For-Profit Colleges

Higher Ed Roundup: Week of April 28 - May 2

Ed Policy — Fri, 02 May 2008 21:49:00 -0400

Student Loan Credit Crunch Bill Sent to President

One in Five Colleges Considering Switch to Direct Lending

Tuition On the Rise, but Spending for Instruction is Not

Report Calls for Revised Pell Grant Formula

Student Loan Credit Crunch Bill Sent to President

The U.S. House of Representatives moved quickly on Thursday to give final approval to H.R. 5715, which would increase the annual and aggregate federal unsubsidized Stafford loan limits, allow parents to defer payments on PLUS loans while their children are in school, and establish the Department of Education as a "secondary lender of last resort" (one of our ideas) with the power to purchase outstanding FFEL loans and service them through the Direct Loan program. Congress put the legislation on the fast track after President Bush used his weekly radio address to highlight the need for quick action to address tight liquidity for student loan providers. The final measure includes amendments that the Senate added to the bill before approving it on Wednesday. Among other things, the bill will now sunset the Education Secretary's authority to designate entire colleges for the "lender of last resort program" at the end of the 2008-09 academic year and direct all savings derived from the legislation to increase funding for the Academic Competitiveness and SMART grant programs. The President is expected to sign the bill shortly.

One in Five Colleges Considering Switch to Direct Lending

Citing instability in the student loan market, 19 percent of colleges surveyed last week by Student Lending Analytics say that they are considering switching from the Federal Family Education Loan program to the Direct Loan program, in which the Department of Education provides loans directly to students through their college. Nearly six percent of institutions surveyed have already made the switch. So far, the largest institutions to make the move have been Indiana University at Bloomington, Michigan State, Northeastern, and Pennsylvania State Universities. Those expressing the most interest in switching programs, however, are community colleges (about 7 percent are planning to make the switch, and another 29 percent are considering doing so) and for-profit trade schools (14 percent are planning to make the switch, and another 43 percent are considering doing so.) These results are hardly surprising as several banks in recent weeks have said they plan to be more selective in making federal loans to financially-needy students attending these types of institutions.

Tuition On the Rise, but Spending for Instruction is Not

Annual tuition hikes are becoming a fact of life at pubic and private colleges around the country, but little of that additional money is going towards student instruction. A new report from The Delta Cost Project, "A Growing Imbalance: Recent Trends in U.S. Postsecondary Education Finance," finds that the percentage of institution revenue dedicated to faculty salaries and other instructional costs at private colleges increased by just 1 percent between 1998 and 2005, down from a 2.2 percent increase between 1987 and 1996. In particular, tuition revenue at public colleges, though on the rise, often did not translate into increased spending because it was used to offset decreases in state appropriations. Since 1998, student tuition has covered a larger percentage of the costs of a student education, up from 37 percent to 47 percent at public schools and up to 31 percent from 24 percent at private institutions.

Report Calls for Revised Pell Grant Formula

Planned increases to the maximum Pell Grant award are important for helping low-income students, but a new report argues that additional modifications should be made to the program to ensure that funds are better targeted to the poorest individuals. "Window of Opportunity: Targeting Federal Grant Aid to Students with the Lowest Incomes," released Monday by the Institute for Higher Education Policy, argues for changes in the Pell Grant award formula, which is determined by taking the difference between the maximum award and the student's expected family contribution (EFC). The report recommends that students be allowed to have a negative EFC of up to $750 (the current minimum is zero), in turn allowing the poorest students to receive a Pell Grant award of up to $750 beyond the maximum limit. The report also recommends increasing both the minimum and maximum Pell Grant awards.

Helicopter School's Crash Leaves Students Grounded

Stephen Burd — Wed, 16 Apr 2008 14:45:00 -0400

If you want to know the dangers of taking out private student loans, just ask the 2,500 students who were, until early this year, enrolled at flight academies across the country owned by Silver State Helicopters.

As recounted by The San Diego Union-Tribune, these students were "left in the lurch" when the Nevada-based company, without warning, shut its doors on Super Bowl Sunday and filed for bankruptcy liquidation. Because the schools did not have the proper accreditation to qualify to participate in the federal student aid programs, the company directed students to take out high-cost private student loans to cover the $70,000 tuition that they were required to pay up front. Unfortunately, these students may be stuck repaying these loans for training they did not ultimately receive.

At Higher Ed Watch, we have often warned of the hazards of private loans, particularly for students attending questionable for-profit trade schools. Private loans almost always have worse terms than federal loans, and lack important safeguards. Unlike federal loans, for example, private loans are not automatically discharged if a borrower attends a school that unexpectedly shuts down before a student completes his or her studies.

