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Ed. Magazine

Don't Bank On It

Photo by Caroline Fleming-Payne

When President Barack Obama overhauled healthcare in March 2010, he also overhauled student financial aid by taking something away: the banks.

[caption id="attachment_2109" align="alignleft" width="200" caption="Photos by Caroline Fleming-Payne"]Piggy Bank in backpack[/caption]

The daughter of a Boston sheet metal worker, and the sixth of seven children, Patricia Reilly, Ed.M.’83, grew up figuring she’d live at home while attending college, as did her elder siblings. But Reilly’s high school counselor encouraged her to look beyond Route 128, insisting she’d qualify for enough financial aid to afford dorm life. Williams College wanted Reilly, and thanks to the aid she received, Williams ended up costing her parents less than if she lived at home while attending a state university.

After graduating, she worked in Williams’ financial aid office, launching a career that led to her current post as Tufts University’s director of financial aid. The mother of four, she now knows the system from the inside and out. Two years ago, three of Reilly’s own children were in college.

“I’m so much better at my job now,” she says. “If you want to talk about need-based aid, work study, and student loans, I’ve lived it. So that gives me more credibility with parents. They know that I get it, and we can commiserate.”

Reilly’s perspective, honed over more than 30 years in the field, continues to mature asthe financial aid system in the United States undergoes yet another round of reforms, and American families fret over how to pay the ever escalating costs of higher education. Advocates for low-income students, meanwhile, say increases in student aid and the availability of affordable students loans are the key to higher education access and a road out of poverty.

Major changes in the federal student loan industry last year capped several years of turmoil, including former New York Attorney General Andrew Cuomo’s investigation of deceptive loan practices. The 2008 banking crisis, sparked by the collapse of the subprime mortgage market, had a huge impact on the private student-lending sector as capital dried up, and federal intervention was needed to keep money flowing to students and to the institutions that serve them.

Legislation signed by President Barack Obama in March 2010, the Student Aid and Fiscal Responsibility Act, eliminated the private banking industry’s involvement in subsidized student loans, with students now borrowing directly from the federal government. Until this change, banks received fees to originate loans plus a “special allowance payment” each quarter for the loans they carried on their books. The government, which guaranteed the loans, assumed almost all of the risk. The Congressional Budget Office estimates that the 2010 reforms will save the government $61 billion over 10 years from payments now going to the private banking industry and nonprofit entities such as American Student Assistance (ASA) in Boston, one of the nation’s 34 guarantors of the government-insured private loans. Those savings will be plowed back into increased grant payments for low-income students under the Federal Pell Grant Program, improvements in the income-based repayment program, and deficit reduction.

Heading the Obama administration’s higher education initiative was Martha Kanter, Ed.M.’74, undersecretary of the Department of Education. It was tacked onto the landmark healthcare legislation in the spring of 2010, with the details hammered out in the budget reconciliation process.

“In these times of recession and pay-as-you-go sweeping the country, this seems like a great way to fund higher education for students, without further burdening taxpayers,” says Kanter, who came to Washington, D.C., in 2009 after working for three decades in the California community college system. “We want more low-income Americans to have an opportunity to go to college.”

Removing the private lenders from the subsidized loan program was not without pain. In 2010, Sallie Mae, the publically held banking concern that was the biggest player in the private market, slashed its workforce from 8,600 to 6,000. It also closed offices in Florida, Texas, and Washington in a company-wide restructuring to cut operating expenses by $200 million.

The nonprofit guarantor agencies took a hit too, with ASA shedding 275 of 800 jobs in 2010. While ASA will still service $40 billion in loans for the government to 1.6 million student borrowers, the agency has embarked on an effort to rebrand itself as an organization that focuses on debt management and default prevention.

Defaulting on a student loan can haunt young adults for years, ruining their credit and remaining a debt, even if they file for bankruptcy. Federal student loans are rarely discharged in such proceedings. One financial aid officer recalls how an alumnus who landed a job with the federal government many years after graduation had to work out a payment schedule before he was hired.

“Debt management is a contact sport, and we are finding ways to communicate with students,” says Peter Segall, Ed.M.’85, a member of ASA’s board of directors and former president of Blackboard, the online education platform. “We helped them get in debt. Now we have to help them get out.”

The reformed federal financial aid system emerged as part of the Obama administration’s push to get more young adults in college and move them along to graduation. Obama has set a goal of having 60 percent of Americans earn a bachelor’s degree by 2020, says Kanter.

