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The problem with student loans
Current system serves lenders, not the public interest

When Cedric Larson started his undergraduate program five years ago, he figured he would be able to cover the costs with scholarships, grants and part-time employment and avoid incurring any student debt. But, by the time he graduated this past spring with a degree in English and international studies, his undergraduate tuition at the UW-Madison had skyrocketed by 69%. He had to start borrowing. His current debt load: about $10,000.

"I learned to cut corners," he says. "I bought used books at book swaps, and I tried not to borrow any more than was necessary.

Larson, a Milwaukee native from a family without a lot of money, was active in United Council of Student Governments while he was a student. Now he is a paid United Council employee who continues to battle legislative budget cuts and rising tuition. He feels lucky to have the job because United Council gives him a tuition-remission benefit of $140 a month to help him pay back his loans.

As tuition rises at a rate several times higher than inflation, students are borrowing record amounts - by some accounts more than $20 billion a year. Student loans are the second-largest profit center for lenders, second only to credit card interest.

Lenders take very little risk on those loans. If a student defaults on a guaranteed student loan, the federal government makes the payments. If she defaults on a private loan, the lender imposes higher interest rates and penalties and garnishees wages. Even if a strapped former student declares bankruptcy, student loans won't be forgiven like other debts.

Loans to students are a cash cow for lenders. And, as an investigation by New York Attorney General Andrew Cuomo revealed about a year ago, it's a system ripe for abuse. There have been kickbacks, preferential treatment and uncontrolled interest rates as lenders competed for this astonishingly profitable business.

Congress responded to this scandal swiftly, by passing the College Cost Reduction Act. This capped subsidies to lenders and used the savings to make more grants and lower interest rates. Another proposal, the Student Loan Sunshine Act, would put stronger restrictions on lenders' practices.

It's a start, but it's not going to solve the problem, says Wisconsin Rep. Tom Petri (R-Fond du Lac).

"I believe that the College Cost Reduction Act and Student Loan Sunshine Act are important first steps towards reform," says Petri. "But taken alone, [they] are merely Band-Aids on the fundamentally and structurally flawed guaranteed loan program."

What's the fundamental flaw? The student loan system is set up to enrich lenders and their stockholders, not to serve students. And taxpayers are footing the bill.

According to Joe Nocera, business writer for The New York Times, the problems with the nation's student loan system originated when the government decided to lend to students through banks and other financial institutions rather than make the loans directly.

"It didn't have to be done that way," Nocera wrote in a July 29 article. "Congress could have decided that only the government could lend taxpayer dollars. But without a middleman, the loans would be listed as outstanding on the government's books, thus increasing the federal deficit. It was far more politically attractive to use banks to make the loans, and then guarantee them with the taxpayers' money."

The conservative notion that government should operate on a business model further muddied the waters.

"We have a lot of representatives who just assume that anything that comes from a government program is bad, and anything that comes from private enterprise is good," says Petri aide Tom Culligan. This is true "even when we can show that the government program is much more efficient."

This past summer, Petri tried to get Congress to pass a more comprehensive reform, which he believes would further drive down costs to taxpayers and allow more Pell Grants. The House Education and Labor Committee approved his proposal, but the conference committee removed it.

Petri and others argue that making government loans directly to students, without a middleman, would save billions of dollars. The model already exists in the Direct Student Loan program, but students must puzzle their way through a Chinese menu of financial aid options: direct loans, Stafford loans, alternative (private) loans, loans to parents, and that perennial favorite, credit card debt.

"I will continue to fight for comprehensive reform," says Petri, "to ensure that we put an end to these abuses that have plagued the program for decades at great expense to students and taxpayers."

Democratic presidential contender John Edwards has jumped on the student loan reform bandwagon. He's calling for a system that "takes banks - which are just an expensive middleman - out of the process, and focus on making sure young people aren't crushed by debt by the time they leave college."

The Cuomo Report, with its revelations about preferred lender lists and financial rewards offered to colleges and universities that put lenders on their lists, sounded an alarm in Wisconsin. Both the state university and technical college systems investigated practices in their own financial aid offices and reported back to the Assembly education committee in late September.

That hearing revealed that Wisconsin students have been spared some of the more egregious abuses uncovered in New York state, according to Mike Mikalsen, research assistant to Rep. Steve Nass (R-Whitewater). Nass serves on the Assembly Committee on Education and was a leader in bringing the issue to a hearing.

"We are concerned that some campuses use preferred lender lists and that the [UW] Board of Regents policy leaves the decision about whether or not to use such lists up to individual campuses," Mikalsen says. Technical colleges have stopped using preferred lender lists.

UW officials told the committee that some UW financial aid officers received expenses for attending conferences from lenders, but there was no evidence of major financial incentives or rewards for recommending particular lending institutions to students.

"A lot was made of the information that a financial aid officer in Milwaukee sat on the board of one of the lending institutions and that another had some travel expenses paid," says Dave Giroux, spokesman for the UW System.