To make matters worse, the federal government has made it extremely difficult for borrowers in financial distress to discharge private loans in bankruptcy. While the law does allow discharge for borrowers who can prove that repaying the loans would cause "undue financial hardship," courts have applied the undue hardship standard unevenly, leaving many desperate private loan borrowers with no way out.

All of which is to say that while the unscrupulous owners of Silver State Helicopters can liquidate their company and escape their debts through bankruptcy, flight-academy students like Hector Leon, a divorced father of two who first enrolled in the school in 2006, have no such recourse.

Like many such students, Leon was taken in by the dreams the school was selling. "When I heard their ads, which said you could make upwards of $150,000 to $180,000 a year, I thought it was the way to get a better income and provide a better life for my two kids," Leon told the Union-Tribune.

Sadly, Leon's story, and that of his classmates, is all too familiar.

In the late 1980's and the early 1990's, the U.S. Education Department and Congress were forced to take emergency actions to crack down on an explosion of fly-by-night trade schools set up solely for the purpose of reaping profits from the federal student aid programs. As a result of the crack down, hundreds, and even thousands, of disreputable proprietary institutions were forced to close or were shut down.

Since that time, advocates for trade schools have lobbied aggressively to get federal policy makers to relax these rules, arguing that the problems of the past are entirely behind them. But over the last several years, some of the largest publicly-traded for-profit higher education companies -- such as the University of Phoenix, Career Education Corporation, and Corinthian Colleges -- have come under intense scrutiny from federal and state regulators and have faced numerous lawsuits over allegations that they have engaged in aggressive and misleading recruiting and admissions tactics to inflate their enrollment numbers, while providing academic offerings of dubious value.

And in recent years, there has been a proliferation of unlicensed and unaccredited (or at least not accredited by groups recognized by the U.S. Education Secretary) trade schools, like the Silver State Helicopters Flight Academy, that do not participate in the federal student aid programs and therefore go largely unregulated. The growth of these schools appears to have been fueled by student loan companies that have willingly and irresponsibly "partnered" with the institutions to provide high-cost private loans to the at-risk students these schools tend to attract.

If Congress doesn't overreach in lubricating student loan liquidity, one of the credit crunch's potential silver linings is that it may discourage lenders from participating in deals with the likes of $70,000 a year, unaccredited helicopter training schools. That would benefit both students and the public.

Higher Ed Roundup: Week of March 31 - April 4

Ed Policy — Fri, 04 Apr 2008 17:00:00 -0400

Democrats Introduce Bills Aimed At Easing Student Loan Credit Crunch

Students at Canadian Career Colleges Have More Loans, More Defaults

Dept. of Ed Issues Guidelines on Lender-of-Last Resort

Democrats Introduce Bills Aimed At Student Loan Credit Crunch

Leaders of the Senate and House education committees offered legislation on Thursday aimed at easing the effects of the student loan credit crunch on lenders that participate in the Federal Family Education Loan (FFEL) program and at helping students in general wherever they attend school. Both bills include two provisions that Higher Ed Watch has recommended as potential answers to the credit crunch: a proposal to provide a modest increase in the federal loan limits to reduce students' need for high-cost private loans and one that would allow the Department of Education to serve as a "secondary market of last resort" to help provide liquidity to lenders that need new capital to stay in business. Under the plan, the department would purchase outstanding FFEL loans from struggling lenders and service them through its Direct Loan program. The bills would also make the federal PLUS loan program more attractive by allowing parents to defer payments on the loans while their children are in school.

The two bills are not identical. The Senate bill, introduced by Sen. Edward Kennedy (D-MA), would increase the maximum Pell Grant, which is currently $4,731, by up to $750 for the lowest income students. The House measure, offered by Reps. George Miller (D-CA) and Ruben Hinojosa (D-TX), doesn't include the Pell Grant provision, but raises annual borrowing limits slightly higher. [Disclosure: The editor of Higher Ed Watch used to work for Senator Kennedy.]

Higher Ed Watch applauds the lawmakers for taking measured action. We are particularly pleased that they didn't embrace poorly thought out proposals to make PLUS loans available to undergraduate dependent students up to the cost of attendance (i.e. a new Undergrad PLUS program). Such a proposal would only encourage schools to inflate prices.

