Senator Dodd’s Second Chance

Will Sen. Chris Dodd once again stand in the way of a vital reform proposal that aims to prevent students from taking on unnecessary private loan debt? We will find out next week when the Senate takes up legislation that the Democratic Senator from Connecticut drafted to overhaul the nation’s financial regulatory system.

At issue is a proposal that is included in the House of Representatives version of the Wall Street reform bill that would require colleges to certify a student’s need for private loans before that individual could receive them. The plan aims to give college financial aid administrators the opportunity to counsel students before they take out expensive private student loans. This is important because, according to the most recent U.S. Department of Education data available, nearly two-thirds of undergraduates who borrow private loans do so even though they haven’t exhausted their eligibility for lower-cost federal student loans first. One quarter of these private loan borrowers do not take out any federal loans at all.

The Senate bill does not include this provision. So far, Dodd has resisted pleas from college lobbyists, consumer advocates, and student groups to include it. Instead, he continues to support a toothless alternative measure he helped push through Congress in 2008.

At the time, students were regularly being inundated with television and radio advertisements and pop-up ads on the Internet from direct-to-consumer private student loan companies that were promising them easy-to-obtain loans of up to $50,000 a year. The ads did not mention that private loans lack the fixed rates, consumer protections, and flexible repayment options of federal student loans. Even worse, many of these companies implicitly discouraged students from taking out federal loans, by stressing how much easier it was to obtain a private loan than a federal one.

Alarmed by these practices, the House included a provision in the Higher Education Act reauthorization legislation it was considering that would have required schools to certify all private student loans. The lawmakers were hoping to build off effort by schools like Barnard College and Colorado State University, which through their counseling efforts had been extremely successful in discouraging students from taking on excessive amounts of private loan debt.

Under heavy lobbying pressure from direct-to-consumer private loan providers, Dodd, the chairman of the Senate Banking Committee, stood side-by-side with the ranking Republican on his panel, Sen. Richard Shelby of Alabama, in opposing the provision.

Instead, Dodd forged a compromise — which was ultimately included in the final reauthorization bill — that simply required students seeking private loans to “self-certify” that they were aware of their federal student loan options.

At Higher Ed Watch, we were extremely disappointed in this outcome. We held out hope, however, that the Federal Reserve Board, in drafting rules to carry out this provision, would require students applying for private loans to obtain the self-certification forms from their college financial aid offices. This would have at least given colleges some opportunity to provide counseling to their students.

Unfortunately, the final regulations the Fed published completely undercut the purpose of the law by allowing lenders to provide students with pre-filled self-certification forms that they could simply sign and send back. In other words, direct-to-consumer private loan providers can continue to circumvent the schools.

Over the last year, more and more evidence has emerged about just how misguided this regulation is. According to Sallie Mae, the country’s largest private student loan provider, school certification reduces the amount of private loans students borrow 30 percent of the time. Meanwhile Moody’s Investor Services has reported that school-certified private loans have significantly lower default rates than uncertified private loans do. For example, Moody’s found that First Marblehead’s direct-to-consumer loans were approximately three times more likely to default than private loans the company distributed that were certified by colleges.

Luckily, with the financial regulatory overhaul bill, Congress has a second shot to get this right. Hopefully, Senator Dodd won’t make the same mistake again.