Student Loan Servicers Aren't the Only Problem...

The Consumer Financial Protection Bureau announced Thursday that it’s launching a public inquiry into student loan industry practices that make repayment “a stressful or harmful process for borrowers.”

So, in its search for ways to make that repayment process something other than today’s less-than-awesome experience, the bureau is soliciting comments on student loan servicing policies, procedures and practices. Those includes the role that compensation programs may play in driving certain behaviors, the extent to which regulatory oversight may need to be augmented and the reasons that fundamentally important information isn’t getting to relief-seeking borrowers.

Although the bureau’s intentions are good and the inquiry it’s launching has the potential to favorably influence public policy, we’re kidding ourselves if we believe that this problem begins and ends with the loan servicers. It doesn’t, for the simple reason that these companies are merely acting at the behest of those that have much more at stake.

I’m talking about the note-holders: lenders—including the federal government—and investors, who continue to finance a good portion of this lending activity after-the-fact. These are the ones who ultimately call the shots because they have the most capital at risk, in the form of the unpaid loan balances.

This is not to say that some over-zealous servicers don’t take undue advantage of incentive-compensation programs. Let’s just not forget who put these rewards into effect in the first place, the negatively-amortizing forbearances that may well be a byproduct of that and, of course, the Truth in Lending Act exemptions that make things even worse.

All that in mind, here are five actions that policymakers and regulators should take for the benefit of the vast majority of student borrowers who are trying to do the right thing.

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1. Equal Accountability

Loan servicers are hired guns. So it’s reasonable to presume that the entities that engage their services are either in agreement with or behind the policies and protocols that govern their work. Consequently, these entities (the note-holders, in this instance) should be held equally responsible for any misdeeds committed on their behalf.

2. Reasonable Compensation

Given the high level of payment delinquency and default, loan administrators must be made to respond more quickly and address remittance problems more completely. One way to achieve that result would be to pay increasingly lower servicing fees for loans that are increasingly past due. And to dissuade servicers from shunting distressed borrowers into anything other than permanently restructured arrangements, all temporary accommodations should continue to be counted as delinquent until routine payments have resumed.

3. Rational Restructuring

There is no point in granting relief today that leaves the borrower with an even higher bill he or she won’t be able to pay tomorrow, which is why short-term accommodations that incorporate negative amortization should be prohibited. In cases where temporary relief is truly appropriate, however, lenders should either structure these forbearances with interest-only payments to prevent the loan balance from increasing or forgo assessing interest altogether during that period.

4. Appropriate Protections

Regulation Z, which implements the Truth in Lending Act, is very specific about the manner in which certain consumer loan remittances are credited: principal and interest before all other assessments. Otherwise, the potential for fee pyramiding exists, where crediting an unremitted late-payment fee first will cause the principal or interest portion to come up short, which in turn will trigger yet another late-payment fee. Although Reg Z prohibits fee pyramiding on mortgages, Title IV (federal) student loans are exempt. This exemption should be repealed if for no other reason than it is immoral.

5. Fair Resolutions

Like many other forms of consumer finance, student loan contracts typically contain a provision in which borrowers have no choice but to agree to waive their right to a trial by jury and instead have their disputes privately resolved by a panel of “experts.” This provision also precludes the ability to file class action suits. Interestingly, Reg Z was amended to prohibit mandatory arbitration for residential-mortgage-loan applications as of June 1, 2013. Here too, student borrowers deserve the same consideration.

No doubt, the CFPB will get an earful on the subject of student loan servicing—both from the standpoint of those who are genuinely frustrated in their efforts to honor their obligations and from a financial services industry that is desperately seeking to preserve the generous latitudes and income it currently enjoys. But wouldn’t we all be better off with a more balanced approach—one that fairly compensates lenders and servicers for their fair treatment of those who, when you think about it, are responsible for that very same compensation?

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.