Students at Canadian Career Colleges Have More Loans, More Defaults

Students at for-profit trade schools in Canada are almost twice as likely to take out a government loan than their peers at public universities, according to a new survey from the Canada Millenium Scholarship Foundation. The foundation reports that 53 percent of students at for-profit colleges rely on government loans compared to 29 percent of public university students in Canada. The Millenium Foundation's survey also found that 81percent of proprietary-school students know little or nothing about government loan and grant programs. Similarly, a recent report on the Canada Student Loan Program expects that 45 percent of students at for-profit colleges will default on their loans, compared to 25 percent of students at public colleges.

The results in Canada are similar to those in the United States. As we reported recently, a recent study by the U.S. Department of Education's National Center for Education Statistics found that students attending for-profit trade schools in this country are by far the most likely to borrow to attend college. According to that report, nearly three quarters of proprietary school students took out a federal loan in 2003-04, compared to 53 percent of students attending private nonprofit colleges and universities. Meanwhile, 42 percent of students at four-year public colleges and 11 percent at community colleges in the U.S. obtained a federal loan that academic year.

Dept. of Ed Issues Guidelines on Lender-of-Last Resort

Amid pressure to ensure that the government is prepared if students start having problems obtaining federal loans as a result of the credit crunch, the Department last week sent a letter to 35 guarantee agencies telling them to review and update the policies of their little-used lender-of-last-resort (LLR) programs. The guarantee agencies have been given 30 days to submit detailed policies regarding their selection of LLR lenders, terms of lending, and operating procedures, which could be used in the case of a government-declared loan emergency. Critics claim that the guidelines do not go far enough to ensure that LLR lenders (possibly including the guarantee agencies themselves) would have enough liquidity to back up the loans. Representative Miller and Senator Kennedy have asked Education Secretary Margaret Spellings to direct federal funds to guarantee agencies in the unlikely event of a crisis.

Blind-Sided at Sallie Mae?

Stephen Burd — Tue, 25 Mar 2008 13:00:00 -0400

Last week, we wrote that Sallie Mae and its promoters on Wall Street claim the company was "blind-sided" by the rising default and delinquency rates on subprime private loans it made to low-income and working class students at poor performing higher education trade schools. It's a convenient argument considering that the loan giant is facing at least one, and possibly several, class action lawsuits by angry shareholders who accuse the company of deliberately misleading them about the amount of risk it was assuming. But the argument is disingenuous at best.

Financial analysts have long raised red flags about Sallie Mae's private lending practices. During earnings calls and at shareholder meetings and investment conferences, analysts regularly peppered Sallie Mae officials with questions about whether the company, which is used to having government backing on its loans, had the expertise needed to assess the risks associated with lending unsecured, private loan debt to financially-needy students.

Of particular concern to these analysts have been the sweetheart deals that Sallie Mae forged with some of the most scandal-ridden chains of for-profit colleges, such as Career Education Corporation and Corinthian Colleges. Under these Orwellian-sounding "opportunity pool" or "recourse loan" arrangements, Sallie Mae agreed to provide funds for private student loans, with interest rates and fees totaling more than 20 percent per year, to financially-needy students who normally wouldn't qualify for them because of their subprime credit scores. Sallie Mae apparently viewed these loans as "loss leaders," meaning that the company was willing to make these loans, many of which were likely to go into default, in exchange for becoming the exclusive provider of federal and private loans for the tens of thousands of subprime and non-subprime students these huge chains serve.

In 2005, Fortune Magazine brought attention to the analysts' worries in an article entitled, "When Sallie Met Wall Street." That piece specifically raised concerns about the loan company's dealings with schools owned by Career Education Corporation, which it noted had had been accused "in multiple lawsuits in several states of using hard-sell tactics to recruit students, promising them high-paying jobs that don't materialize and leaving them with mountains of debt that they can't pay off."

The article's author -- Bethany McLean (who, by the way, helped break the Enron scandal) -- proved prescient in predicting the predicament in which Sallie Mae now finds itself. McLean wrote:

[A] big question looms in Sallie Mae's private credit business: How many students who take out these high-interest loans will end up defaulting? After all, private credits are basically unsecured loans to people without jobs. Sallie argues that there won't be a problem. Each quarter it books a reserve for potential losses; at this time its loss on private credit loans in repayment are running at only 2.4%. Plus, Sallie says, almost half its private credit loans are guaranteed by a parent.

But because private credit is a new business and because students are taking on unprecedented levels of debt, there are no historical measurements by which to gauge potential defaults. As Sallie's financials note, "the provision for loan losses is inherently subjective as it requires material estimates that may be susceptible to significant changes." And the current low delinquency rate may be misleading, because as of the end of 2004 nearly half the students to whom Sallie has lent private money hadn't left school yet.

