Studying Student Loans Part 2

by Ouida on April 29, 2010

Here is part two about the student loan provisions in the health care bill and how they will affect you.  You can read part one here

Part 2 The Good:

STUDENT LOAN REFORM – DID THE CHICKENS COME HOME TO ROOST?

By Ruth Vincent.

Some good though came from all of this with the entry of Government Direct Loans in 1994-95.  This additional competition resulted in the expedited delivery of student loans and loan proceeds to students/schools through the deployment of innovative computer technology and programs such as METEOR, National Student Loan Clearinghouse, National Student Loan Data System (NSLDS) for loan tracking and Mapping your Future for entrance and exit counseling which in my opinion continue to provide added value.

In 2008 with the financial collapse, student loan lenders were unable to raise capital through securitized bonds, lines of credit, etc. to make loans so the Government stepped in with the ECASLA program which allowed the Government to purchase loans from lenders for purposes of liquidity so they could continue to make FFELP loans to students. This was truly a sweet deal as it paid the lenders $75 per FFEL loan plus all accrued interest as of the date of the sale to the government less any origination fees the lender had paid to the Government. This program will expire June 30 2010 when all FFELP loans are made through the Direct Student Loan Program beginning July 1, 2010.

So what does student loan reform in the Health Care and Education Affordability Reconciliation Act of 2010 (HCEARA) mean for you?

  • All loans with first disbursements after July 1, 2010 will be made through the Direct Student Loan Program. About $40 Billion of the $61 Billion used to pay lender subsidities will be given directly to students through several program improvements:
  • Borrowers will continue to obtain their loans by applying through their financial aid office and will no longer have to be concerned about choosing their lender or having one chosen for them.
  • For a limited period of time July 1, 2010 to June 30, 2010, borrowers may use an In-School Consolidation to consolidate their loans into the Direct Loan program, (1) if the borrower has loans in at least two of the following categories: Federal Direct Loans, FFEL loans owned by a lender, and FFELP loans owned by the government under ECASLA (PUT) loans; (2) At least one of the eligible loans has not entered repayment.  Note of Caution: While there may be an interest break because the interest rate of the Consolidation loan will not be subject to rounding, borrowers lose their grace period consolidating while in school (unless this is subsequently changed in the law) and parent PLUS and Graduate PLUS borrowers are eligible for post-enrollment deferment only on PLUS loans not on Consolidated loansAs a reminder, NSLDS mentioned above can be used to track your loans while you are enrolled.

  • On July 1, 2010, interest rates for Direct PLUS loans will be 7.9% rather than 8.50% under FFELP.  As prescribed by earlier law, interest rates on Direct Stafford undergraduate loans will be 4.5% rather than 5.6 % and Direct Graduate Subsidized and Undsubsidized loans will remain at 6.8%

  • New borrowers as of July 1, 2014 will qualify for Income-Based Repayment (IBR) if the borrower’s standard repayment exceeds 10% of discretionary income (will be lowered to 10% of discretionary income) and loan forgiveness will result in 20 years of repayment. (Discretionary income is the amount of the borrower’s AGI that exceeds 150% of the poverty line for the borrower’s family size.)  Currently it is 15% of discretionary income and 25 years for forgiveness.  See link below:      http://studentaid.ed.gov/PORTALSWebApp/students/english/IBRPlan.jspp

Also (just for information) important under HCERA are the mandatory funding add-ons for Pell grants which raise the maximum grant for 2010-11 to $5500 from $5350 in 2009-10 with annual increases beginning in 2013-14 to match the COI-U (Consumer Price Index for Urban All Consumers).  It also made more students eligible in 2010-2011 by increasing the Expected Family Contribution (EFC) by $656 to 5273.

I have lots of friends in the student loan industry and have some who have lost their jobs.  No, I am not happy about it, but as a taxpayer I was no longer willing to pay for the greed in the industry.  The student loan industry like others undergoing change, must retool itself if it is to survive. It now has an opportunity in its new roles provided in HCERA in such areas as, default prevention and financial literacy at the local level and as cost competitive and effective servicers for the loans that will be originated under the Direct Student Loan program.

Hopefully, Higher Education will not erode these student level gains by continuing to raise its costs and therefore the price of education.  Higher Education where I have many friends is another enterprise needing reform.  All I can say is watch out Higher Education, your chickens are on their way home too!

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Studying Student Loans

by Ouida on April 28, 2010

My mother, Ruth Vincent, is a 40-year veteran of the student loan industry working at the college, state, federal, and corporate levels. She has consulted for the Gates Foundation. For years I have encouraged her to write about the industry and start a blog of her own educating students and parents about loans, how to get them, and how to prepare to pay them back. One of the best talks I have ever heard was the talk she gave in November 2001 for the Georgia Consortium for Financial Literacy. Subprime was just a word, but it was a word that had meaning for my mother. So did the word default. She made clear that students were graduating with levels of undergraduate debt that they were not likely to ever repay. At the time of her talk, grants for college were few and far between and the Pell grant amount had not changed in over 20 years. That and many other things changed with the passage of the health care bill. Yes, student loans were part of that bill. I knew something was up when my mother disclosed to my sister and brother-in-law that colleges tend to steer students toward lenders who offer the colleges the biggest kickbacks, not students the better interest rates.

