How did student loans go from a “sleepy backwater” in finance, dominated by private banks, to a major issue in the 2020 presidential race?

Experts point to the way the finance industry seized on the opportunity to make money.

“It was exactly like the mortgage crisis in that... banks were making enormous loans to people that there was no way they were ever going to be repaying them and then securitizing them into asset backed securities and selling them to investors,” Austin Smith, a student debt lawyer with Smith Law Group, told Yahoo Finance.

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

‘Take out a student loan today, get a toaster’

Student loans have been a part of American life since the Higher Education Act in 1965, which established a system where banks or private lenders provided student loans — most of them to young borrowers who had little-to-no credit history — that were guaranteed by the federal government.

In the early years, the relatively small student loan market was “considered a sleepy backwater in consumer finance,” former Consumer Financial Protection Bureau (CFPB) Ombudsman and current Executive Director of D.C.-based nonprofit Student Borrower Protection Center Seth Frotman told Yahoo Finance in a previous interview.

But things changed as U.S. college enrollment increased from 8.5 million in 1970 to 20 million in 2010.

“You can kind of see this paradigm shift where more and more financial interests get into the game,” Frotman said. “We see this with big banks and other financial players… and it's really hard not to look at what has happened over the last decade to decade plus has just the real financialization of higher education in America.”

According to one report, in the 80s, when a Senate aide walked into a bank in Maine, they saw a sign that said: “Take out a student loan today, get a toaster.”

By 2005, “Sallie Mae's growth was nothing short of phenomenal,” Fortune Magazine reported. “Net income more than quadrupled between 2000 and 2004, from $465 million to $1.9 billion. … One analyst described Sallie's business as "high-growth, profitable, recession-proof, and almost 100% federally guaranteed."

A system designed to send Americans to school manifested as an industry oriented to generate profits.

“We made mistakes from the beginning,” Sara Goldrick-Rab, professor of higher-education policy at Temple University, told Yahoo Finance in a previous interview. “The mistakes were made, even in the ’60s and ’70s, in crafting the system itself… Our presidents since that time has inherited the system and made choices about what to do about it.”

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

In 2010, Obama administration overhauled the student loan program, eliminating fees paid to private banks to acting as intermediaries. But the foundation of the old system remained: Servicers continued to secure government contracts with the Education Department to make dollars and cents for each student loan they service.

A. Wayne Johnson, a former top student loan official who resigned in November 2019, believes “the whole system was designed to feed the colleges and universities need for funding at the expense of students taking on loans.”

This system, as Johnson experienced it, created “a never ending supply of money going against this never ending demand of funds from the schools” that led to “more and more American students into deeper debt, along with their families, who were signing on the line for them as well.”

By the end of 2019, American households owed $14.15 trillion in debt, out of which student loans represented about $1.51 trillion. Student loan debt remains a considerable financial weight on millions of Americans and a key issue in presidential elections.

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Full transcript:

Aarthi Swaminathan (00:00):

It was 1996. Heather Shade had just graduated from law school in North Carolina, and she was moving to Asheville with her husband and two children to open up her own law practice. She wanted to practice juvenile law, keen to help others, particularly children. She set up an office, she hired a secretary and she took on some clients. It didn't pay much, but the work was meaningful.

Heather Shade (00:30):

I was good at what I did. I'm intelligent, I'm educated and I cared. I work probably 50, 60 hours a week with the children and raised my family and worked very hard. I represented some juveniles that you would think would be lost, but I would work with them. And that time, and when I was doing some of the delinquency work, we got paid, I think it was $145 by the state, whether we were in court one time or 20 times, it didn't matter. We had a flat fee at that time. But that's not what mattered to me. I would talk to these kids as long as I needed to, to build their trust, to talk to them and try and redirect them from the path they were on.