The Fortune article also raised a question that is central to the class action lawsuit filed by shareholders in the Federal District Court in Southern New York: Was Sallie Mae deliberately not putting enough money in reserve to cover anticipated losses on "uncollectible loans" so that it could artificially boost its earnings?

Some worry that Sallie may already be struggling to deliver on its promises to Wall Street. The company encourages investors to look at a measure it calls "core cash" earnings, which, among other adjustments, strips out the gain Sallie books when it sells loans to an off-balance-sheet trust and replaces it with Sallie's estimate of the spread those loans are earning. In other words, Sallie's "core cash" results are affected by the reserve it books on those off-balance-sheet loans. Over the past year the company has reduced its reserves, thereby boosting the earnings measure that it encourages investors to watch. Currently, Sallie's allowance for losses on the private credit loans that are in repayment is 3.9%, down from 6.2% a year ago. Sallie attributes the reduction to an improvement in its portfolio's credit quality and says that the idea that reducing reserves helps earnings is wrong.

How did Sallie Mae officials react to the story? Did they reexamine their business practices? No, they lashed out at the magazine. "In short, your article was a baseless attack on a company that has helped million of Americans who, without our financing tools, may not have had an alternative to attend college and improve their lives," Tim Fitzpatrick, the company's then-CEO, wrote in a letter to the editor.

Sallie Mae officials were warned of the dangers ahead and chose to ignore the warnings. The truth is company officials took a huge gamble. They believed that that all the new business they would get from forging deals with these gigantic for-profit school chains would more than make up for the losses they would endure from making available high-cost private student loans for high-risk borrowers. They were wrong.

The people actually blind-sided were students pressured by aggressive recruiters at dubious for-profit trade schools to take out high-cost loans to pursue an expensive, high-risk program with dubious graduation and job placement track records.

As we have noted, serious questions have been raised about whether some of these companies such as Career Education Corporation have duped disadvantaged students into taking on private loan debt without making them aware of their cheaper loan options first.

Perhaps Sallie Mae's shareholders were duped as well. They may at least get their day in court to air their grievances. Company officials will argue that they never could have anticipated the dangers of providing high-cost loans to subprime borrowers. Don't believe them.

Class Action Lawsuit Challenges Sallie Mae’s Subprime Lending Practices

Stephen Burd — Thu, 20 Mar 2008 18:48:00 -0400

Sallie Mae is facing a potential series of class action lawsuits from angry investors who believe the student loan giant misled them about the amount of risk the company was taking on in pushing high-cost private loans on subprime borrowers attending poor-performing trade schools.

Sallie Mae is already facing at least one class action lawsuit filed by shareholders in the Federal District Court in Southern New York, and company officials have alerted the Securities & Exchange Commission that they expect "similar actions" to be filed elsewhere shortly. The pending New York lawsuit accuses Sallie Mae of failing to "engage in proper due diligence" before providing private loans to high-risk students at for-profit, trade schools; of deliberately not putting enough money in reserve to cover anticipated losses on "uncollectible loans" in order to artificially boost earnings; and of making "false and misleading statements" to shareholders about the overall quality of its private loan portfolio to keep its stock price high.

Officials at Sallie Mae have not yet filed a formal response to these claims. But actions that the loan giant has taken recently appear to boost the shareholders' case. In January, the company, reeling from the news that it was spending hundreds of millions of dollars to cover losses on bad loans, announced that it would no longer engage in subprime lending at trade schools. "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, said at the time. In court, that's called a statement against interest.

And just this month, the loan giant created a new position at the company of chief credit officer and hired a banking industry veteran to fill it. With this hire, Sallie Mae, apparently for the first time, will have a top level executive in charge of of overseeing "the company's private student loan underwriting policies" and of managing its exposure to credit risk. Better late than never, right?

Still, Sallie Mae won't overtly admit fault and poor management. Instead, the company and its promoters on Wall Street have been testing another explanation for its difficulties. An analyst with CreditSights Inc., in New York, recently tried it out when he told Bloomberg.com that the loan giant had been "blind-sided" by the rising default and delinquency rates on the subprime private loans it had made to low-income and working-class students attending trade school of dubious quality.

We find the blind-sided explanation hard to believe. But in Tuesday's post, we'll assess the explanation in full. Stay tuned.