Financial aid experts say adequate financial aid — through grants and affordable loans — needs to be in place to achieve that goal.

“Students with identical academic credentials are six times less likely to graduate from college if they come from the bottom income quartile, compared to the top quartile,” says William Fitzsimmons, Ed.M.’69, Ed.D.’71, Harvard College’s dean of admissions and financial aid. “No country can afford to waste so much talent if it hopes to play an important role in a world that needs more college graduates every year.”

Financial aid for college students involves public and private capital — from banks, the U.S. Treasury, and the 6,000 public and private colleges and universities that provided education for 20 million Americans in 2009. In 2008–09, the College Board reports that $168 billion in financial aid was distributed to undergraduate and graduate students in federal grants and loans, work study, federal tax credits, and deductions. In addition, students borrowed $12 billion, with federal loans comprising 45 percent of aid for undergraduates and 65 percent of student aid for graduate students.

Harvard’s Early Aid System

Providing financial support for needy students dates back to the early days of American higher education. Just seven years after Harvard College was founded in 1636, Lady Anne Moulson Radcliffe donated £100 in a fund for “the maintenance of some poor scholar,” according to Seymour Harris’ book Economics of Harvard. In 1814, the Commonwealth of Massachusetts imposed a bank tax, which over the next decade provided $10,000 a year to Harvard to defray the tuition fees of up to 50 percent of those enrolled.

By the early 20th century, Harvard was making loans to help students pay their tuition in a program that suffered one of the problems of today’s system: Students failed to repay their loans. In 1914, a report from Harvard’s president found that among 591 graduates with outstanding loans, 44 percent hadn’t repaid a cent.

Defaults remain an issue, but certainly not of that magnitude. Reports show that 7 percent of student college loans go into default within two years of graduation. Since 1995, 20 percent of all federally guaranteed student loans have gone into default, with another 20 percent delinquent at some point, says ASA President Paul Combe.

In 2010, new borrowers will be able to cap monthly payments at 10 percent of their discretionary income, down from 15 percent. And all remaining debt will be forgiven after 10 years of responsible payment for those working in public service, and 20 years for all others.

Discretionary income is defined as anything earned above 150 percent of the poverty line: In 2010, that was $16,245 for an individual, $33,025 for a family of four. “This helps education be more affordable,” says Kanter. “We really want to get the word out.”

Student with Piggy BankThe amount of outstanding student indebtedness is stunning — $830 billion, slightly more than Americans owe in credit card debt, according to Mark Kantrowitz, publisher of, an information site on student finance issues.

“Student loan debt has been growing steadily, and students have borrowed $300 billion in the last four years,” says Kantrowitz.

Reforms under the Obama plan now allow students to extend their repayment beyond the standard 10-year schedules from the program’s earlier years. On the down side, Kantrowitz predicts that in a decade, there will be parents strapped to help their children go to college because they will still be paying off their own student debt.

“It’s going to be a problem,” he says.

Federal Intervention

The federal government entered the student loan market in 1958, providing direct loans from the U.S. Treasury through the National Defense Education Act, according to New America Foundation’s Federal Education Budget Project. By the mid-1960s, the push to expand the program ran into strict budget rules, in which loans would be counted as expenditures in the year they were made. So in 1965, Congress opted to move the program to the private banking sector, where the federal government guaranteed the loans but any federal payments on the defaults would be several years down the line.

By 1990, Congress required that the costs of default payments be included in the current year projections, forcing policymakers to look at the real costs of making student loans. That sparked interest in again developing a direct loan program through the U.S. Treasury. By 1993, it was in place under the administration of President Bill Clinton, with the proviso that direct lending be phased in over time. Then came the Republican revolution of 1994, and the GOP targeted direct lending for elimination. What emerged was a dual system — federally guaranteed loans sold by the private banking industry, and new direct loans from the U.S. government. This dual system was in place until the Obama plan passed in March 2010.

Rodney Oto, Ed.M.’82, associate dean of admissions and director of student financial services at Carleton College in Minnesota, says the emergence of the government’s direct loan program resulted in improved customer service by the private banks. It also encouraged banks to make private capital available for the loans. At the time, there were complaints from students that the private banks wouldn’t lend to them.

“The competition helped in the early 1990s,” recalls Oto, whose career in financial aid has taken him to Colorado College, Austin College (Texas), the University of Minnesota, and now Carleton. “We’d been having trouble getting the private lenders to make the loans.”

