Ever hear of the term risk-based pricing?

According to the Consumer Financial Protection Bureau, “lenders offer different consumers different interest rates or other loan terms, based on the estimated risk that the consumers will fail to pay back their loans.”

Said differently, the higher the risk, the higher the rate.

Lenders are perfectly justified in pricing their products to compensate for that risk, as long as it’s done without prejudice (Note 1). No doubt, you and I would do the same.

But when it comes to determining the actual interest rates and fees to charge, how high is too high, as greed often precedes catastrophe?

And to what extent should policymakers be held to account for permitting that to occur?

Case in point is a recent Department of Education rescission (Note 2) of a 2015 Obama administration directive prohibiting so-called guaranty agencies from charging “collection costs” to defaulting Federal Family Education Loan program borrowers who subsequently entered into rehabilitation agreements with these same entities.

Let’s start with the collection costs.

Borrowers default on their loans because, well, they don’t have enough cash on hand to make the payments. Sure, there are those who purposefully default, in the hope of gaining certain concessions from their lenders: discounted loan balances and lower interest rates, for example. We heard a bit about that in the run-up to the 2016 presidential election. But that’s not what’s at play with federally backed loans that can be offset against tax refunds and, even, Social Security payments.
So, the question is, if the borrower hasn’t been able to make consecutive monthly payments to the point of default (which for government student loans occurs after nine months), how much sense does it make to charge a potentially high multiple of that monthly payment in the form of processing fees for rehabilitating a defaulted agreement?

Not much, if the most recent data on student loan borrowers who are defaulting a second time on their previously remediated agreements (Note 3) is any indication — loans for which U.S. taxpayers are ultimately on the hook.

That’s one reason to scratch your head over the ED’s decision to gut the Obama administration’s directive. The other has to do with the role that these guaranty agencies play.

An especially illuminating report (Note 4) by the Century Foundation — a nearly 100-year-old non-partisan think tank — chronicles the history of the guaranty agency. Devised by Congress under the auspices of the Higher Education Act, guaranty agencies act as the administrative bridge between the government’s education-related lending activities and the consumer-learners who would become student-loan borrowers. Lawmakers also ensured that the government would reimburse this stable of financial intermediaries for the costs incurred to process loan applications, disburse funds and administer loan repayments, including for contracts default.

Defaults that, despite what one might infer from the words guaranty agencies are fully covered by the U.S. government. And until the 2015 Obama administration directive, entities that were also permitted to assess fees to financially distressed borrowers for rehabilitating their loans, atop those that the government appears to have paid for the same work.

It should therefore come as no surprise that guaranty agencies have over the years aggregately amassed a substantial amount of money, thanks to what appears to be a very one-sided arrangement.
Then why the need to restore the added avenue of rehabilitation-fee revenue?

Beats the hell out of me. And it doesn’t portend good things for the time when the Trump administration decides to divest some or all of the one-plus trillion dollars’ worth of Federal Direct student loans that currently reside on the ED’s books.

I say that because such a transaction will likely resurrect some form of the discontinued FFEL program that has helped deliver us to this miserable era of extraordinarily high payment delinquencies and loan defaults in the first place.

Which brings me back to the title of this op-ed piece.

Could it be that the thinking behind the ED’s rescission is merely faulty, which implies a level of incompetence? Or is it deliberate, which suggests something else entirely?

References

Note 1
Note 2
Note 3
Note 4

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Mitchell D. Weiss

Mitchell D. Weiss is an experienced financial services industry executive and entrepreneur. He is an Executive-in-Residence at the University of Hartford, co-founder of the university’s Center for Personal Financial Responsibility and adjunct faculty at Rutgers University as well. His books include Life Happens: A Practical Course on Personal Finance from College to Career, Business Happens: A Practical Guide to Entrepreneurial Finance for Small Businesses and Professional Practices and Practical Finance: A Straightforward Guide to Personal and Entrepreneurial Finance, all of which are undergraduate courses that he teaches at the aforementioned schools and elsewhere.
Mitchell D. Weiss
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