When Kyle McCarthy graduated with a master's degree from the University of San Franciso's business school, he dreamed of becoming an athletics director. But just four months after graduation, in April 2007, he slipped and tore his meniscus and two ligaments while playing soccer. It was a slip that would end up costing him his livelihood.
Bedridden for two months while awaiting surgery, McCarthy was unable to work. Meanwhile, the six-month grace period elapsed on his undergraduate and graduate student loans, which totaled $72,000. According to McCarthy, he unsuccessfully tried to put them into forbearance, then missed his first two payments amid the stress and confusion of having surgery. Suddenly, his monthly payment ballooned by several hundred dollars. His mother couldn't afford to fly out from Maryland to see him, let alone help him financially. And so McCarthy began a painful spiral into default.
"This has been the most horrible, demoralizing thing I've ever been though," he said. "Once you stumble, it's over. And you have no way out."
Today, two of McCarthy's loans are in default, and another is in delinquency. In order to get them in "good standing," he'd have to pay thousands of dollars. But he's nowhere near able to meet his obligations, as he only earns $14.75 an hour from his job at Borders bookstore. "I want to pay what I owe, but they're asking for too much," he said. "And they won't negotiate with me."
McCarthy, 28, is one of a growing number of people who have taken out large loans to fund their educations but are having difficulty paying them back. The reasons are numerous: Tuition rates have been rising for years at roughly double the rate of inflation, while federal grants have declined. Student loans are easily approved, and low interest rates make them an attractive alternative to credit cards. These days, more than two-thirds of all college students are borrowing; the average undergraduate borrows $23,000 and graduate students borrow about $40,000. Meanwhile, variable rates, hidden fees, and the growth of private loans have created incentives for lenders to make risky loans, leading to predatory lending.
The results of this simmering situation could spell a financial meltdown similar to the sub-prime mortgage crisis. At roughly $850 billion outstanding, student loan debt recently surpassed credit cards as the nation's largest segment of consumer debt. And a big chunk of that is in default — about $61 billion in federal and private loans, according to Mark Kantrowitz, founder of the student loan advice web site FinAid.Org. Like the victims of the sub-prime mortgage crisis, students were lured by the promise of a more lucrative tomorrow to borrow money against a future that never materialized. The most notable difference is that student loans are notoriously difficult to avoid repaying since they aren't easily dischargeable in bankruptcy. In the end, however, we'll all likely have to deal with the consequences.
How We Got Here
In 1965, President Lyndon Johnson signed the Higher Education Act, which provided grants and scholarships to help more students go to college. It also authorized private banks to make student loans, and created the Federal Family Education Loan Program (FFELP) to guarantee these loans, so that if a student defaulted, the bank would be repaid almost all of the principal. In 1972, the government created SLM Corporation, commonly known as Sallie Mae, to purchase these loans from banks, and thereby expand the amount of credit available.
While Sallie Mae began as a federal entity, it took steps to privatize in the Nineties and completed the process in 2004. In the meantime, Sallie Mae became a giant of the lending industry, with tremendous stock growth and profits. From 1995 to 2005, the company's stock rose 1,600 percent. Part of that growth was attributable to favorable legislation that Sallie Mae helped push for.
"Sallie Mae essentially wrote the laws that paid it," said Barmak Nassirian, of the American Association of Collegiate Lenders and Registrars. "The reason that Sallie Mae was so phenomenally profitable in the 2000s had to do with the fact that it had friends in the Congress."
One of those friends is Congressman John Boehner, the likely new speaker of the house and former chairman of the House Committee on Education and the Workforce. He has received more than $122,000 from Sallie Mae since 1989. In the early 1990s, Sallie Mae relied on its Republican friends in Congress to help overcome its greatest threat: a Direct Lending program that would deprive Sallie Mae of the FFELP loans that had become its lifeblood. In 1993, President Bill Clinton approved legislation that created the Direct Loan Program, low-interest loans made by the US Department of Education that were proven to be more cost-effective than FFELP. In the first two years after the creation of Direct Loans, Sallie Mae shed more than 50 percent of its market value. In response, Sallie Mae spent millions of dollars lobbying Congress to starve the Direct Loan Program. Sure enough, by 2006, Direct Loans accounted for just 19 percent of the market, from a high of 34 percent.
There are signs that Sallie Mae's heyday may be behind it. The financial crisis of 2007 hit the company hard. Then the Health Care and Reconciliation Act of 2010 completely eliminated the FFELP, which accounted for roughly 87 percent of Sallie Mae's portfolio. In response, Sallie Mae laid off 2,500 employees earlier this year.