Aarthi Swaminathan (01:11):

But pretty soon things began to unravel. Heather started experiencing a range of medical issues from diabetes to post traumatic stress disorder. Expenses began to pile up. Debts that she owed, began to grow. One pile of loans, in particular, started haunting her. Back in the summer of '96 when she had graduated, Heather had owed about $100,000 in student loan debt. She was going to pay it back but over the years, as she struggled with her medical problems, which led her to eventually close her law office and lose her insurance, that debt had grown. That debt had grown to $242,000. A decade after she graduated from law school, Heather Shade owed nearly a quarter of a million dollars.

The thing is though, Heather is not alone. Heather Shade is just one of the millions of student loan borrowers across the United States who took out money to embark on a career or to fulfill a dream or just simply get educated and are now standing waist-deep in student loan debt. How did we get here?

Aarthi Swaminathan (02:39):

I'm Aarthi Swaminathan and, and this is Illegal Tender, season five. The whole issue of student loans or student loan debt has become such a big, buzzy topic. Let's cancel trillions of dollars of student debt. No, no, no. Let's make college free. Or how about let’s make college free for some people, but charge other people? It's really easy to get lost in all of this noise.

But at the heart of this entire issue lies two big ideas, two big ideas that have morphed and mutated into a monster that is just virtually unrecognizable today. First, meet fairness. Fairness is the big promise behind why student loans even came into being. It was to make education more accessible and to reduce the barrier of high costs. And so, the federal government set up the student loan system. Through the Higher Education Act of 1965, the federal government began guaranteeing loans that banks gave out called the Federal Family Education Loan Program, it gave Americans the opportunity to attend college, to get a bachelor's degree or a master's degree by lowering the upfront cost of college.

And thanks to that education, we then meet the next big grand idea of student loans. The American Dream. You can be rich, you can be poor, but with a good education, the great equalizer, we create a meritocratic society that offers us a better life.

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

Ronald Reagan (04:27):

My fellow Americans, I'd like to talk to you today about one of the most important issues that touches our lives and shapes our future. The education of America's children. We've always had a love affair with learning in this country. America is a melting pot, and education has been a main spring for our democracy and freedom. A means of providing gifts of knowledge and opportunity to all citizens, no matter how humble their background so they could climb higher, help build the American dream and leave a better life for those who follow.

Aarthi Swaminathan (04:56):

That was former President Ronald Reagan. He made sense, right? Well, not exactly. Over the years, the cost of attending a college, a higher education institution, had grown by so much that it became so expensive that most people just simply couldn't afford it. According to the National Center of Education Statistics, say you attended a four-year college as a full-time student, you would have paid $10,900 in 1985 for one academic year. The year Heather graduated in 1996, on average, it cost about $13,800 per semester. That's $3,000 more than what she would have paid in 1985.

But then in 2016, a student for one academic year had to fork out $23,000. Now, just think about that for a second. How could a high school student possibly pay for $23,000 a year times four. Of course, you know there is a difference between the sticker price, which is the number that schools list on their brochure and the net price, which is how much they owe after subtracting scholarships, grants, financial aid. But even then, even after subtracting all of it, to attend a university or a college and climb that bronc on the social ladder to reach the American dream, you had to cough up all that cash. How do you even do it? You take out student loans.

Barack Obama (06:32):

Now in America, higher education cannot be a luxury. It's an economic imperative that every family must be able to afford.

Aarthi Swaminathan (06:43):

Obama had a point, but at this stage in 2020, more than trillions of dollars have been borrowed by so many millions to attend colleges and universities over the decades. Millions were struggling to keep up with owed crushing debt and these people were begging for mercy, for some sort of relief.

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

Seth Frotman (07:04):

What the current single loan borrowers face is not normal like the historic and tremendous and significant growth of student. You had that play out in terms of obviously, 1 trillion, $1.2, $1.6 trillion.

Aarthi Swaminathan (07:21):

That's Seth Frotman. Seth used to head up student loans at the Consumer Financial Protection Bureau, which is essentially a federal agency that's dedicated to helping and protecting consumers against big financial companies. He knows a lot about student loans.

