States Put Stamp on Student Loan Oversight

Before the legislative session that began in January, consumer groups in Colorado had twice sought to work with state lawmakers to pass a bill establishing a student borrower bill of rights, coming up short both times. But with Democrats in control of both state houses in 2019 and a new attorney general focused on consumer protections, the measure passed in May with days left in the legislative session.

Charley Olena, the advocacy director at New Era Colorado, a progressive group that backed the bill, said student debt had come to be a prominent concern for voters in midterm elections in a way it hadn’t before.

“Debt wasn’t necessarily an issue rising to the top before,” she said. “There were a lot more people in the legislature willing to engage with us on it this time.”

Lawmakers in a growing number of states have sought to tackle student debt as a consumer protection problem. Over the first half of 2019, legislatures have enacted a flurry of bills taking aim at the companies that process and handle payments on the roughly $1.5 trillion in outstanding federal student loan debt.

Loan servicers have come under increased scrutiny from consumer advocates in recent years. And the Trump administration’s decision to dial back federal oversight of the industry appears to have prompted several states to act themselves, often at the urging of consumer groups.

New state regulations are testing arguments by Education Secretary Betsy DeVos and the Trump administration that only the federal government, and not the states, has the authority to police loan servicers. Recent court rulings, though, appear to have only strengthened the hand of states seeking to wield more oversight powers.

Seven states so far this year have passed laws requiring loan servicers to meet consumer protection requirements. And a bill that may be the most far-reaching in the country could be headed for passage in the California Senate.

Most of the new laws require loan companies to be licensed through the state and ban deceptive practices. They also will lead states to create several new ombudsman offices to which borrowers can turn with complaints or unanswered questions about student loans.

Critics of servicers say state consumer protections are finally catching up to the scale of the problem. But the industry argues it’s taking the blame for deeper problems with the structure of the federal student loan system. And loan companies say the new laws could create a patchwork of regulatory regimes that drive up costs without real benefits for borrowers.

Only a handful of states and the District of Columbia had sought to regulate loan servicers before this year. The new laws will test the impact of state regulation on a scale not seen before, covering millions more borrowers across the country.

Filling Gaps in Oversight

Under the Obama administration, the Consumer Financial Protection Bureau put the spotlight on the servicing sector. The agency began collecting thousands of complaints from student borrowers -- many of them involving issues like faulty information from servicers or errors in processing payments. It began publishing statistics on those complaints in annual reports. In January 2017, the consumer bureau (along with the attorneys general for Illinois and Washington State) filed a lawsuit against the servicer Navient that helped paint the Delaware-based company as a poster child for misconduct by student loan companies.

The company has denied wrongdoing in response to the lawsuit and argued witnesses failed to confirm the allegations by CFPB.

In recent years, DeVos has made an aggressive shift in its oversight of loan servicers. In 2017, she killed an information-sharing agreement between the Education Department and CFPB allowing the agency to track consumer complaints. Mick Mulvaney, the director of the Office of Management and Budget, also shuttered a special CFPB unit dedicated to student loan issues last year.

And after pressure from loan servicers facing new state regulatory regimes, DeVos declared last year that states don’t have the authority to regulate federal student loans. That hasn’t deterred state legislators. While several of those laws emerged from new Democratic trifecta states, a bill adding oversight of loan servicers was also signed into law by Republican governor Larry Hogan in Maryland this year.

“What you’re seeing now is an effort by elected officials across the country -- most of which are being done in bipartisan fashion -- to ensure people who take on student loan debt, when they get ripped off, can get some justice,” said Seth Frotman, executive director of the Student Borrower Protection Center.

Frotman was the student loans ombudsman at CFPB before publicly resigning last year in a letter that rebuked the Trump administration’s higher ed policies. He’s also played a big role in pushing for new legislation targeting loan servicers at the state level.

His group hailed the California State Assembly's passage in May of the loan servicing legislation, which is currently in committee in the Senate. The bill would go further than most other new state laws by requiring that board members of servicing companies pass background checks. Consumer complaints found to be valid under the bill could also result in monetary damages being assessed against the companies.

Scott Buchanan, executive director of the Student Loan Servicing Alliance, the industry trade group representing servicers, said those companies are taking the blame for issues outside their control. Many complaints from borrowers, he said, are related to loan repayment or forgiveness options that were made complicated by Congress. The new state requirements, Buchanan said, “don’t move the needle for borrowers who are really struggling.”

SLSA opposed legislation in California and other states. Buchanan warned that the requirements could drive up compliance costs and force companies to spend money defending themselves from lawsuits.

“Our interests are already pretty well aligned with those of borrowers,” he said. “Our incentives financially are to keep a borrower in repayment, not to become delinquent or default.”

A New Playing Field for Loan Companies

The industry has argued for years that states don’t have the authority to regulate federal contractors -- ever since the first student borrower protections passed in states like Connecticut and Illinois. But a recent federal court ruling undercut that position.

Last month, the U.S. Court of Appeals for the Seventh Circuit ruled that a student borrower in Illinois could sue her loan servicer, Great Lakes Education Loan Services, for violations of the state’s consumer protection laws. The borrower, Nicole Nelson, argued that the company steered borrowers away from options like income-driven repayment toward inferior options like forbearance.

The court ruled that while the Higher Education Act states that loan servicers are not subject to state disclosure requirements, the company could be sued for affirmative misrepresentations -- in this case, statements that representatives offer expert help or that they work on behalf of borrowers, not the company.

“The biggest impact of the decision is that it clarifies that loan servicers are not effectively immune from state consumer protection law,” said Dan Zibel, vice president and chief legal counsel at the Student Legal Defense Network. “The argument they’ve been making fundamentally is that the Higher Education Act pre-empts state law.”

Colleen Campbell, director of postsecondary education at the Center for American Progress, said it’s likely that more borrowers will bring lawsuits against their loan servicers as a result of new state regulations.

“The inclination of folks now is to handle as much as possible in the courts,” she said. “I worry that doesn’t address the root cause of these issues.”

Campbell, who studies how loan servicing can be improved, said Congress crafted federal student loan laws in a restrictive manner so that programs like loan forgiveness are difficult to access and repayment plans are difficult to navigate.

States are often on the front lines of dealing with resulting consumer issues and can push those problems onto the national level, she said. But Campbell said ultimately there is no replacement for federal accountability.

“We want borrowers to be treated the same across the country. I don’t want their treatment to be dependent on their servicer or the state that they live in,” she said. “And unless the Department of Education wants to hire thousands of new employees, we need the loan servicers.”