Group calls for improved supervision of student lenders

http://chronicle.com/article/Group-Calls-for-More-Oversight/144127/?cid=pm&utm_source=pm&utm_medium=en

"The Sallie Mae Saga: A Government-Created Student Debt Fueled Profit Machine"
http://www.studentloanborrowerassistance.org/wp-content/uploads/File/report-sallie-mae-saga.pdf

Will Student Loans Be the Next Bubble to Burst?

          Background.  In the early 1990s, the savings-and-loan debacle shook financial markets and hammered employee pension plans.  A decade later, the dot-com bubble burst, throwing the U.S. into recession and gutting another gaggle of pension funds.  Worst of all was the 2008-09 derivatives-driven debacle.  This disaster, which left many individual brokers richer than Croesus, but bankrupted (e.g., Lehman Brothers), nearly destroyed (e.g., AIG), or forced distressed sale of (e.g., Bear Stearns, Merrill Lynch) their firms, has generated a plethora of lawsuits.  It’s no surprise that pension plans are among the plaintiffs, as a brief review of a sampling of recent decisions reflects:

• IBEW Local 90 Pension Fund v. Deutsche Bank AG, 2011 WL 6057812 (U.S. District Court, S.D.N.Y., December 5, 2011): The complaint alleges that during the Class Period, the defendants issued materially false and misleading statements regarding Deutsche Bank's business and financial results. The plaintiffs also allege that the defendants concealed the Company's failure to write down impaired securities containing mortgage-related debt and intentionally disregarded findings that residential mortgage loans did not comply with underwriting guidelines. As a result of the defendants' alleged misconduct, Deutsche Bank's securities traded at artificially inflated levels during the Class Period.  Because of the precipitous decline in the market value of the Company's securities, the plaintiffs and putative class members suffered significant losses.
• The Government of Guam Retirement Fund v. Bank of America Corp., Case No. 2:11-cv-06239 (U.S. District Court, C.D.Cal., Nov. 22, 2011):  “On November 22, 2011, Bank of America Corporation reached a settlement with various institutional investors who had opted out of a $624 million settlement in 2010 stemming from allegations that Countrywide Financial Corporation’s officers made false statements regarding its lending standards and the quality of its home loans. Bank of America purchased Countrywide in 2008.The terms of the settlement were not disclosed, but the settling plaintiffs include the California Public Employees’ Retirement System, T. Rowe Price Group Inc., BlackRock Financial Management, Inc., and others. The original complaint was filed against Countrywide in July 2011, and alleged that the bank's public statements - assuring investors that the loans behind the mortgage-backed securities were high quality - were false, and that the securities included risky lending practices to subprime borrowers.” (Source: http://www.lowenstein.com/sflupdates/#BOA_AG1; motion accessible at http://www.lowenstein.com/files/Uploads/Documents/CapitalMarkets/settlementmotioncountrywide.pdf)
• Employees Retirement System of the Government of the Virgin Islands v. Morgan Stanley & Company, Inc., 2011 WL 4526045 (U.S. District Court, S.D.N.Y., September 30, 2011): Institutional investor filed class action complaint for common law fraud and unjust enrichment against brokerage firm, which marketed and sold AAA-rated notes issued as part of a collateralized debt obligation (CDO). The brokerage moved to dismiss. The District Court held that:

(1) the investor failed to adequately allege that brokerage firm made a materially false misrepresentation or omission of fact, and (2) unjust enrichment claim was preempted by New York's Martin Act.

           Extent of student loan exposure.  In November of last year, the Federal Reserve Bank of New York’s Research and Statistics Group released its Quarterly Report on Household Debt and Credit. (http://www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q32011.pdf)   The report contains a startling and very disturbing admission:

Revisions to Student Loan and Total Debt Balances

From the inception of the FRBNY Consumer Credit Panel, we have frequently compared the aggregate balances reported on our sample of consumer credit reports to other publicly available sources of data. For most categories of consumer debt, our aggregate figures are close to other public estimates and/or we are able to understand the differences we observe. However, we came to realize that our aggregate reported student loan balance was at the low end of the substantial range of publicly available sources. After several months of discussions with our vendor, we have now come to understand the source of this difference.

Our new data reflect changes to our vendor’s method of identifying outstanding student loans in 2011Q2 and 2011Q3. In particular, the new data for student loan balances – and total debt outstanding – incorporate additional student loan accounts that had previously been excluded.