A Silver Lining from the Credit Crunch

Stephen Burd — Wed, 05 Mar 2008 03:27:00 -0500

The Los Angeles Times recently provided a disturbing example of how some for-profit trade schools like Corinthian Colleges have been pushing subprime, high-risk students to assume heavy levels of debt that they may never be able to repay. In an article on the credit crunch, the LA Times quoted a 20 year old student, with a 10 month old baby, who is taking classes at Everest College in West Los Angeles to become a medical assistant. To pay for an eight week course at the Corinthian-owned school, this student has had to take out an $8,000 private loan with an 8 percent interest rate. The student, and several friends with similar loans, told the newspaper "that they knew that repayment would be difficult on the $9 an hour or so they expected to earn if they got jobs." The course, they said, gave them "75% to 90% of what they need to get and keep a job."

[slideshow] The students say the loans were worth taking because they gave them an opportunity to attend the school. But they probably won't be so happy when they go into repayment, particularly if those jobs don't materialize. They may be even more disappointed when they discover that they could have gotten the same training for a fraction of the cost at the nearby Pasadena City Colleges, which according to the LA Times, "charges $628 annually in tuition and fees to in-state residents."

If there is a silver lining to the credit crunch, it is that for-profit colleges and loan companies, like Sallie Mae, are being forced to think twice before pushing high-risk borrowers to take on expensive private loan debt that they have little hope of ever paying back.

Of course, this is not the story that the mainstream press is telling. Instead, they are focusing on the sensational story that student loan funds are drying up. That story, which is creating a panic, is misleading at best.

Despite the hysteria, we have not heard of a single case in which a student has been unable to obtain a federally guaranteed student loan as a result of the credit crunch. As we have said repeatedly, students are in absolutely no danger of losing access to federal Stafford loans.

As of now, the borrowers who mainly appear to be in danger of losing access to high-cost private student loans are those with poor credit records attending for-profit trade schools of dubious quality. (Note: we're not saying all trade schools are of dubious quality, but many are.)

Even within the for-profit higher education sector, the impact of the credit crunch has been limited so far. In recent weeks, some trade-school chains, such as Capella University, Devry Inc., Strayer College, and the University of Phoenix, have gone out of their way to assure nervous investors that the credit crunch has had little to no impact on students attending their institutions. "We are really not seeing any impact on our business," Stephen Shank, Capella's chief executive officer, recently told The New York Times.

The companies that are feeling the pinch are those that have aggressively steered financially-needy students to take out high-interest private loans, such as Career Education Corporation, Corinthian Colleges, and ITT Educational Services Inc. According to company disclosures, private loans make up 30 percent of the revenue at ITT, 18 percent at Career Education, and 13 percent at Corinthian. Corinthian has revealed that 75 percent of its private loans go to subprime borrowers.

In contrast, private loans make up just about 4 percent of the revenue of Apollo Group, which is the parent corporation of the University of Phoenix, 3 percent at Strayer, and 1 percent at Capella. A recent report from Investor's Business Daily reveals that only one quarter of one percent of private loans at Strayer go to subprime borrowers.

Of course, some advocates for trade schools argue that cutting off private loans to subprime borrowers attending these institutions will lead to a severe access crisis. But their argument fails to recognize just how dangerous it is to rely on private loans as a college access tool. Because private loan providers price their loans based on students' credit scores, those with the greatest financial need are almost guaranteed to get loans with the highest interest rates, the highest up front fees, and worst conditions. These lenders have proved to be notoriously unwilling to help struggling borrowers find ways to make repayment easier. And the government has made it extremely difficult for borrowers in dire straits to discharge their private loans in bankruptcy.

Our colleague, Erin Dillon at Education Sector, wrote yesterday that pushing a high-interest private loan on "a student with a low chance of graduating or getting a job is more a recipe for life-long indebtedness and a destroyed credit history than it is an educational opportunity."

Erin is right. As a country, we are doing no favors to the most financially needy students by pushing them to take on such expensive debt to attend schools of dubious quality. Perhaps the credit crunch will force policy makers to realize that.

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An Unsettling Settlement in Pennsylvania

Stephen Burd — Thu, 28 Feb 2008 14:29:00 -0500

Pennsylvania Attorney General Tom Corbett's decision last week to reach a $200,000 settlement agreement with the for-profit trade school chain Career Education Corporation over allegations that one of its schools had duped students into taking high-cost private student loans has come under withering criticism. At Higher Ed Watch, we believe that criticism is well deserved, as the settlement provides no relief for the former students who appear to have been misled into taking out expensive private student loans, and will do nothing to protect students at the scandal-ridden chain's other colleges who may be falling victim to similar deceptive practices.

