Don’t expect the cavalry to ride in and rescue the $1.7 trillion student debt mess.
While modest relief programs for defrauded borrowers have passed legal muster, broader schemes to forgive large swathes of student loans have been rejected by the courts as a usurpation of Congressional prerogative. But in one particularly troublesome corner of this broken system, a repeat offender in the loan game is receiving a red card.
Navient Corp., once the largest administrator of federal education loans, is being permanently banned from the federal student loan program for its long history of illegal and abusive conduct.
The Consumer Financial Protection Bureau announced a settlement forbidding Navient from participating in the lucrative student lending ecosystem. The order also imposes a $20 million penalty in addition to $100 million in restitution for borrowers harmed by the company. Navient had previously announced its intention to exit the servicing business and transfer its portfolio to another somewhat troubled servicing company called Mohela, but the action formally concludes a dispute that began in 2017.
Higher education lending is a Rube Goldberg contraption that has evolved over nearly 80 years and is highly opaque to the average borrower. The present system features a confusing panoply of players that separates the lending function from servicing and collection, incentivizing fraud, abuse and profiteering. Purging one miscreant is a small but satisfying step.
America began directly subsidizing higher education with the GI Bill in 1944 to benefit returning military veterans. The first meaningful college lending program was created with the 1958 National Defense Education Act, aimed at boosting math and science capability after Russia shocked the U.S. with the launch of Sputnik.
Yet the kernel of the current system can be traced to the 1965 Higher Education Act, which created the first education lending program that was broadly available to students in any discipline, known as the Federal Family Education Loan Program. These loans were issued by commercial banks but were guaranteed by the federal government if the borrower defaulted.
Yet despite the government backstop and strong demand from students, lender participation was lackluster. To encourage more private lending, Congress created the Student Loan Marketing Association in 1972, a half-government, half-private creature referred to as a government-sponsored entity. Its purpose was to use U.S. Treasury funds to buy up existing student loans from issuing banks to free up capital for more loans, an innovation that proved to be successful as college enrollment surged.
The Student Loan Marketing Association, or SLMA as it was known, soon acquired the nickname “Sallie Mae.” You may be familiar with similar entities like Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp.) created to perform a similar role in providing liquidity to mortgage market.
The real fun began when Congress authorized the privatization of these quasi-government corporations. In 1996, Sallie Mae was allowed to expand into other business lines including private lending and, notably, for-profit debt collection. In 2004, Sallie Mae flew the government nest and became a publicly traded corporation four years later. What could possibly go wrong?
You name it. Privatization with insufficient regulatory oversight created massive conflicts of interest within Sallie Mae as well as the other government-sponsored entities, just as the financial crisis of 2008 necessitated billions of taxpayer dollars in bailouts. Fannie and Freddie became wards of the state, while Sallie capitalized on its deep political ties.
The student loan program became such a morass that by 2010, the federally guaranteed loan program was euthanized. Henceforth, all federal student loans would be made directly by the U.S. Treasury, cutting out private lenders from a lucrative source of revenue.
In a concession to Sallie Mae’s considerable lobbying offensive, the government contracted with the company and other private lenders to service the massive portfolio of loans for a flat fee per loan. This only reinforced the inherent conflicts and precipitated a series of scandals and led to over $2 billion in settlements. David Dayen, executive editor of the American Prospect, quipped: “A government agency servicing private loans became a private company servicing government loans.”
Loan servicers act as middlemen, handling tasks like billing, payment processing, credit reporting and collections on behalf of the lender. They are paid a flat fee per loan, creating a perverse incentive to minimize customer service interactions, which is exactly what happened.
Faced with mounting legal challenges and public disdain, Sallie Mae spun off its loan servicing unit in 2014 into a new company it called Navient (perhaps because “caveat emptor” was taken?) that serviced federal loans for the government, while Sallie promoted private loans and other financial products.
Yet changing the name did little to alter the behavior, as Navient racked up an impressive list of complaints and enforcements actions. In 2021, the company cried uncle, ending its government contract and transferring its sizeable portfolio to other servicing companies, notably Mohela. Banishing Navient feels like closing the barn door after the mule has left, but it sends an important signal.
It is sometimes said that a camel is a horse designed by a committee. The current student loan contraption is a camel designed by Congress, and the prospect of meaningful reform seems whimsical in the current environment. So, it is encouraging when a particularly offensive player like Navient is ejected from the game, even if they were already headed to the showers.
Christopher A. Hopkins, CFA, is a co-founder of Apogee Wealth Partners in Chattanooga.
Christopher Hopkins