The revisions to the data are fairly substantial: as of our August report, 2011Q2 student loan balances were reported at $550 billion. We now estimate that student loans outstanding in that quarter (2011Q2) amounted to $845 billion, $290 billion or 53.7% higher than we reported earlier. These previously excluded loans were also missing from the total debt outstanding; as a result, our estimate of total debt outstanding in 2011Q2 is also revised upward by $290 billion (2.5%).

For now, we only have data using the revised methodology for the two most recent quarters – 2011Q2 and 2011Q3. As noted above, the charts and data for the 2011Q3 Quarterly Report have been adjusted and annotated to reflect this fact. We are continuing to work with our vendor to make revisions to earlier data (1999Q1-2011Q1) and will report revised data when we have them.

       In the wake of this revelation, one knowledgeable commentator opined, “It is estimated that by the end of 2011 national college debt will surpass $1 trillion—that’s even more than the nation's credit card debt. Undergraduate students, on average, will owe $25,000 at the time they graduate, and they will be heading out into a job market that hired 20 percent of law school graduates as food servers in 2010.  While much focus has been placed on the problems associated with the funding sources (or lack thereof) responsible for the student debt crisis, few have taken aim at the actual increase in the cost of education, which has outpaced inflation by 3.1 percent.”

      He adds, “In an attempt to ease the student debt burden, President Obama recently approved a new student loan plan allowing students to consolidate their loans, lower their interest rates and reduce monthly payments to 10 percent of their discretionary income over a 20 year period; any remaining debt after 20 years will be forgiven.  This plan is scheduled to take effect in January 2012 and represents the first sign of relief for students in recent years.  President Obama's bill will help an estimated 1.6 million students meet their financial obligations, but his solution does not address the underlying problem regarding the continued increase in the cost of public education.” (Jon Berk, “Student Debt Crisis Hits Tipping Point,” Faculty Row, Dec. 1, 2011, accessed at http://www.facultyrow.com/profiles/blogs/student-debt-crisis-has-reaches-breaking-point)

       Regarding the Obama plan referred to above, the White House issued a Q&A that included:

1. What is income-based loan repayment?  Income-Based Repayment (IBR) is a repayment plan that caps your required monthly payments on the major types of federal student loans at an amount intended to be affordable based on income and family size. All Stafford, PLUS, and Consolidation Loans made under either the Direct Loan or Federal Family Education Loan programs are eligible to be included in the program. Loans currently in default and Parent PLUS Loans are not eligible for the income-based repayment plan.  The program lowers monthly payments for borrowers who have high loan debt and modest incomes, but it may increase the length of the loan repayment period, accruing more interest over the life of the loan.

2. Who qualifies for IBR?  IBR helps people whose federal student loan debt is high relative to income and family size. While your loan servicer (the company you make your loan payments to) will determine your eligibility, you can use the U.S. Department of Education’s IBR calculator to estimate whether you are likely to qualify for the plan. The calculator looks at your income, family size, and state of residence to calculate your IBR monthly payment amount.  If that amount is lower than the monthly payment you are paying on your eligible loans under a 10-year standard repayment plan, then you are eligible to repay your loans under IBR.

3. Will my eligibility change if I'm married? What if my spouse also has loans? If you are married and file a joint federal tax return with your spouse, both your income and your spouse’s income are used to calculate your IBR monthly payment amount. If you are married and you and your spouse file a joint federal tax return, and if your spouse also has IBR-eligible loans, your spouse’s eligible loan debt is combined with yours when determining whether you are eligible for IBR. If the combined monthly amount you and your spouse would pay under IBR is lower than the combined monthly amount you and your spouse are paying under a 10-year standard repayment plan, you and your spouse are eligible for IBR.

4. How will President Obama's changes help lower my monthly payments though IBR? In the 2010 State of the Union, the President proposed – and Congress quickly enacted – an improved income-based repayment plan that allows student loan borrowers to cap their monthly payments at 15 percent of their discretionary income. Starting July 1, 2014, the IBR plan was scheduled to reduce that limit from 15 percent to 10 percent of discretionary income for all new borrowers. The President today announced that recent graduates shouldn’t have to wait that long to see lower monthly payments. Pay As You Earn will limit student loan payments to 10 percent of a graduate's income in 2012, rather than having to wait until 2014. This cap will reduce monthly payments for more than 1.6 million borrowers. 

