Who Pulls the Strings on Your Student Loans?

The call came after we’d already gone to bed.

Our younger child—who was working at a summer job a couple of states away—was crying so hard we could hardly make out what she was trying to tell us. It was only after she’d handed the phone to the police officer on the scene that we learned her car was wrecked. Thankfully no one was injured, but there was a bit more to the story.

The officer passed the phone to a man who identified himself as the president of a local bank. It seems a good portion of the vehicle was now parked inside his lobby.

The car was registered in my wife’s name. So when our daughter decided to toss the keys to some knucklehead who peeled rubber down a narrow alley, lost control of the wheel and turned a traditional bank building into a drive-through, the financial responsibility for the resultant damages was ours to bear. That’s because liability tracks the asset: The owner is the first to be held accountable even if he wasn’t directly involved in the event.

Unfortunately, not everyone seems to understand how this concept applies to less tangible forms of property — such as loan agreements.

The Buck Stops Where?

In a recent report, internal auditors at the U.S. Department of Education criticized the Federal Student Aid office for its lax oversight of the private collection agencies it hires for the loans it owns or guarantees. But it didn’t hold the department directly responsible for the agencies’ missteps.

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That echoes earlier DOE testimony with regard to certain lapses on the part of its subcontracted loan servicers. Once again, the discussion was about improving oversight instead of acknowledging the responsibilities of ownership. In fact, loan servicers are commanding so much attention these days that lawmakers are calling for reforms and even a so-called loan-servicer code of conduct to safeguard the rights of student borrowers.

Simply put, though, loan servicers are hired help. These companies don’t own the contracts they’re tasked with administering. Consequently, they haven’t the authority to alter key contractual terms (such as the loan balance, payment amount, repayment duration or interest rate) because doing so could diminish the loans’ owners’ anticipated rates of return.

Therefore, it’s reasonable to presume that the actions that are being taken by the servicers are indeed sanctioned by the owners—a group of privileged puppeteers that, in this case, includes banks, investors and the federal government—who should also withstand the consequences for what they authorize.

Fortunately, the Consumer Financial Protection Bureau is beginning to zero-in on that.

In its own recently released report, the agency says that it holds servicers and lenders equally responsible for the mistreatment of financially distressed borrowers. But much of report centers on private student loans, which is disappointing because the scope of the problem extends well beyond that.

Private loans make up 10% to 15% of all education debts. By contrast, Federal Family Education Loan-program debts account for roughly half of all the government-backed loans that are in repayment. Some of the same subcontracted servicers handle these contracts; as well, a fair amount of the loans have even been securitized.

Taking Responsibility

It’s not enough for the CFPB to attribute loan-administration failures and inadequate offers of relief to the complexities of the financial services industry and leave it at that. The agency needs to be blunt about the role the owners of these loans play in directing the actions of their subcontractors, and the implications that has for borrowers and taxpayers unless the owners are held to account for the decisions they make.

The DOE should also acknowledge that it, too, is responsible for the choices it makes—the companies it hires, the compensation schemes it puts into place, the directives it gives and the oversight it conducts.

As for Congress, lawmakers exacerbate the problem with their unwillingness to accept the hard truth that with roughly half of all borrowers behind in their payments or in default, the appropriate course of action is to mandate the restructure of all student loans, as well as to fundamentally redesign the program itself.

Congress is also remiss in articulating a cogent plan to deal with the nearly $700 billion in Federal Direct loans on the DOE’s balance sheet.

Trees don’t grow all the way to the sky: At some point, the government will need to reduce that exposure by selling a portion of its portfolio to the private sector. What will happen then? A replay of the failed FFEL program, in which the private sector takes ownership of the loans, skims the profits, limits relief programs and leaves the taxpayers to cover the losses?

Let’s not underestimate the resourcefulness of a financial services industry that’s very good at finding ways to make up for diminished profits. Just as our daughter lost her car privileges for several years because of the poor decisions she made, so too should those who pull the strings on these loans be forced to accept less than what they’d like because of their own actions, or lack thereof.

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