Seth Frotman (07:38):

It's just common nature to them that this is something that is holding them back, that this is something that is holding back our country, and it's also just kind of generationally unfair, because they're be asked to bear a burden that no prior generation has really had to. And I think that's why the comparisons are unfair because, in a lot of ways, students today are just asking to be treated like generations before them. And I don't think that that is out all that outlandish.

Aarthi Swaminathan (08:08):

In other words, it's one thing to say the cost of college is higher and hence we pay more and we owe more. It's just basic math, you could argue. But part of the reason why that original idea of fairness of the American Dream and the entire notion of higher education as a way to get to a better life got so corrupted, and is a Seth Frotman says, holding back the entire country, it was because of the introduction of greed.

Aarthi Swaminathan (08:42):

Let's pretend for a moment that we have a magic wand. We can wave it, we can point it, whatever it is, we use it to wipe away all the student loan debt, all the student loans, and reset to where it all began. Now, let's assemble the key components. First, you bring in the parents, middle-class parents, while well-intentioned, thoughtful, caring, but ultimately ambitious people who want to give their children the best, most amazing education ever. Already you begin to send some turbulence. Here's how Betsy Mayotte, President and Founder of the Institute of Student Loan Advisors put it.

Betsy Mayotte (09:23):

I want to tell you a story, a phone call I had probably at this point 10 years ago, maybe even 15 years ago, that I think illustrates the issue that I'm talking about. I'll never forget this call. The company I was working for, I think it was somebody that was a friend of our, someone on our board of directors, and they asked me to talk to this woman who was trying to figure out how to fund her daughter's college. So I talked to her. She was a Massachusetts resident. Her daughter was also a Massachusetts resident. Her daughter wanted to go to University of Rhode Island. She'd gotten an excellent financial aid package, but because she was an out of state student, they still had to find $15,000. So they've maxed out all the loans for the student. The mother was not in the financial position to take on parent debt herself or to cosign for her daughter, which is why they were talking to me to see if they had missed anything.

Betsy Mayotte (10:07):

So I went through all the options and there wasn't any other opportunities out there for her. So I took a different tactic and I said, "Why does your daughter want to go to URI? What is she going to study?" She said, "Criminal justice." I said, "That's perfect. UMass, Lowell is nationally renowned for their criminal justice program and because you guys are Massachusetts residents and based on the package that I've already seen that you received, she'll be able to go to UMass Lowell for free." So better are a credentialed program. No debt, going for free. I have never been yelled at as loudly as this woman yelled at me.

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

Betsy Mayotte (10:44):

How dare I make that suggestion? Her daughter wants to go to URI, and that's where she's going to go. And I think that without the extreme to [inaudible 00:10:53] to that particular story, I think that is the point of view of a lot of families. It's a point of pride. My kid wants to go here, that's where my kids going to go. And they don't take a step back and see is this the best fit for this student? And what people don't realize is that something like 70% of all undergraduate students either change schools or change majors. So just because this student is saying, Oh my God, I absolutely want to be an accountant and I have to go to Bentley or I have to go to Babson because I want to be an accountant. 70% of those people are going to decide pretty quickly they don't want to be an accountant.

Betsy Mayotte (11:25):

That's why the average time period to get a four-year degree is five years because people are transferring programs and transferring schools. That's why I say one of the issues is we need to get the thought process changed. This same mother, I guarantee you, this same mother that yelled at me for suggesting UMass, Lowell, if her kid came to her and said, mom, I want a brand new BMW because that's what I want, her mother would have laughed at her. And a car is not the same as higher education but the fact that the vehicle that you're choosing for your kid versus the college choice needing to be the right fit, both financially and for what what their lifestyle is, are very parallel.

Aarthi Swaminathan (12:04):

Betsy's experience was far from unique. Now factor in how this entire system was going to work, some sort of framework for who is going to lend the money and how the student after graduating would pay it back. The banks had it all figured out. They entered the student loan game early on and before Obama got to the White House, student lenders were having a field day making out loans for people left, right and center.

