Economics, Law

Student Loans: A Recipe For Social Unrest

Rodrigo Rato led the IMF from 2004-2007. Before that he served as Spain’s economy minster. In both roles he was a staunch advocate of real-estate fueled economic growth.

After the financial crisis Rato served as the head of Bankia, a 2010 rollup of seven regional banks.

Today Bankia is 64% owned by the Spanish government and so is Rato: in February, 2017, he was sentenced to 4.5 years for embezzlement. Rato maintained his innocence, arguing bank issued credit cards he used for personal expenses were part of his compensation package.

All things considered it is difficult to believe Rato would have received such a stiff sentence but for one issue: many Spanish have come to revile bankers.

The reason for their anger lies in Spanish mortgage and foreclosure practices. Like their US counterparts, Spanish bankers had extremely lax underwriting criteria before the financial crisis. Since they securitized and sold the loans originators showed little concern about credit risk. As the real-estate market tightened and home values declined, servicers demanded co-signers, additional collateral, or minimum interest clauses to compensate for negate interest rates. As borrowers lost their jobs, due to the financial crisis, foreclosures skyrocketed.

In the US, after a foreclosure banks may or may not be eligible for a deficiency judgment, a money judgment for the difference between the loan, accrued principal and interest payments, legal fees, and the price the house fetched at auction. But even when servicers have the legal right banks rarely pursue these judgments because they are easily discharged in bankruptcy.

While it is arguably not nice to stiff the bank life takes twists and turns, especially after the world economy falls off a cliff. Bankruptcy exists because it is economically preferable that a borrower be restored as a productive member of society than saddled with debt forever.

In Spain, unlike the US, banks almost always obtained deficiency judgments for mortgages and those judgments could never be discharged in bankruptcy. Further, the judgments were strictly enforced ensuring that the borrower — and their guarantor — were wiped out for decades, if not their whole life as interest on the debt continued to accrue.

Banks were brutal, frequently refusing to modify loans or negotiate deficiency judgments. Since guarantors were often family members the defaults would cascade. A young adult might default on their mortgage that their parent had guaranteed; post eviction they would move into their parents home but the deficiency would force their parents to default. A different child might have guaranteed the parents mortgage; entire families were thrown into homelessness.

Rato is in jail with 65 other Bankia bankers, accused of collectively stealing about €12.5 million. Did they do it? Probably. Would Rato have receive 4.5 years in prison for buying shoes and booze on the company card but for the foreclosure madness? Probably not. Consider this passage: “Bankia is not the only bank kicking people out of their homes, but we chose to focus on it because we feel it’s been the most noxious,” said a leader of the anti-foreclosure Indignados movement.

Bringing this back to the shores of America, US student loans are also non-dischargeable in bankruptcy. Here is a link to the long and depressing narrative about how student loans came to enjoy this unique status. Even entirely private student loans, with no government money at risk, cannot be discharged in bankruptcy except under extremely narrow circumstances.

Like Spanish foreclosure deficiency judgments student loans live for life. Creditors can, and do, garnish social security checks to pay student loans.

The Federal Reserve has already determined the obvious: carrying student loan debt reduces the ability to buy alternative goods and products. Money that went into first homes is going into early student loan repayments. Higher student loan debt is associated with lower homeownership rates.

US student loan debts are growing at a furious pace. Just years ago the passed the $1 trillion mark; American students now owe about $1.34 trillion according to the Federal Reserve. Americans owe more money for student loans than any other type of debt except primary mortgages.

About 11 percent of those loans are more than 90 days late, an already high number until we consider that just under half of the outstanding loans are not yet in repayment. Considering that the loans are not in repayment because the borrowers are still in school, with ever higher tuition, it is safe to predict that these will eventually default minimally at similar rates.

Spanish mortgagors, meet American students. You two hardly know one another but have a lot in common.

Both Spanish borrowers and US students have lists of debt-inspired suicides. Googling “student loan suicide” brings up one link, from a website for millennial investors, arguing suicide is not the answer. Other links include articles about paying off student loans. Then, oddly, there are the multiple advertisements from student loan lenders. You’d think the value of a student loan borrower contemplating suicide wouldn’t be an attractive advertising target but, for student loan lenders, you’d be thinking wrong.

Similar to their Spanish counterparts American student loan bankers routinely demand co-signers and lobby for ever more power over their borrowers. US Education Secretary Betsy DeVos has recommended A. Wayne Johnson, CEO of Reunion Student Loan Services, a private student loan lender, to lead the government loan program. Their hunger for yield and power knows no bounds.

Under political pressure and a ruling by the European Union the Spanish are slowly revising their foreclosure laws. Reforms, coupled with worries about public backlash that results in long prison sentences for minor crimes, have pushed Spanish servicers to work more equitably with borrowers. Economic reality probably also helped as banks realized reduced payments, for a short time until a borrower recovers economically, are arguably better than no payments for near worthless properties.

Similarly, the economic and social pain from the student loans are likely to eventually force change.

 

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