5. How will enrolling in IBR affect my monthly payments compared to the standard repayment plan? It depends on your income. But, take for example a nurse who is earning $45,000 and has $60,000 in federal student loans. Under the standard repayment plan, her monthly repayment amount is $690. The currently available IBR plan would reduce her payment by $332, to $358.  President Obama’s improved “Pay As You Earn” plan -- reducing the cap from 15 percent to 10 percent -- will reduce her payment by an additional $119, to a more manageable $239 -- a total reduction of $451 a month.

6. How will enrolling in IBR affect my payments over the life of the loan compared to the standard repayment plan?  In general, your payments will increase as your income does, but they will never be more than they would have been under the standard 10-year repayment plan. Although lower monthly payments may be better for some borrowers, lower payments may also mean you make payments for longer and the longer it takes to pay your loans, the more interest you pay compared to the standard repayment plan.

7. Is it possible my payments will be higher under IBR than they would under the standard repayment plan? IBR will never cause your payments to increase more than they would have been under the standard repayment plan. It is possible, however, that your income and the size of your outstanding loan balance may mean that IBR is not beneficial to you. If your payments would be higher in IBR than they would be in the standard repayment plan, the IBR option will not be available to you.  Also, because a reduced monthly payment in IBR generally extends your repayment period, you may pay more total interest over the life of the loan than you would under other repayment plans.

(http://www.whitehouse.gov/blog/2011/10/26/how-president-obama-helping-lower-monthly-student-loan-payments)

          Who holds this debt?  Sallie Mae (formally SLM Corporation) currently owns or manages the student loans of some 10 million former students.  These loans total $130 billion.  (http://www.money-zine.com/Financial-Planning/College-Loan/Sallie-Mae-Student-Loan/)  In July 2009, the Public Broadcasting System reported on “two federal lawsuits that have been brought against student loan giant Sallie Mae over the last few years. Both allege that company employees were given incentives to push large numbers of borrowers into forbearance. Both say Sallie Mae wanted to put those borrowers into forbearance to keep loan default rates artificially low. Both lawsuits say, in some cases, the borrowers did not know they were being put into forbearance.” The complaint in the more significant of the two lawsuits states:

Lead Plaintiff SLM Venture and additional plaintiff Sheet Metal Workers Local No. 80 Pension Trust Fund… allege the following upon personal knowledge as to themselves and their own acts, and upon information and belief as to all other matters….

5. In fall 2006, the prospects of new legislation and overall declining prospects of SLM’s FFELP business prompted Defendants to undertake a sale of SLM to private equity investors.  In November 2006, then-Chairman of the Board Albert Lord initiated negotiations with a group led by private equity firm J.C. Flowers & Co, Bank of America and JP Morgan.  A sale of SLM on favorable terms to the Flowers group or another buyer depended on Defendants’ ability to persuade investors that SLM remained an attractive acquisition target despite SLM’s declining prospects.
6. In an attempt to secure a sale of SLM as an attractive price, Defendants devised and implemented a scheme to boost short-term profits by sharply expanding SLM’s PEL portfolio through aggressive and indiscriminate lending, thereby, allowing SLM to book favorable near-term financial results.  Simultaneously, SLM used a series of accounting manipulations to defer recognition of the loan losses implicated by its high risk lending strategy. Between June 2006 and December 2007, SLM’s PEL portfolio more than doubled, growing from $7billion to $15.8billion.  
7. Defendants achieved the increase in SLM’s PEL portfolio by relaxing SLM’s standards for PELs and writing “non-traditional” loans to students with low credit ratings or who were attending proprietary (private, for-profit) schools with low graduation rates and high default rates.

(Complaint accessed at http://www.pbs.org/now/shows/525/9-3-09-FILED-Second-Amended-Complaint.pdf)

         These allegations are an eerie echo of the sub-prime-mortgages, bundled as so-called derivatives, which were the core causes of the 2008 financial-industry crisis.  In December 2011 a report, entitled State Inaction: Gaps in State Oversight of For-Profit Higher Education, was released by the National Consumer Law Center.  The NCLC opened the report with the warning, “The astronomical growth in for-profit higher education has exposed increasing numbers of students to the rampant fraud in the sector.”  The report argues, “State relief for students is critical because relief at the federal level is limited.  Many states have either a student tuition recovery fund… or a bond program to reimburse defrauded students.”  The report alleges conflicts of interest in some states, occasioned by for-profits’ dominance of state higher-education supervisory bodies, or statutes and/or practices which result in this sector of the higher-education industry enjoying similar undue influence.

