Regulating Private Student Loans

Exhorted by consumer groups, the Obama administration and its Democratic allies in Congress are moving to create a federal Consumer Financial Protection Agency, which is designed to regulate credit card fees and other forms of consumer credit that get comparatively little oversight from existing federal agencies.

Advocates for students have argued that the new agency could fill what they say are significant gaps in the government's ability to regulate non-federal student loans, which grew steadily in popularity as college tuitions rose throughout this decade.

But as the House of Representatives drafts its version of legislation to create the new agency, a broad coalition of groups are concerned that lawmakers may ignore a burgeoning form of alternative loans: those that for-profit colleges make directly to students to fill gaps in their ability to pay.

They are urging Congressional Democrats to clarify that a planned exemption in the bill designed to shield local merchants from excessive regulation would not apply to publicly traded higher education companies that are directly giving students tens of millions of dollars in small loans, often structured as consumer financing rather than student loans, and sometimes at double digit interest rates.

"To effectively protect consumers, the CFPA must have full authority to regulate private student loans regardless of the institution offering them," the groups wrote in a letter this month to Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee. "For consumers, a private student loan can pose the same serious risks whether issued by a financial institution or by a school. The CFPA should apply and enforce standards based upon the product and not the issuing institution."

A spokeswoman for Frank said that the committee would continue drafting the legislation this week, but that she could not comment on a report by a Wall Street analyst that Rep. Maxine Waters (D-Calif.), a long-time critic of for-profit higher education, would introduce an amendment to specifically subject loans made by the colleges to regulation under the proposed new agency.

For-profit college officials say the groups misrepresent the nature of the loans, which they say are designed to fill the gap (often as little as $1,000) between the federal aid the students qualify for and the cost of their educations, funds that have been harder for students to come by since the tightened credit markets crimped the availability of other private student loans. They also point out that relatively few colleges provide such financing, and argue that private student loans -- including those issued by institutions -- are already regulated, thanks to changes made in last year's renewal of the Higher Education Act.

'Gap' Loans and Federal Regulation

The full extent of for-profit colleges' "gap" loans, as they are often called, is, like much of the world of non-federal student loans, hard to gauge, precisely because they have historically been little regulated. In the wake of the 2007 scrutiny of student loans prompted by New York Attorney General Andrew M. Cuomo and Congressional Democrats, Congress took initial steps toward increasing federal oversight in last year's Higher Education Opportunity Act. The law makes private student loans subject to regulation under Regulation Z of the Truth in Lending Act beginning next February, imposing numerous new reporting and other requirements on providers of such loans.

But the facts that students are increasingly turning to such loans to pay ever-rising college tuitions, and that private student loans are not dischargeable in bankruptcy -- the subject of a House hearing last month -- have continued to stimulate calls for greater federal oversight of private loans.

As conceived by the Obama administration and Congressional allies, the proposed Consumer Financial Protection Agency would flesh out the federal government's ability to regulate various types of consumer credit for which existing U.S. agencies have limited authority -- including non-federal student loans offered by lenders.

Ironically, the poor economy and the new Higher Education Act rules on private loans have driven large numbers of traditional providers of private loans out of the market, and in their place, several of the major for-profit higher education companies have started making loans directly to students or stepped up the extent to which they do so.

The loans are designed to help students cover the part of their tuition bills that federal aid does not -- and to help the institutions themselves comply with a federal law that requires no more than 90 percent of their tuition revenue to come from federal sources.

But the loans are risky; an Associated Press article last month noted that two large providers of such loans, Corinthian Colleges, Inc., and ITT Educational Services, Inc., had noted in securities reports that they expected students to default on as many as half of their "gap" loans, based on the students' credit scores.

Facts like those -- and the reality that significant numbers of low-income students drop out of college (for financial as well as academic reasons) and end up struggling to repay their loans as a result -- pique the concerns of groups like the Institute for College Access & Success and the National Consumer Law Center, which are among the signers of last month's letter to Frank.

"Private student loans are one of the riskiest ways to pay for college, yet a growing number of students have private student loans as well as, or instead of, federal student loans," the groups wrote. "Private student loans are expensive, mostly variable-rate loans that cost more for those who can least afford them. They lack the fixed rates, consumer protections and flexible repayment options of federal student loans, and are not financial aid any more than a credit card is when used to pay for textbooks or tuition."

The groups say they are concerned that major for-profit colleges would fall under the umbrella of language that Frank included in a draft of his Consumer Financial Protection Agency legislation to placate small merchants that extend credit to their customers (see page 67 in this draft bill). "We just want to make sure that the risky financial products that some colleges, for-profits in particular, have been making to students are still covered by this agency, and not undercut by a well-intentioned suggestion of how to make sure that the neighborhood grocer isn’t unfairly and unduly impacted" by increased regulation, said Lauren Asher, president of the Institute for College Access & Success.

"It’s one thing to be able to buy your eggs and butter on credit," Asher said. "It's another to be sold a very risky financial product" to pay for an expensive college education.

Harris Miller, president and CEO of the Career College Association, which represents for-profit colleges, said the consumer groups' complaints are "disingenuous at best," given that "the institutional loans referred to in the letter are already covered by federal law, with limited exceptions, under TILA." And while Frank envisions the new agency filling gaps in areas where "existing regulatory systems apparently have failed to work properly to protect consumers," Miller wrote in an e-mail message, "there is no evidence presented in the letter or elsewhere that higher education institutional loans by not for profit or for profit institutions have caused consumer problems."

Trace A. Urdan, an analyst of for-profit higher education at Signal Hill, said in an e-mail message that restricting the ability of for-profit colleges to make small loans to their students could make it impossible for thousands of needy students to get the vocational training they need.

"The harm would accrue to those in greatest need of professional training, and for that reason it is a harmful policy direction," he said of attempts to end such lending. "To imagine that a student who is seeking the training in order to obtain a job that pays $14 per hour has $1,500 sitting around gathering dust shows a real lack of understanding of who these students are."