The Government Fires a Few Debt Collectors, But Completely Misses the Point

Some surprising news on the student-loan front: The U.S. Education Department announced that it would terminate the contracts of five of its 22 debt-collection company subcontractors. Per the department’s press release, the soon-to-be ex-collectors made “materially inaccurate representations to borrowers about the [government’s] loan rehabilitation program” and also what borrowers could expect to be reflected on their credit reports.

How ironic. The ED is sanctioning firms—supposedly those it had carefully selected in the first place—for aggressive practices the department arguably encouraged with the contracts it hands out.

Collections companies are in the business of recovering every last nickel and dime from severely past due and defaulted debtors. The means by which they may accomplish that task is a matter for the companies to decide as long as they don’t break any laws along the way.

Sounds simple enough.

But what if the department that subcontracts this work also arms these companies with tools that give them an extraordinary leg up in collecting what’s due — such as the ability to divert (via garnishment) payments from Social Security, Supplemental Security Income, Veterans’ Benefits, Civil Service and Federal Retirement and Disability Benefits, Military Annuities and Survivors’ Benefits, and Federal Emergency Management Agency/Federal Disaster Assistance—and pay them bonuses on top of that?

And what about the apparent conflict of engaging collections companies that are corporately affiliated with the loan-servicing firms that failed to prevent borrowers from missing so many payments in the first place? In fact, what if the loan-servicing and debt-collections companies were once part of conglomerates that originated, owned and/or managed some of the same loans?

Sure, it’s a really good thing that the feds have at long last come around to taking action against these collectors, but will this really solve the problem?

I ask because a little less than half of all student debts that are in repayment at this time represent legacy loans made under the discontinued (2010) Federal Family Education Loan program—contracts that were originated in the private sector, guaranteed by the federal government and are now, to a meaningful extent, securitization collateral for the benefit of God knows how many investors in God knows how many places. As such, I would think it’s the loan servicers that should be drawing the ED’s attention—even more than the collectors.

Servicers are responsible for the day-to-day administration of the loan portfolios entrusted to them—activities that include the routine collection of non-serious, past-due payment amounts (generally, payments that are fewer than 90 days delinquent). Most important, they’re being paid, in part, to prevent these delinquencies from worsening so that the owners of the loans are spared the added expense of hiring debt collectors (hence the concern about affiliated companies getting paid twice for working the same contract).

More fundamentally, though, is the question of the entity that’s being served. In the matter of the FFEL loans, paying for the day-to-day administration of these contracts is the responsibility of the private-sector lenders and investors who own them. But let’s not lose sight of the fact that should these debts become seriously past due to the point of default, the government is contractually obligated to pay them off. By extension, then, the loan servicers should be endeavoring to protect the taxpayers’ interests, right?

Wrong. Because the taxpayers aren’t writing the checks.

So when the government announces a crackdown on a handful of debt collectors—and even puts into place a so-called student-aid bill of rights, as the Obama administration just announced—it’s hard not to view these pronouncements for what they are: acknowledgements of the obvious and missed opportunities to address the fundamental policy and administrative lapses that brought us to this point.

This is especially important as the ED approaches the point when it will need to once again turn to the private sector for help with the nearly $1 trillion worth of Federal Direct Loans that currently reside on its books. Unfortunately, there’s no good reason to believe the department will do any better job managing this next financial-markets windfall when it comes to pass.

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