       The NCLC report concludes with the warning, “The stakes are high.  If schools get away with fraud and deception, they leave individuals seeking to better their lives with nothing but worthless certificates and mountains of debt.”

        Combine the $1trillion dollars in student-loan debt with allegations of fraud in the student-loan industry and the tenacious nine-percent level of U.S. unemployment, and we arguably have the makings of another “Perfect Storm” in our financial markets with predictable impact upon, among other potential victims, employee pension funds.

        Who holds these student loans? According to www.finaid.org, financial institutions with billion-dollar or better exposures to a massive student-loan default include:

1.  Sallie Mae ($20.99 billion)

2.  Citi Student Loans ($6.87 billion)

3.  Wachovia Education Finance Inc. ($6.54 billion)

4.  Well Fargo Education Financial Services ($5.14 billion)

5.  Bank of America ($$4.92 billion)

6.  JP Morgan Chase Bank ($3.54 billion)

7.  Pittsburgh National Corp. ($2.65 billion)

8.  U.S. Bank ($2.26 billion)

9.  Discover Bank ($1.72 billion)

10. EdAmerica ($1.55 billion)

11.  National Education Loan Network (($1.55 billion)

12.  Citizens Bank Education Finance ($1.25 billion)

13.  Regions Bank ($1.14 billion)

14.  Fifth Third Bank ($1.12 billion)

15.  Access Group ($1.01 billion)

 A comprehensive list of financial institutions and other organizations holding significant amounts of student-loan debt is accessible at http://www.finaid.org/loans/biglenders.phtml.

     Author’s comment.  The trillion dollars in student debt, viewed as individual debt obligations spread across millions of current and former students, is arguably manageable.  A November 3, 2011, CNN Money story pegged the average student loan among students graduating in May 2010 at $25,250.   (http://money.cnn.com/2011/11/03/pf/student_loan_debt/index.htm) An employed alumnus ought to be able to manage that “mortgage” on his/her diploma.  The total student debt is spread across many financial institutions.  However, the New York Times reported the following repayment rates for 2009, citing U.S. Department of Education data: “Although the department issued no analysis or comparison of repayment rates by sector, outside advocacy groups that analyzed the data found that in 2009, repayment rates were 54 percent at public colleges and universities, 56 percent at private nonprofit institutions, and 36 percent at for-profit colleges.”  (http://www.nytimes.com/2010/08/14/education/14college.html)

       How serious a problem this dismal repayment rate poses for the debt holders, some of which remain in shaky shape from the 2008-09 crisis, is something I can’t judge.  The SML litigation, which continues at this writing and in which at least one union pension fund is a lead plaintiff, suggests to me that the threat of another bursting bubble is not purely hypothetical.  Meanwhile, one keen observer, Blogger Robert Applebaum (http://forgivestudentloandebt.com/) opined late last year, “President Obama's recent announcement was little more than a baby step on a journey of a thousand miles, however, I don't blame him for the shortcomings of his plan -- his announcement merely highlighted, for me at least, the limits of unilateral executive power. The president can only do so much on his own, without a Congress willing to do the job it was elected to do.

“Congressional Republicans have made it abundantly clear that their sole priority is the defeat of Barack Obama for a second term. All other issues are secondary to that singular goal and, as such, they're ignoring not only the will of the people, but the needs of the people at a unique time in our history when we need everybody working towards the common good of all. Ideological purity is fine for lecture halls and think tanks -- not so much for a nation of 310 Million people who are truly suffering in the wake of 30 years of failed economic policies.” (http://www.huffingtonpost.com/brett-greene/robert-applebaum-student-loan-forgiveness_b_1084979.html)       Mr. Applebaum’s politics are showing.  But his point may be well taken.

Source: Compensation & Benefits Law Bulletin, January 2012

http://legalsolutions.thomsonreuters.com/law-products/Newsletter/Compensation-and-Benefits-Law-Bulletin/p/100006287?siteTheme=swc&staticContentVersion=&staticContentUrl=%2Flaw-products%2Fstatic&siteId=legal&appVersion=-1.6.86