First the dirty laundry of the student loan industry from my mom.
STUDENT LOAN REFORM – DID THE CHICKENS COME HOME TO ROOST?
by Ruth Vincent

Part 1: The Bad, The Ugly

Having started collecting National Defense Student Loans (now called Perkins Loans) in 1963, that no one thought they would have to pay back, left the ‘industry’ in 2004, and watched it from a far since, I am sorry to have to say it was about time for this reform. And yes, 1963 was before the Higher Education Act of 1965 (HEA) when the large Federal Family Student Loan Programs (FFELP) today were originally created, so believe me in my 41 active years, I witnessed and experienced the good, bad and ugly.

You note that I emphasize ‘industry’ which Wikipedia defines as the “production of an economic good (either material or service) within an economy”. I recall it was the mid to late 1980s following the 1978 enactment of the Middle Income Assistance Act (an amendment to the HEA) which made all students, not just low income students, eligible for student loans that we in student loans: lenders (profit and non-profit), guarantors, loan servicers (profit and non-profit), secondary markets, investment bankers, debt collection agencies, credit bureaus, etc. started referring to the business of making student loans as the Student Loan Industry. Suddenly, we became highly compensated CEO’s, Presidents, CFOs, Executive Vice-Presidents, etc. moving from student centered to bottom line operations because FFELP loans provided an opportunity to make a lot of money. We started getting larger by expanding operations, building expensive buildings often with lavish furnishing, identifying operational functions that could be split from non-profit to profit and state based loan operations began a competitive assault on other state based operations in an effort to book more loan volume on the balance sheet to increase income potential. Every time the Government talked about cuts to subsidities, we cried foul, predicted the demise of student loans and set loose your Washington based lobbyist with millions of dollars to stop the reform.

Before you knew it, students had multiple FFELP loans from multiple lenders, guaranteed by multiple guarantors and sold to multiple secondary markets and serviced by multiple servicers. And somehow we are mystified about the student loan default rate! Student borrowers no longer were primary, but just an output of production. Relationships between lenders and guarantors who also have a responsibility for lender oversight became tense when guarantors tried to intervene in this morass. Schools were being inundated with visits from lender and guarantor representatives some of whom were compensated by their success to obtain the school’s loan volume. School administrators in some cases made business decisions to settle scores with local agencies without regard for the best interest of students, but rather based on what lenders wined and dined them, provided the best entertainment at meetings, supported professional organizations, appointed them to advisory boards with paid travel and in some cases provided supplemental consultant opportunities. Though these things had gone on for years, the indiscretions became public in 2007. Might I add, in my opinion all fueled by “greed”.

End of Part I.  Thanks, Mom!

Commentary:  Okay by now we know the alphabet soup of the housing crisis:  MBS (Mortgage Backed Securities), CDO (Collateralized Debt Obligations), CDS (Credit Default Swaps).  Fannie Mae and Freddie Mac which create a secondary market for mortgages.  Now we read about a secondary market for student loans and multiple secondary markets for student loans.  Just like with mortgages, because the lender doesn’t retain the student loan on their books, but sell it into the secondary markets students may not understand who they need to deal with when issues arise with their loans.  It was all pretty gnarly.

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Patagonia

by Ouida on April 27, 2010

CNN Money featured a video interview with Yvon Chouinard founder of Patagonia. Chouinard is certainly the epitome of “do what you love and the income will follow.” An impassioned outdoors man, Chouinard used his knowledge of climbing to create some of the best ice and rock climbing gear available today. He opened Patagonia in 1970. I personally own only 2 articles of Patagonia clothing. Purchased on sale of course. One fleece pullover is over a decade old and my synchilla jacket is 5 years old. Both look as new as the day I bought them.

I always thought of Patagonia clothing as high quality, but expensive. It hardly occurred to me that the company would have an environmental message. They actually recover plastic pop bottles to create their recycled fleece fabric. They also have a program whereby you can surrender your old, worn out fleece from any manufacturer and Patagonia will recycle it turning into new material for new clothing.

Patagonia actually has a list of fabrics that they use in their clothing available for anyone’s perusal on their site. Yvon was asked during the interview what he would say to customers: “I would say only buy a jacket if you need one.” Wow! How is that for not promoting consumption for the sake of consumption. Here is the full interview here. (just takes a couple of minutes. Depending on your browser, it will play when you click or download)

Business, financial, personal finance news – CNNMoney-2.com

I just learned more about the Wolverine visiting their site than I ever knew.
Over the past week I have blogged about Goldman Sachs and Magnetar. It is just plain wonderful to see a businessman engaging his passion and extending a hand to do some good.