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

Aarthi Swaminathan (12:41):

According to one report, in the 1980s when a Senate aid walked into a bank in Maine, they saw a sign that said, " [inaudible 00:12:48] a student loan today. Get a toaster." Just listen to this news article from 2005 from Bethany McLean. When we met in the first season of The Legal Tender when she wrote for Fortune magazine. "Under CEO L. Lord, Sallie Mae's gross was nothing short of phenomenal. Net income more than quadrupled between 2000 and 2004 from $465 million to $1.9 billion. Sallie Mae, which earns a return on equity of about 35%, is one of the most profitable financial services firms in the entire world and has told the street, Wall Street that is, that it will continue to grow its earnings at a 15% to 20% annual clip. One analyst described Sallie Mae's business as high growth, profitable, recession-proof and almost 100% federally guaranteed. The entire industry was thriving.

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

Seth Frotman (13:50):

And I think what you can see is this paradigm shift, where more and more financial interests getting to the game. We see this with big banks and other financial players for profit and [inaudible 00:14:03] schools, debt collectors, private equity companies. And it's really hard not to look at what has happened over the last decade today [inaudible 00:14:11] plus. It's just the real financialization of higher education in America.

Aarthi Swaminathan (14:20):

Think about this for a second, about how greed manifests itself. You make that decision to go to college. And to pay for that, you ask a parent or parents and then you take out a loan. That's a financial obligation that you develop through the college's financial aid office and maybe a loan officer. Sign here, sign there, you're good to go. But you know that that's not where it really ends. You've got to pay for it, sure. But that's also, in fact, where it all begins for the finance guys. Frotman and others like him believe that therein lies the rot with the way the industry has developed with a lender and a loan servicer who basically don't have the borrower's best interests at heart. Here's how Austin Smith, a lawyer who deals with student loan matters, saw it. In your mind, is there one person or one entity that you can blame for this entire student debt fiasco that has happened because we don't see it in other countries?

Austin Smith (15:25):

Until 2010, pretty much every major bank that you've heard of was involved in student lending. And this was because when the government set this up, they wanted this kind of public/private partnership, where the banks actually made the loans and the federal government just guaranteed them. And so, all a lot of banks did this. I mean, JP Morgan, Citibank and they were called eligible lenders under the Higher Education Act. And they also made private loans on the side.

Aarthi Swaminathan (15:57):

The student lenders made some good money while they were at it.

Austin Smith (16:01):

You know, private lending still exists today but not nearly in the form it did in 2005, when it was, I think there were a lot of articles that called it the Wild West of lending. I mean, it was exactly like the mortgage crisis, in that banks were making enormous loans to people that there was no way they were ever going to be repaying them and then securitizing them into asset-backed securities and selling them to investors.

Aarthi Swaminathan (16:24):

But then disaster struck. The Obama administration basically came in and wiped out private lending in 2010 and all the lenders scattered. Citibank, for one, ended up selling $2.5 billion worth of private student loans to Discover in 2011. Some services remain. Securing government contracts with education department where they make dollars and cents for each student loan that they service. And with that one move by Obama in 2010, we fixed the rot. We drained the swamp, right? Wrong.

Aarthi Swaminathan (17:06):

On one hand, parents were actually becoming more and more desperate to get their kids into good schools. Remember that ambition scandal where approximately 30 parents had literally bribed the exam proctors and school officials to get their kids placed at Yale, Stanford, and so on. On the other side, it appears that we have now swapped the "bad guys" out who were securitizing those student loans and hawking them to third parties and making a tidy profit. And we replaced them with really confused, stressed, and underpaid guys who did not see the point in student loans.

Aarthi Swaminathan (17:43):

Just listen to Wayne Johnson. Up until 2019, Wayne Johnson ran Federal Student Aid Office, which basically manages all the student loans that are federal.