We might not be so concerned if this were the first time we heard such allegations against Career Education Corporation, which owns more than 80 campuses in the U.S. and serves over 95,000 students worldwide. But over the last several years, Career Education Corporation has come under scrutiny from federal and state regulators and faced numerous class action lawsuits by former employees, shareholders, and students over allegations that its schools engage in aggressive and misleading admissions tactics to inflate their enrollment numbers.

The charges made by former students at Lehigh Valley College are disturbingly similar to ones that have been made by students at other Career Education Corporation colleges: that the school deceived students about its job placement rates and about the transferability of its credits to other colleges, and that it rushed them through the financial aid process without accurately disclosing the terms of the private student loans they were being assigned. A 2005 class-action lawsuit filed by former Lehigh Valley College students accused the school of misleading them into thinking that the loans they were receiving "were low-interest, government-guaranteed student loans, when in reality the loans were not government-backed loans and included interest rates in excess of 15%."

Attorney General Corbett's announcement of the settlement agreement provides at least the appearance that his office has taken these allegations seriously and will lead to changes that will help students. "The consumer settlement," the news release states, "will ensure that students receive accurate information and full disclosure about financial aid, the ability to transfer credits to other schools, and the likelihood of finding work following graduation -- all key issues to a student's selection of a school." Under the settlement, Lehigh Valley College has agreed to abide by a Code of Conduct that prohibits the institution from making "false and misleading statements" to students about their future employment opportunities, ability to transfer credits, and the terms and conditions of their student loans.

It's pretty questionable, however, about how much affect the code will have on Lehigh Valley College, as the school is no longer enrolling new students. In fact, Career Education plans to close down the school entirely by the end of next year. The company had tried to sell the school, but there were no takers.

And, to the frustration of some Pennsylvania state and federal lawmakers, the agreement the Attorney General struck with the for-profit higher education company clearly states that "none of its terms apply to any other school owned or controlled by Career Education." U.S. Rep. Patrick Murphy (D-PA) has written a letter to Career Education's chief executive officer, asking "as a gesture of good faith," to have all its Pennsylvania schools "at the very least, voluntarily abide by the code." He also outlined additional steps he believes that all Career Education schools should take "to partially restore the trust lost by your corporation's actions at Lehigh Valley College." Among other things, he proposed having the company's schools disclose to applicants the lifetime default rates of their former students.

Corbett has also taken a lot of heat for settling for $200,000 and not compensating the former students who were the victims of the schools' deception. Perhaps he honestly believes that given the facts of the case, this was the best he could do. But The Morning Call, the Allentown newspaper that first reported on the school's practices, has raised some concerns about the conduct of the investigation. The newspaper questioned why the attorney general's office had never contacted several former Lehigh Valley college officials and teachers who had gone public "with damning accounts of the school's tactics" -- including a former admissions officer who had told the newspaper that he had been under orders to deliberately withhold information from students about the terms of their private loans for fear of discouraging them from attending.

So what should be done? For starters, the U.S. Department of Education or Department of Justice should investigate whether the corporation as a whole has been encouraging its schools to mislead students about the terms of their loans. These allegations are extremely serious. It's bad enough that some financially needy students have no choice but to take out private loans to pay for college. But it's unconscionable and bad business for schools to saddle students with private loan debt without making them aware of their lower-cost, federal loan options first.

Second, we would embrace the proposals that Representative Murphy included in his letter to Career Education and extend some of them to all colleges nationwide, be they for-profit or nonprofit. For example, we believe that Congress should require all colleges to report their lifetime default rates to prospective students -- so that students can make an informed decision about the risks they're willing to take before they fall for a recruiter's sweet pitch.

Cohort Default Rates: The Good, the Bad, and the Ugly

Ben Miller — Wed, 13 Feb 2008 00:00:00 -0500

Two weeks ago, we wrote in favor of a proposal to change how student loan defaults are calculated for the purposes of college accountability. We argued that lengthening the timeframe the government uses to measure student loan defaults could bolster everyone's ability to judge the quality of education offered by different institutions of higher education. Unfortunately, the House of Representatives seems to have caved to pressure from the trade school industry in particular and significantly weakened the proposal in ways that make it less useful. Today, we take a look at the good, the bad, and the ugly of the House's action.