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Upcoming, my mother will contribute to the blog with an explanation of how the Health Bill affects student loans. Sounds like that reform was long overdue.

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I swear to goodness gracious, where do they get these names? In Goldman Sachs and the Three Bears I talked about the fraud charges against Goldman Sachs and I said at the end:  I doubt Goldman Sachs is the only investment bank who has done this.  Holy, Moly, I hadn’t even heard of Magnetar when I wrote this!  Basically, upstart Hedge Fund manager creates CDOs(collateralized debt obligations) then bets against them earning hundreds of millions for his share holders and costing the US taxpayer billions in bank bail outs.  Yes, the banks lost some money, but collected more in fees and individuals at the banks made tens of millions in bonuses.  Wow.  The crazy thing about Magnetar is that this hedge fund got started after the peak of the real estate market in 2005 when CDO officers at the banks began to sense an unwinding in real-estate markets and softening in home prices.  These CDO officers were beginning to see increasing mortgage defaults among subprime mortgages and they were thinking they weren’t going to be able to sell anymore CDOs.  Along comes Magnetar offering to buy CDOs.  They offered to buy the riskiest CDOs.  It goes something like this:

Joe buys a house and his mortgage, along with a hundred others, goes to create a Mortgage Backed Security, an income investment similar to a bond that pays interest to the investors who buy it as long as Joe and the others in the pool of mortgages who make up the Mortgage Backed Security make their payments as scheduled.

A very large pool of Mortgage Backed Securities is used to create a CDO.  Now the CDO is divided into slices or tranches, we’ll call them A, B, C, D.  Tranche A is considered the “safest” and tranche D is considered “toxic waste”.  Tranche A offers the least return for each dollar invested and tranche D offers the greatest return for dollar invested.  As you can imagine it is easy to sell the safer stuff to investors and hard to sell the unsafe stuff, the toxic waste to investors.

In 2005 as the mortgages began to default, CDO officers felt that the CDO market would come to a close because they would not be able to sell the toxic waste.  Here is the deal, if you create a CDO and you are forced to hold onto a portion of it because you cannot sell it to another investor, wouldn’t you rather be forced to hold onto tranche A?  That is what the creators of CDOs felt if they couldn’t sell the toxic waste there was no point in creating the CDO.

Folks if the CDO market had been allowed to collapse in 2005 as it was supposed to, we would have had a recession, but it wouldn’t have been as severe and millions of homeowners would now not be facing foreclosure.  They never would have been able to qualify for the mortgages they got in the first place.

Alas, it was not to be.  In steps Magnetar, offering to buy toxic waste.  Because the toxic waste was essentially pre-sold to Magnetar, the CDO industry got revived.  Now CDOs were assembled by a CDO manager and Magnetar would call individual managers and make suggestions about the securities that should be included in the CDO. Hmmmm.  Then they would go out in secret and take out insurance to reimburse themselves in the event the CDO failed.  Now no one would bug out if all Magnetar did was buy insurance to protect themselves in the event that the toxic waste failed, but that is not what happened.  They had a hand in the selection of “assets” or “securities” that ultimately went into the CDOs and, wouldn’t you know it, they had a tendency to select the riskiest assets to be included in the CDO.  Then they took out insurance, not to cover the toxic waste or the D tranche, they took out insurance to cover the B or C tranches.  These were much larger tranches than D and the insurance would pay out considerably more if an A,B or C tranche failed.  The insurance that they took out is called a Credit Default Swap (CDS) and the market for them is completely unregulated.  Who owns them is one big fat secret, a secret that is until an insured investment goes belly up and the firm who issues the CDS has to pay up.

So here is the deal laid bare.  Magnetar promises to buy CDO toxic waste for $10 million dollars.  The CDO is created.  The A, B and C tranches are sold to investors, but unbeknownst to them Magnetar has pressured the CDO manager to include “likely-to-fail” assets in the CDO.  Magnetar then takes out insurance on tranche B or C and makes a killing when the CDO fails.  Their success formula?  Rinse and repeat.  Magnetar sponsors the creation of 26 CDOs all but one, the first CDO they created, Orion, has failed.

Honestly these are suspenseful stories and they are fun to read and comment on.  If these were a bunch of guys in suits ripping each other off, I got no problem, but over the last two decades, average investors have been pulled into the markets, mutual funds, endowments, trusts and pension funds fell victim to the Magnetar trade.  Some have sued and have regained a meager portion of their losses but most have been stunned into silence.  The problem is that the 401K is at the center of the majority of American’s retirement plans and mainstream financial medial is pushing the average person to invest heavily in stocks.

We need financial regulation because it is not just guys in suits stealing from each other.  The American public is caught in the crossfire.

Resources:

This American Life Episode 405 explains the Magnetar Trade.

Propublica.org Investigative journalism that explains the Magnetar Trade.

Finally, I just picked this up. If is written by a member of the Virginia Fed.

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