In late April, we asked [9] if for-profit college closures would represent the next multi-billion dollar taxpayer-funded bailout. While the country’s $1.3 trillion student debt bubble represents a very real risk to taxpayers over time, for-profit institutions pose a more immediate threat.
From a ‘big picture perspective, the push for student loan forgiveness and “debt-free” higher education is certainly kicking into high gear, with the likes of Elizabeth Warren [10] and Bernie Sanders [11] pushing ideas such as a tax on stock transactions to fund college education in America. Meanwhile, The White House is exploring more “efficient” ways for students to discharge debt in bankruptcy and the “cancel all student debt [12]” calls have begun in earnest. That said, any kind of sweeping overhaul will likely take years to implement, but in the mean time, IBR repayment programs [13] allow students whose post-graduation disposable income isn’t deemed sufficient, to simply pay nothing on the way to total debt forgiveness in 25 years. Clearly, many borrowers will, at some point in their lives, make enough to pay something each month, but the point is that the government is now actively promoting the fact that the full principal needn’t be repaid and this, in turn, has led to the proliferation of IBR plans and rising default risk for student loan-backed ABS.
So that’s the long-term outlook, and as we’ve said repeatedly, this likely won’t end well for taxpayers. But there’s a more immediate threat and it comes from for-profit college closures.
To recap, the for-profit sector has been under intense government scrutiny for years due to, among other things, deceptive recruiting strategies and fabricated data on post-graduation job placement rates. These institutions rely heavily on federal student loans for their very existence, even as many are publicly traded and pay their CEOs millions. In addition, tuition rates at for-profit colleges are, on average, double the rates charged by large public universities, a fact which explains why nearly 90% of students at for-profit schools have taken out loans to pay for their education.
[14]
[15]
As we discussed a few months back, the delinquency and default problem that hangs over the student debt bubble is far worse for loans extended to students that attend for-profit colleges than for those who attend or have attended public institutions (note the discrepancy in share of enrollment versus share of defualts):
[16]
This, along with poor graduation rates and allegations of deceptive marketing practices, has led to increased government scrutiny of the for-profit sector, scrutiny which ultimately caused Corinthian Colleges to wind down operations last year amid allegations it falsified job placement rates.
The company — which is publicly traded — received nearly $1.5 billion per year in financial aid funding from the government, meaning the US taxpayer was subsidizing federal loans to students who very well may have been getting a subpar education and were thus even more likely to get behind on their loans and eventually default.
Corinthian was able to sell off many of its campuses in November and although the writing has been on the wall for quite sometime, the company closed its remaining physical campus in late April without notice to students or faculty.
As we noted when the doors were shut, for-profit students won’t have a particularly easy time transferring their credits (meaning they would have to start over at another school if they wanted to complete their degrees), and so will likely seek to take advantage of their 'right' to have their debt discharged. Fast forward to late May and sure enough, the government was scrambling [17] to figure out what to do after Secretary of Education Arne Duncan received a group request from 78,000 students requesting loan forgiveness.
At the time, Reuters said that because the government had never used its authority to cancel student debt on a large scale, the Department of Education was "unsure how it would work," to which we responded [17] as follows:
Well Department of Education, allow us to tell you how the debt “relief” will work. You will end up being forced to write it off because you closed down the school.
And while your decision to shutter the college was likely the right move given the for-profit industry’s reputation for absurdly predatory recruiting practices, you have no one to blame but yourself for allowing these institutions to live off of billions in federal loans for years (while their CEOs pulled in millions in compensation), when you likely knew that in the end, they would have to be closed down once Congress got wind of how they went about luring students.
Sure enough, The Department of Education now says it will forgive federal student loans made to Corinthian students who can prove they were victims of fraud. The potential cost to taxpayers: nearly $4 billion. And that is for just one for-profit school. AP has more [18]:
The federal government will erase much of the debt of students who attended the now-defunct Corinthian Colleges, officials announced Monday, as part of a new plan that could cost taxpayers as much as $3.6 billion.