Background

For nearly 20 years, the U.S. Department of Education has kept track of the cohort default rates of every college that participates in the federal student-aid programs. The rates measure the percentage of students who have defaulted on their federal loans within two years of leaving college. For example, the 2005 rate reflects students who left school in 2005 and defaulted on their loans in 2006 and 2007. Borrowers who defaulted in the third year or later are not counted in the cohort default rates.

Schools with more than 30 individuals in a given repayment cohort are subject to sanctions if more than 10 percent of a cohort defaults. A default rate of 40 percent in a given year or 25 percent for three consecutive cohorts results in the school losing access to federal funds.

Large numbers of loan defaults from a specific institution of higher education can reveal that students are failing to complete degrees or classes (the largest general predictors of default) or are leaving an institution unprepared to meet the needs of employers. In fact, unemployment and low-paying jobs are reasons for default cited in one study by 59 percent and 49 percent of relevant borrowers, respectively.

Default rates have dropped precipitously over the last two decades. However, the Education Department’s own Inspector General has raised questions about whether the rate provides an accurate measure of student loan performance.

Among other things, Congress in 1998 made changes to the way the rate is calculated that artificially lowered the rate and made it a much less useful tool for the government to assess the extent of the student-loan default problem. That year, lawmakers extended by three months – to 270 days from 180 days – the length of time before the government declares a delinquent borrower to be in default.

Once that happens it takes an additional 90 days for the government to pay the insurance claim. This means that it takes roughly 360 days, basically a full year, for an unpaid loan to officially be counted as going into default. These 360 days do not, however, include the 60 day grace period most borrowers have to make their first payment. In other words, a borrower who decides to never pay back a single penny of a student loan will not be considered in default until roughly 420 days after their first payment was due. (The chart below shows this concept as a timeline).

[slideshow]

Because it takes so long for a loan to go into default, the rate doesn't capture all the students in a cohort who leave school and default within the next two years. As a result of the change, a 2003 audit report by the Inspector General's report states, "some borrowers may not be included as defaulters in the cohort-default-rate calculation, even though they never make a payment on their loans and default at the first opportunity."

The Good

The House bill seeks to remedy problems caused by the 1998 change by extending the timeframe measured from two years to three years. We applaud this change because it would make the default rate calculation more accurate by including all students that default within the first two fiscal years, as Congress originally intended.

An even better solution would be to extend the default rate window to four years, which is not so long that students are completely divorced from their colleges, but long enough that they are starting to establish themselves in the workforce. But for now, the three-year window is at least a step in the right direction.

The Bad

Under pressure from for-profit college lobbyists, the House agreed to raise the default rate threshold at which sanctions kick in. Previously, colleges could have their federal aid restricted if three consecutive cohorts had default rates above 10 percent or taken away if that figure exceeded 25 percent. Thanks to lobbying efforts by the Career College Association (CCA), an organization that represents trade schools, penalties would only kick in after three successive years above 15 percent and 30 percent, respectively.

The CCA claimed this greater leeway was necessary because schools that serve large numbers of low-income students — such as community colleges, for-profit trade schools, and historically black colleges and universities — are going to have higher default rates under the new window and could lose access to needed federal funds.

But allowing higher rates removes any incentive to tackle issues that may be causing high defaults, such as abysmal graduation statistics. Instead, it sends the message that it is ok for nearly one out of every three students to put themselves in a financial hole that could haunt them for the majority of their working life. After all, defaults only really hurt two parties: students, who have their wages garnished and credit tarnished, and taxpayers, whose money goes to pay back the student loan company. Schools, meanwhile, get their money up front, whether the loan is ever paid back or not.

As one final concession, the for-profit colleges won a one-year reprieve from the new regulations. The 2009 cohort, not the 2008 group, will be the first cohort to be measured under the three-year window. This means the new regulations will not take effect until 2012 at the earliest. This gives schools an unnecessary extra year to find ways to evade the sanctions.

The Ugly

The biggest failing of the House legislation though is that it does nothing to address the underlying issue of who is (or is not) counted in cohort default rates. As the IG report notes, students who either defer their payments or enter into forbearance can artificially lower a school’s default rate. This is because the calculation counts those students even though they are not actually making payments. Thus, if a school with 100 students in repayment has 10 defaulters and 25 individuals who have received deferments on their loans, the institution’s default rate is only 10 percent. Yet if the rate were calculated as the percentage of students defaulting who are actually making payments, the default rate would be 10 out of 75, or 13.3 percent.

Failure to fundamentally alter the cohort calculation, such as keeping track of how cohorts do through the lifetime of their loans or counting the students whose loans are in deferment as part of a cohort once they resume repayment, means that colleges will still be able to easily disguise how their students’ are doing in repaying taxpayer-supported loans over the long run.