Despite the emergence of the direct loan program, by the early 2000s, private lenders had stepped up their marketing efforts and controlled a majority of the subsidized student loan market. The banks were also bundling the loans as securities, and selling them in the secondary market, providing new capital for the banks.

But the financial crash of 2008, which sent shockwaves through the entire banking industry, dried up credit, and left banks scrambling for capital to lend. “Securitization made sense, banks had a stable rate of return, and it was a way to generate capital for new loans at a low cost,” says Harrison Wadsworth, a spokesperson for the Consumer Bankers Association. “But then there was trouble in the mortgage sector, it imploded, and capital dried up.”

Many banks left the guaranteed loan program, and by 2008, the Department of Education under President George W. Bush had stepped in to buy loans from private lenders, providing them with capital to originate new loans.

That led to President Obama’s push for full direct lending, which was passed this spring, ending the dual system and the banking industry’s ability to originate subsidized federal loans. (Banks can still provide private loans, but the loans are no longer guaranteed by the government.) The banking industry unsuccessfully fought the plan, arguing that the dual system provided the dynamic that led to better service and lower prices.

The transition to the new system has gone smoothly, according college officials across the country. At Carleton, Oto says his staff worked out the kinks this past summer, and students barely noticed. But he remains concerned about what happens in the future, without the competition to keep the federal government sharp.

“The Department of Education has done a great job getting it off the ground and making sure it works,” he says. “But time will tell if the government becomes lax and less responsive. Hopefully not, but when you have only one game in town, it can become easy to see customer service decline.”

At Tufts University, the transition occurred without a hitch. Lee Coffin, Ed.M.’90, dean of undergraduate admissions and enrollment management, and an Ed School adjunct lecturer, remains concerned that that Pell Grants, which don’t need to be repaid and benefit low-income students, haven’t kept pace with the rise in education costs.

“As need goes up, students aren’t getting the federal dollars to offset the cost,” he says. “That puts pressure on institutions to raise funds and use endowment income to meet those full needs.”

Need Still Great

Piggy BankWhile the federal loan program helps students from the full spectrum of income levels finance their education, the Pell Grant Program is targeted to families demonstrating financial need. The increases under the new Obama plan in the maximum Pell Grant this year will certainly help low-income students. But the Pell Grant, which Undersecretary Kanter says once covered two-thirds of college costs, now only covers one-third, leaving low-income students hunting for loans and institutional aid to make ends meet.

In a 2007 paper in the Harvard Educational Review, Ed School Professor Bridget Terry Long says the loss of the Pell Grants’ buying power has hurt low-income students.

“Years of research demonstrate that grants make a difference in enrollment decisions,” she wrote. “Unfortunately, the purchasing power of the Pell Grant is only a fraction of its original level.”

Donald Heller, Ed.M.’92, Ed.D.’97, director of the Center for the Study of Higher Education at Pennsylvania State University, says the financial pinch has created a stratified system of higher education, with wealthier families able to afford more selective four-year colleges, and lower-income students flocking to community colleges.

The rise of merit-aid programs in many states, like the Helping Outstanding Pupils Educationally (HOPE) scholarship program in Georgia, has provided financial support to huge numbers of middle- and upper-income students whose families could afford to pay the tuition bill — not the program’s intention.

Georgia students who qualify for HOPE scholarships receive full tuition to attend state universities if they maintain a B average in high school. In 2004, the commission found that only 30 percent of the HOPE scholars came from low- and moderate-income.

“The money goes disproportionately to wealthy families,” says Heller.

The Obama plan adopted in March made significant progress in addressing the needs of low-income students. The maximum annual Pell Grant — now at $5,550 — will be tied to the Consumer Price Index for 5 of the program’s 10-year period. The Congressional Budget Office estimates an increase in Pell spending of $21 billion from 2010 to 2014, with an additional $15 billion earmarked for students by 2019.

Undersecretary Kanter says this bodes well for low-income students over the coming decade. But she acknowledges reaching the president’s college-graduation goals will take considerable efforts, with low-income students among those targeted for increased achievement on the higher-education level.

“It’s really a national imperative that 100 percent of qualified students have a chance to go to college,” she says. “And more American students with low income want to have that opportunity.”

David McKay Wilson, who writes for university magazines around the country, is a regular contributor to Ed. magazine.

Ed. Magazine

The magazine of the Harvard Graduate School of Education

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