Corinthian Colleges was one of the largest for-profit schools when it nearly collapsed last year and became a symbol of fraud in the world of higher education and student loans. According to investigators, Corinthian schools charged exorbitant fees, lied about job prospects for its graduates and, in some cases, encouraged students to lie about their circumstances to get more federal aid.
In a plan orchestrated by the Department of Education, some of the Corinthian schools closed while others were sold before the chain filed for bankruptcy this spring. The biggest question has been what should happen to the debt incurred by students whose schools were sold. The law already provides for debt relief for students of schools that close, so long as they apply within 120 days.
The latest plan expands debt relief to students who attended a now-closed school as far back as a year ago. And it streamlines the process for students whose schools were sold but believe they were victims of fraud.
"We will make this process as easy as possible for them, including by considering claims in groups wherever possible, and hold institutions accountable," Education Secretary Arne Duncan said in a statement.
As an example, the department said it has already found that many programs at a California subsidiary of Corinthian Colleges, known as Heald College, were "misrepresented" to students. So any student enrolled in that school between 2010 and 2015 would likely qualify for relief.
The amount of debt relief could be staggering. Officials estimate that some 40,000 borrowers at the Heald College alone took on more than $540 million in loans that potentially qualify for debt relief.
But the final amount could climb significantly when looking across all Corinthian Schools, which include Everest and WyoTech. In all, the department estimates that about $3.6 billion in federal loans was given to Corinthian students.
This precedent set by this decision is precisely what we warned about nearly two months ago. In essence, this means that if the government continues to crack down on for-profit schools, the ensuing debt cancellations will run into the tens, if not hundreds of billions.
[19]
WSJ has more on the fallout [20]:
Officials said that under the emerging plan, the government will consider forgiving any loans made directly by the government—those held by the majority of the 43 million Americans with student debt—so long as the borrower can document a school persuaded him or her to take out the loan under conditions that would violate state laws.
The Education Department plans to use a provision of a decades-old federal law that allows borrowers to have loans discharged if they can prove their schools broke a state law—such as by using false advertising or other deception—to lure them to apply and borrow funds.
Federal officials acknowledged the potentially high cost of the policy. In the case of Corinthian alone, the Education Department said 350,000 Americans who owe roughly $3.5 billion in loans could be eligible for forgiveness. In all, Americans owe more than $1.2 trillion in outstanding student debt.
Federal officials declined to disclose the potential total amount of loans that could be eligible for forgiveness.
Under Secretary of Education Ted Mitchell said the agency realized the move could invite applications from across higher education, whether from community college students or law-school graduates. The agency said it would hire a “special master” to figure out many of the details, including what standards the department should use to determine whether a school had violated state law. The department also would likely hire additional personnel to handle the applications.
Mr. Duncan, the education secretary, said Corinthian won’t be the last company to come under close government scrutiny. “There may be more,” he said.
Various arms of the federal government have become more aggressive in pursuing for-profit schools for misrepresentations. Ashworth College, an online college based in Norcross, Ga., agreed late last month to settle Federal Trade Commission allegations that the school misrepresented how well it prepared students for certain vocational licenses and whether students could transfer credits from Ashworth to other schools.
Meanwhile, the Securities and Exchange Commission announced in May that it had brought fraud charges against ITT Educational Services Inc. and two of its top executives, alleging they misled investors about the financial prospects of some internal student-loan programs.
We'll close with what we said last month when we last discussed the idea of debt discharge for Corinthian students because, frankly, our assessment proved extremely prescient.
The real question now is whether continued pressure on for-profit colleges will result in further closures and more petitions from hundreds of thousands of students with hundreds of billions of loans they now know can be legally discharged. Note that we have not used the term "canceled", because as we like to remind readers, liabilities are never "canceled", they are simply written off by the person for whom they are an asset.
