The swelling trillion-dollar student loan market is missing key data and regulations necessary to head off another financial crisis, according to Rohit Chopra, the Consumer Financial Protection Bureau’s top official in charge of dealing with student loans.
In speaking before the Federal Reserve Bank of St. Louis on Monday, Chopra said it would be “irresponsible for financial regulators” to avoid taking action now to shield the $1.2 trillion student loan debt market from a severe bust. Chopra said regulators could act on a range of options without waiting for Congressional intervention, including requiring lenders to disclose more data and instating policies that encourage the refinancing of student loans.
“We must resist the temptation to address these concerns solely through an education policy lens, when, in fact, they may require very significant attention from financial regulators and the financial services industry,” Chopra said. “Congress enacted a wide range of reforms to the mortgage market; and they may shed light on options to address the significant structural deficiencies in the student loan market.”
Chopra’s concerns stem from similarities to the housing market collapse, including a significant growth in student debt coupled with “heavy use” of government guarantees through federal loan programs. Roughly 40 million Americans have $1.2 trillion in student debt outstanding, according to the CFPB with each borrower holding an average of $30,000 in debt.
While such debt is increasing, the wages for recent graduates are decreasing. Real wages for a young college graduate dropped by 5.4% while they fell 11.1% for high school graduates between the years of 2000 and 2011, according to the CFPB’s analysis of the Current Population Survey
Chopra said that as younger graduates struggle to pay down higher student debt with lower wages, it will become more difficult for them to get approved for a mortgage and further impede the housing recovery.
“Outstanding student loan debt has doubled since 2007 a stark contrast to the credit card and mortgage markets,” Chopra said. “Rising student debt burdens may prove to be one of the more striking aftershocks of the Great Recession, especially if continued to leave unaddressed.”
Chopra highlighted several options that can be addressed through regulation such as having institutions that securitize student loans in the secondary market hold 5% of the risk much like the risk-retention rules for securitized mortgages required in the Dodd-Frank Act. He also suggested lenders make a “good faith effort” to ensure borrowers have an ability-to-repay, similar to what the CFPB now requires in the mortgage market.
Chopra acknowledged criticism that it’s more difficult to require ability-to-repay since student lending is based on the student paying their debt after they graduate and have higher-waging jobs. But he contended that there other ways private student lenders can strengthen underwriting, such as some form of income-contingent plan commonly offered in federal loans.
“Private student lenders don’t offer these features and their loans were disproportionately utilized by students enrolled in programs with low graduation rates and high default rates,” Chopra said. “The Department of Education is currently seeking to address these moral hazard issues by addressing program eligibility for schools that may not be preparing graduates for employment that helps them repay their debt.”
Chopra also suggested that schools be paid by federal loan programs whether or not a student drops out of college.
“This may provide an incentive for schools, particularly for those who owe a fiduciary duty to shareholders, to focus primarily on enrollment rather than outcomes,” he said. “The similarity to a mortgage originator whose compensation is not dependent on loan performance is quite striking.”
Like the mortgage market, Chopra said he is also concerned with the lack of incentive for servicers to place struggling borrowers in some type of modification program. But he added that it was difficult to correctly analyze the default rates and success of modification programs since student loan data is aggregated with other non-mortgage loans when companies report financials to their regulator.
“While comprehensive data is not available, several major market participants in the federal guarantees program do not appear to be succeeding in enrolling struggling student loan borrowers in these income-contingent plans,” he said. “The CFPB and other regulators have made significant strides to assemble existing mortgage data to better monitor the market. Similar efforts are needed to better understand the drivers of student loan origination and performance, as well as the impact on household balance sheet composition and the mortgage market.”
The CFPB has already been calling on private student loan servicers to help struggling borrowers through some form of modification or lower payment plans but Chopra said the industry has made “little progress to date.” The CFPB has issued a proposal to supervise the largest non-bank private student loan servicers, which many observers expect to see finalized in the coming months.
“If finalized, the rule would create a level playing field between banks and nonbanks,” Chopra said in his prepared remarks. “Supervision can help correct deficiencies early, before harm becomes widespread.”