Subprime Mess Reaches Higher Ed

Policymakers and journalists, don’t be fooled by the Career College Association’s spin. Sallie Mae’s decision last week to stop engaging in subprime student lending at some of the most scandal-ridden chains of for-profit colleges is good news for low-income and working class students, not bad.

For years, Sallie Mae and some other lenders have “partnered” with giant publicly-traded, for-profit higher education companies to provide high-cost private student loans, with interest rates and fees of more than 20 percent, to low income and minority students who normally wouldn’t qualify for them because of their subprime credit scores. Serious questions have been raised about whether some of these companies such as Career Education Corporation and Corinthian Colleges — which have both come under scrutiny from federal and state regulators and have faced numerous class action lawsuits by former employees, shareholders, and students over allegations that their schools have engaged in aggressive and misleading admissions tactics — have duped disadvantaged students into taking on private loan debt without making them aware of their cheaper loan options first.

Just how risky are these loans? According to a leaked Wall Street equity research firm analysis of the for-profit sector, Sallie Mae requires some for-profit higher education companies to take on some of the risk of these loans defaulting because of “high levels of uncollectibility.” For example, Career Education has had a “recourse loan” agreement with Sallie Mae that requires the company to pay the lender a fee worth 25 percent of the subprime loans funded at its schools to cover expected losses on the debt. Corinthian’s recourse agreement “has historically ranged from 20% to 40%” of the value of the recourse loans funded, the Wall Street equity research firm analysis states. Meanwhile, Senate investigators recently reported that the subprime loans Sallie Mae offered to one such school had an expected default rate of 70 percent.

Why have Sallie Mae and some other loan providers been willing to make these types of loans if they are so risky? These loan companies appear to have viewed these loans as “loss leaders,” meaning that the lenders have been willing to risk having a large number of private loans go into default in exchange for becoming the exclusive provider of federal and private loans for the tens of thousands of financially-needy students these huge chains serve. Because federal law makes it virtually impossible for borrowers to discharge private student loans in bankruptcy, subprime borrowers remain on the hook for these loans, whether they have the means to repay them or not.

So how much subprime borrowing has been occuring at these schools? Given the data available, it’s difficult to say, but it appears to be substantial. Corinthian Colleges revealed last week that private loans accounted for 13 percent of its U.S. revenue last year, and that 75 percent of these loans went to borrowers with subprime credit scores. Career Education Corp. did not provide comparable data. However, we know from the leaked Wall Street equity research firm analysis that private loans made up 22 percent of that company’s revenue stream last year. And In its announcement last week of Sallie Mae’s decision to stop providing subprime loans to its campuses, Career Education Corporation estimated that recourse loans to new students accounted for up to $60 million of that revenue.

These numbers are alarming when considering the spotty record with which these relatively high-priced schools graduate students. For example, at American Intercontinental University at Los Angeles, which is one of Career Education Corporation’s flagship campuses, only 20 percent of students who entered the school in 2000 graduated within six years, according to data collected by the U.S. Department of Education. Low-income and working class students who are at a high risk of dropping out should never have been stuck with loans with such usurious terms.

Sallie Mae officials are finally beginning to recognize the error of their ways. “Sallie Mae has lent too much money to students who have gone to schools without very good graduation rates,” Al Lord, the company’s Chief Executive Officer, recently told investors.

The loan giant, however, did not alter its practices, because it had a crisis of conscience. It did so out of economic necessity as the company is spending hundreds of millions of dollars to cover losses on bad loans it should never have made. Sallie Mae and the for-profit higher education companies are now paying the price for their predatory practices. But it is the students who were harmed by these practices who will suffer the most.

Hopefully, when the House of Representatives turns to consideration of the Higher Education Act reauthorization in the next week or so, Congressional leaders will recognize who the real victims are and take at least one very important step to ease their burden.