Wayne Johnson (17:55):

There was the point about Secretary DeVos, [inaudible 00:17:57] the chief operating officer for Federal Student Aid, the [inaudible 00:17:59] the position that's responsible for the administration of all the money being deployed and all the money that's out there. But the more I got into it and the more I basically went about doing my daily work, the more it became crystal clear to me that the whole system was designed to feed the colleges and universities need for funding at the expense of students taking on loans. It became clear to me that this never ending supply of money going against this never ending demand of funds from the schools, was just getting more and more American students into deeper debt, along with their families, who were signing on the line for them as well. And then I really understood how, quite frankly, broken the system is.

Aarthi Swaminathan (18:45):

We covered Wayne's exit from the Education Department. Almost every media outlet did, because Wayne wasn't cut from the same mold that Austin or Seth or even Elizabeth Warren or Bernie Sanders or whoever it was who was decrying this broken foul student loan system. Wayne was from Georgia and Wayne was a Republican. Sorry, we didn't want to bring politics into it, but we just had to, because Wayne's radical idea, which was developed after observing that greed and the resulting rot in the system, was simple. And it harked back to the idea of fairness and the American dream.

This is part 1 of Yahoo Finance’s Illegal Tender podcast about how student loans have wreaked havoc across American finances for decades. Listen to the series here.

Aarthi Swaminathan (19:26):

The interesting thing to me about you, and I just think that fascinating person because you are a conservative, you are Republican, but you also happen to be calling for $50,000 of student debt being forgiven for each borrower. I mean, how do you reconcile that? I mean, people should be You're sounding a little more Democratic than Republican onto. How would you respond to these people?

Wayne Johnson (19:48):

Well, I hope I'm sounding sane. The way in which you got to approach this is you got to start over. When you find yourself in a hole, there's an old expression, you need to stop digging. And so, our nation needs to stop digging this hole. The conclusion I've reached after doing a lot of research is, we need to give every high school senior who graduates $50,000 as an education allowance that they can go spend. I call it an opportunity plus scholarship grant.

Aarthi Swaminathan (20:16):

Wayne is running for the Senate seat in Georgia on this exact platform.

Wayne Johnson (20:21):

$50,000 we'll get just about everybody through some form of post high school education, either on the technical path or either on an academic path. If you're going to give everybody going forward $50,000, than by fairness, the people that are on the books today, you should relieve up to $50,000 worth of debt. And by the way, that $50,000 worth of debt relief would totally wipe out the debt for 37 million Americans. They're total of 44 million Americans who owe student loans, federal student loans. The other 7 million would still have some level of debt, but it wouldn't be nearly as egregious. I mean, it would be $50,000 less. I also want to accommodate those people that have paid off their student loan debt or never used student loan debt. Give them a tax credit up to $50,000, so it's equity for all.

Aarthi Swaminathan (21:16):

It's not exactly clear whether we'll see student loan forgiveness in the near future. Maybe with the coronavirus, things may change as people struggle to repay their debts as they face unemployment. But perhaps there's another way out.

In 2007, Heather Shade filed for Chapter 7 bankruptcy for her $242,000 in federal student loan debt. Heather fought long and she fought hard with the education department and eventually the loans were forgiven. She was finally debt free, but Heather wasn't exactly thrilled about this outcome because at the end of the day, student loans were meant to help people and help level the playing field. Education was supposed to lift people out of their current situation and offer a chance at true meritocracy.

But then Heather wrote to me in an email. She said, "The American dream is dead now." In the next episode, we'll take a look at one case of how the trillion dollar federal student loan machine failed and also examine how Heather, and other people like her, got rid of student loans.

Illegal Tender is made by Yahoo Finance at our studios and homes in New York City. This episode was written and hosted by me, Aarthi Swaminathan. Illegal Tender was created, edited, and produced by Alex Sugg. Thank you to Heather Shade, Betsy Mayotte, Austin Smith, Natalie Jean-Baptiste, Seth Rotman, Kelly Finlaw, Wayne Johnson, and everyone else who I haven't mentioned, for sharing your knowledge.

If you enjoyed this podcast, head over to Apple Podcasts and leave us a five star rating and review it for the show. Until next time, thank you for listening to Illegal Tender.

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