Be warned: One of these days, conservative budget hawks are going to team up with progressive higher ed reformers on the default issue just as they did on student loan corruption. And when they do, the cohort default rate games aren't going to be so much fun for the proprietary school industry.

The Career College Association's Misleading Arguments

Stephen Burd — Wed, 06 Feb 2008 00:00:00 -0500

Last week, we argued that Sallie Mae's decision 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. Disadvantaged students with poor credit ratings should never have been stuck with high-cost private student loans, particularly ones with interest rates and fees exceeding 20 percent.

[slideshow]The Career College Association, which lobbies on behalf of these proprietary school chains, disagrees with our assessment. The group's leaders say the move by Sallie Mae and some other lenders to stop providing subprime loans to high-risk students at the schools it represents will "foreclose access to higher education for thousands of borrowers."

"Our member institutions tell us that many lenders have stopped subprime student lending and may stop private lending altogether," Harris Miller, the association's president, wrote in a news release. "Their retreat may leave many students unable to finance the balance of their educations."

To avoid a "crisis" that will jeopardize "the last, best chance of many students to earn a college degree," Miller argues that lawmakers should, among other things, consider reversing some of cuts Congress made last fall to the subsidies that lenders receive for participating in the Federal Family Education Loan (FFEL) program. He also calls on legislators to back off their attempts to eliminate the types of sweetheart deals between colleges and FFEL lenders that have caused so much controversy over the last year.

We are confident that Congressional leaders will ignore such misguided advice. But just in case they waver, we'd like to offer our responses to some of the group's most outlandish claims:

Congressional subsidy cuts caused a "crisis"

False. Sallie Mae decided to stop offering subprime private loans to students at poorly performing trade schools because the financially-struggling loan giant has been taking huge losses on those loans. Unlike the case in FFEL, the federal government does not insure private loans, nor guarantee their profitability. Sallie Mae is on the hook when borrowers default on these loans. And by all accounts, defaults on subprime loans are growing alarmingly.

Truth be told, Sallie Mae took a huge gamble in making these risky loans in the first place. The company appears to have viewed these loans as a "loss leader," meaning that it was willing to have 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 that these huge chains of for-profit trade schools serve. Now Sallie Mae is paying the price for its gamble and predatory practices -- spending hundreds of millions of dollars to cover losses on bad loans should never have made and have burdened many, many borrowers.

Student loans are drying up at for-profit colleges

Mostly false. Students who attend for-profit trade schools that participate in the federal financial aid programs are in absolutely no danger of losing access to government-backed student loans. As of now, Sallie Mae has said that it will stop providing subprime private loans to students at trade schools. But even if Sallie Mae and every other FFEL lender refuse to serve these students, nothing is stopping these schools from entering the federal Direct Loan program. One of the major advantages of direct lending, which is run by the Department of Education, is that it does not engage in redlining.

As for maintaining access to private loans, only those chains of for profit schools that routinely pushed high-risk students to take out subprime loans -- such as Career Education Corporation and Corinthian Colleges -- appear to be in trouble. More respectable chains like Devry Inc. pretty much shrugged off the news, because only a small proportion of its students received subprime loans.

Students' access to college is threatened

False. Low-income and high-risk students do not have to rely on private loans to go to college. Between federal student loans, which are universally available, and federal grant aid, over a thousand state and community colleges are within reach. Tightened credit markets will cause some low-income students to reconsider where and how much they'll pay to pursue a postsecondary education but will not in a widespread way impact their decision to pursue a postsecondary education because of the availability of federal aid and of low-cost public colleges.

If low-income, high risk students attend a trade school with the help of an expensive private loan and then drop out, they will be in very, very bad shape -- saddled with debt and with little in the way of a quality post-secondary education. Not all trade schools are of low quality, but students should be especially careful when choosing an institution in this sector and assuming an expensive private student loan in furtherance of their post-secondary education plans.

We cannot emphasize enough that if students have no other choice but to borrow private loans to attend for-profit colleges, then they can and should consider seeking training at more affordable schools, such as community colleges.

Bottom Line:

As policymakers, journalists, and others evaluate the Career College Association's arguments, they should keep in mind that the group's ultimate goal is to protect the profitability of its member institutions, whether or not they are helping or hurting students.

Subprime Mess Reaches Higher Ed

Stephen Burd — Thu, 31 Jan 2008 00:00:00 -0500

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.