borrowers delay
payments through continuing education, deferrals, forbearance, and income-based repayment plans.8
The creation of income-based repayment plans has had the unintended consequence of a perverse
incentive program. According to a report written by Michael Simkovic:
“This is a subsidy to students who are studying fields with the lowest value in the labor market and a tax on
students who are studying fields with the highest value in the labor market and the best employment
prospects….Many students do not know which majors and programs are the best investment until they have
nearly completed their studies, and many universities find it more convenient to channel students toward
whatever can engage them at the lowest cost rather than whatever is most valuable to students and
employers. Perversely, uniform pricing of student loans subsidizes the subject areas that are least
economically valuable, while penalizing those that are most valuable.”15
Conclusion
The growth of student loan delinquency rates is a serious problem affecting not only the students and
their families who borrow the money, but also the overall health of the economy. Many of the causes of
student loan delinquency rates are a result of the complex historical interplay between the private sector,
the government, and the student lender. Imbedded deep within this complexity, solutions can be
identified to help mitigate and ultimately eliminate the majority of the student loan delinquency problem.
I thank the college candidates and their parents/legal guardians for reading this problem memorandum.
I hope that you will share in exposing the severity of the student loan delinquency problem, and thus
provide the clarity and information necessary for others and yourself to make more sound financial
decisions about higher education.
Michael Tanney
PAF9103
September 17, 2014
Notes
1
Pike, Allen. "Half A Million More Americans Are In Default On Their Student Loans Than A Year Ago."
ThinkProgress RSS. N.p., 06 Aug. 2014. Web. 13 Sept. 2014.
<http://thinkprogress.org/education/2014/08/06/3468269/student-loan-defaults-rise/>.
2
"LBJ Library and Museum - Education WHCA370." LBJ Library and Museum - Education WHCA370.
N.p., n.d. Web. 13 Sept. 2014. <http://www.lbjlib.utexas.edu/Johnson/lbjforkids/edu_whca370text.shtm>.
3
United States. Cong. Higher Education Act of 1965. Cong P.L. 89–329. District of Columbia: n.p., 1965.
Web. 11 Sept. 2014. <http://legcounsel.house.gov/Comps/HEA65_CMD.pdf>.
4
"Sallie Mae Selects Navient as Name For New Loan Management, Servicing, and Asset Recovery
Company." Sallie Mae Selects Navient as Name. N.p., 25 Feb. 2014. Web. 11 Sept. 2014.
<http://news.salliemae.com/press-release/corporate-and-financial/sallie-mae-selects-navientname-new-loan-management-servicing->.
5
"20 U.S. Code 1087-€ 2 Student Loan Marketing Association." LII / Legal Information Institute. N.p., n.d.
Web. 13 Sept. 2014. <http://www.law.cornell.edu/uscode/text/20/1087-2>.
6
"Government Extends Its Power in Student Lending." Washington Post. The Washington Post, 21 May
2008. Web. 12 Sept. 2014. <http://www.washingtonpost.com/wpdyn/content/article/2008/05/20/AR2008052001912.html>.
7
"Reconciliation Bill: Obama Student Loans Program." SimpleTuition. N.p., n.d. Web. 11 Sept. 2014.
<http://www.simpletuition.com/student-loans/obama/>.
8
Brown, Meta, Andrew Haughwout, Donghoon Lee, Joelle Scally, and Wilbert Van Der Klaauw.
Measuring Student Debt and Its Performance. New York Federal Reserve, Apr. 2014. Web. 13
Sept. 2014. <http://www.newyorkfed.org/research/staff_reports/sr668.pdf>.
9
Michon, Kathleen, J.D. "Student Loan Debt in Bankruptcy." NOLO Law For All, n.d. Web. 11 Sept. 2014.
<http://www.nolo.com/legal-encyclopedia/student-loan-debt-bankruptcy.html>.
10
Dai, Emily. Student Loan Delinquencies Surge. St. Louis Federal Reserve. N.p., Spring 2013. Web. 12
Sept. 2014. <https://www.stlouisfed.org/publications/itv/articles/?id=2348>.
11
Rampell, Catherine. "Re: Why Tuition Has Skyrocketed at State Schools." Web log comment. New
York Times, 2 Mar. 2012. Web. 12 Sept. 2014.
<http://economix.blogs.nytimes.com/2012/03/02/why-tuition-has-skyrocketed-at-stateschools/?_php=true&_type=blogs&_php=true&_type=blogs&_php=true&_type=blogs&_r=2&>.
12
Bidwell, Allie. "Bill Would Shorten Financial Aid App, Expand Grant Access." US News. U.S.News &
World Report, 19 June 2014. Web. 13 Sept. 2014.
<http://www.usnews.com/news/articles/2014/06/19/senators-propose-legislation-to-simplifycollege-financial-aid-process>.
13
Bidwell, Allie. "Lack of Financial Literacy Complicates Student-Aid Process, Report Says." The
Chronicle of Higher Education. N.p., 3 May 2013. Web. 12 Sept. 2014.
<http://chronicle.com/article/Lack-of-Financial-Literacy/139223/>.
Michael Tanney
PAF9103
September 17, 2014
14
Mishory, Jen, JD, and Rory O'Sullivan, JD, MPP. The Student Perspective on Federal Financial Aid
Reform. Young Invincibles, Nov. 2012. Web. 12 Sept. 2014. <http://younginvincibles.org/wpcontent/uploads/2012/11/Student-Perspective-on-Federal-Financial-Aid-Reform.pdf>.
15
Simkovic, Michael. Risk-Based Student Loans. Social Science Research Network. Washington and Lee
Law Review, 5 Sept. 2011. Web. 12 Sept. 2014.
<http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2250562_code572508.pdf?abstractid=19410
70&mirid=5>.