He sees this as small potatoes.

"These were legitimate business activities, and these people were not benefiting personally," says Giroux. "Our investigation did not find any of the kinds of egregious [activities] that were uncovered in New York."

Giroux says UW System policy now requires that campuses publish a list of criteria for putting lenders on a "preferred" list. For example, they may list only lenders that do not charge a loan-origination fee.

UW-Madison doesn't use a preferred lender list, according to Susan Fischer, the university's director of student financial services. She says her office deals with about 280 individual lenders, although UW Credit Union loans account for 50% to 60% of lending to students at Madison.

"It's not very efficient," she adds. "I can understand why some smaller campuses might try to simplify their operations by limiting the number of lenders they have to deal with."

Currently, the UW Credit Union has about $160 million in student loans. That's roughly 20% of the its total loan portfolio.

Mike Long, vice president of lending, says the Credit Union does not sell these loans to big lenders like Sally Mae, but services them through the Great Lakes Higher Education Corporation: "We have a strong commitment to service to our members."

The Credit Union has been on "preferred lender lists," at some institutions, according to Long, but "we have never participated in the kind of revenue sharing or other activities that were revealed in New York."

Long says the College Cost Reduction Act will probably affect the Credit Union's bottom line, and the loss of subsidies for loans in default might mean that some of the benefits offered to student borrowers will be reduced. Currently, the Credit Union pays the loan-origination fee for borrowers and offers interest rate reductions to those who make their payments on time every month.

However, the Credit Union has relatively few loans in default. The default rate for UW-Madison students is about 1%; it's 2.5% statewide. That default rate is one of the lowest in the nation.

In 2005-2006, UW-Madison undergraduates with student loans (47% of all graduates) finished college with an average debt of $20,282, Fischer says. Graduate and professional school graduates who took out loans owed much more. Law school graduates who borrowed (228 of 286) owed an average of $64,535. New medical doctors with loans (124 of 134) owed an average of $130,938.

"For most students, the loan repayments will be manageable," Fischer says. But she worries about students who borrow much more than they need to finance a lifestyle that is luxurious by student standards. After they exhaust the funds provided by federal grants and loans, they borrow on the private market, where interest rates can increase dramatically, leaving students with much higher payments than they expected.

"The private, alternative loans are where most of the problems are," she contends.

The College Cost Reduction Act will cut subsidies to lenders by $19 billion, and lower interest rates on new federally backed loans. The intent is to provide more money as outright grants and help students avoid borrowing so much in alternative (non-government-sponsored) loans. The legislation provides for the repayment of some loans to students who go into jobs in "areas of national need," and rewards colleges for lowering costs to students.

These changes will help, but the interest rate reductions are not as dramatic as they appear at first look.

The 3.4% interest rate cap looks like half of the current rate of 6.8%, but the decreases will be phased in over four years. That means the combined interest rate will depend on when the student took out loans and for how much. And the cap expires after the fifth year. Former students now repaying existing loans are not affected.

On the upside, a former student making less than $18,000 does not have to make any payments until his or her income increases, and payments can never be more than 15% of adjusted gross income.

It's still too much, contends Ben Manski, a founder of the Madison-based Liberty Tree Foundation, a progressive nonprofit organization that seeks to promote a "democratic revolution" in all segments of American society.

Manski argues that the high cost of a college education is fundamentally undemocratic. His solution to the student loan mess is a system that provides education at public colleges and universities for free.

"An entire generation of Americans," he says, "are facing debt coming out of college that their parents could not even imagine."

For the 2007-08 school year, in-state tuition at the UW-Madison is $7,010. According to the campus Registrar's Office, other expenses - like books, room and board and transportation - bring the cost for the year to $18,010. (For nonresidents, tuition alone is $21,010.)

Today's student's parents paid a fraction of that. If they attended during the 1972-73 school year, their tuition was $470.

In addition, the Legislature has steadily nibbled away at the percentage of state funding provided to the university system. State support for the cost of undergraduate instruction in the UW System has dropped from 65.5% to 45% over the past 10 years.

Manski, who says his tuition increased by 56% during his three years in the UW Law School, graduated in 2005 with $70,000 in student loan debt. Many young lawyers don't worry too much about making their loan payments. But Manski, who chose to work as a public interest lawyer, only makes about $20 an hour. His loan payments eat up a big chunk of his monthly income.

"Most months, I figure it's between one-fourth and one-sixth of what I earn," he says.

Last summer's loan scandal is a symptom of a deeper crisis in higher education, he contends. The new legislation may help, but millions of former students with big debts won't be affected.

"The underlying problem is the cost of college in the first place," he says. "The high cost of a college education is undemocratic because it shuts out many people entirely."

Manski is thinking a lot these days about how to get out from under his own student debt. Ironically, he's considering taking on even more debt to get an advanced degree in law, to help him land a law school teaching position. He recently got married, he says, and he needs to make more money to pay off his loans.

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