Tuesday, June 03, 2008


Citibank to CC's: Drop Dead

Several alert readers sent me links to this article from the New York Times. Apparently, Citibank, JP Morgan Chase, and several other major lenders have stopped providing student loans to students at many community colleges and some less-tony four year schools. The key quote:

The banks that are pulling out say their decisions are based on an analysis of which colleges have higher default rates, low numbers of borrowers and small loan amounts that make the business less profitable. (The average amount borrowed by community college students is about $3,200 a year, according to the College Board.) Still, the cherry-picking strikes some as peculiar; after all, the government is guaranteeing 95 percent of the value of these loans. (emphasis added)

So smallish loans to struggling students are bad, despite being guaranteed by the government. But biggish loans to struggling students elsewhere are okey-dokey.

Alrighty then.

Obviously, the only reasonable course of action for cc's, in this case, is to jack tuition up to the sky. Make those loans big enough to be worth offering. What could possibly go wrong?


Clearly, the student loan racket needs to be dismantled and rethought from the ground up.

Education loans are a tricky business in the best of times. You can't really repossess an education, the way you could repossess a car or a house. So the way to get private lenders to take the chance of being stiffed, in the absence of collateral, without having them charge politically unacceptable interest rates, has been through subsidies and guarantees.

Here's where my Scandinavian/social democrat side gets confused. If you have to subsidize and guarantee anyway, why do you need private lenders at all? Why not just have a single public agency, with a single set of rules and a single pile of paperwork? Run it on a non-profit basis, and let Citibank and its ilk lend for houses and cars and businesses.

If that's still too much paperwork, you could always replace the loans with scholarships. Call them vouchers, if that makes you feel better. I prefer 'grants,' but to each her own. If an educated workforce and citizenry is a public good, and I believe strongly that it is, then why not have the public handle it?

Come to think of it, this might work for health care, too. Why deal with 500 different sets of HMO paperwork, each with its own incentives to make 'mistakes'? If only there were a precedent for a single-payer system in an advanced country, with lower health care spending and better outcomes...


This is so seriously messed up, it's hard to know where to begin. First, there's the ecological inference fallacy. Credit risk is supposed to attach to people, not groups. If I've defaulted many times before, then yes, I'm risky. But if others who share my zip code have defaulted, does that mean I'm more likely to? This smells like educational redlining.

Then there's the staggeringly obvious fact that different majors at the same college have different employment prospects. Our Drama majors have some difficult choices to make, and face long odds in their field of study; our Nursing majors are hired before they graduate. Averaging them together tells you about...who, exactly?

And what about the students who transfer to complete four-year degrees? How do they count? In my mind, they count as 'successes' for us, but I could see where they'd drag down the 'starting salary' figures.

Besides, if ability to pay the loan back were really the issue, wouldn't the smaller loans be the ones least likely to get cut? It's easier to pay back $3,000 than $30,000. I would think the community college Nursing grads would be the best risks, since they combine small debts with healthy salaries upon graduation. But Citibank is cutting those, while happily lending $50,000 or more to poetry majors at Midtier State. Ability to pay ain't the issue.

The category mistake here is in treating a largely public good as a purely private one. Lenders get paid back by individuals, so they have to think in terms of a private good. But higher ed was never meant to be nothing more than the personnel office of the economy (even if it has a role to play there).

Some folks have an ideological interest in claiming that any market move must be right by definition. But for those of us who prefer to deal in objective reality, this just smacks of straight-up class bias. After all, the same banks who turn up their noses at community college student loans have been more than happy to lend those same people much larger amounts of money in subprime mortgages. No, this isn't economically rational or the act of a disembodied market. This is snobbery, this is wrong, and this needs to be dismantled.

Several points:


Individual risk can be calculated from a number of factors that are shared by a group. If the person only has 3 years or less of credit history that may be the only way.


Here's the quote you summarized:

“temporarily suspended lending at schools which tend to have loans with lower balances and shorter periods over which we earn interest. And, in general, we are suspending lending at certain schools where we anticipate processing minimal loan volume.”

Small loan amounts and few borrowers means that it's hard to get any economies of scale or even cover the overheard for the people assigned to the area in question.

It's not snobbery, it's profit motive. They basically came right out and said they can't run the loans profitably.

Also, not all the banks are using blanket rules. SunTrust was targeting specific schools.

"If an educated workforce and citizenry is a public good, and I believe strongly that it is, then why not have the public handle it?"

Because it's not a pure public good. There are many disciplines that, while fine in and of themselves, do very little to make a person more productive or a better citizen. e.g. having a degree in drama is unlikely to make you a better neighbor / bank teller.

If everyone, but everyone, got 5k / year to go to school every school would raise their tuition by 5k. You wouldn't want to, but when your legislature did the budget one of them would realize that they could cut your funding by that amount because you're already getting it.

Also, you've written many times about how you get annoyed when people assume malice on your part. You've said they do this because they don't have the same information that you do and that if they did they'd realized that you're not as free an actor as you appear. You seem to be doing the same thing here.

One final question, does your school allow banks to sell credit cards on campus? If so this might give you some leverage with the parent banks.

Note that the swedish model (as one of the main sources for the scandinavian take DD was refering to) has two sides:
1) There's public funding for students on a total of about $1000 a month, divided into 1/3 grant and 2/3 state issued loans. This is available for 6 years, and dependent on at least 75% pass grades each semester.
2) There isn't tuition. Even the (rather few) private universities in Sweden are explicitly forbidden to take out tuition - to a large extent even from foreign students. Hence, the funding available to the students goes into sustaining the students through their studies, not straight into the University budgets.
I think DD is referring to his Scandinavian heritage (think self-reliant Norwegian farmer in Minnesota) that questions the idea of a taxpayer subsidized profit motive. My very Republican father decries the sort of cost plus contracts that the people he votes for use to guarantee a profit on top of whatever profit can be gained through shell corporations passing on shoddy electrical work that kills our troops along with their own costs and profits.

But we should not be surprised, just outraged, that Citi et al are extending the business model they use for credit cards and mortgages to the student loan business. You can't repackage those "loans with lower balances" into so-called investment grade securities if they get paid off too quickly. The perfect sucker/customer is one that can just barely afford to pay the interest forever but can never pay off the principal. The mistake in the sub-prime mess was that they pushed this model too far.

'joe' needs to notice the rationale quoted in the article is not about economies of scale, but rather a concern that the loan will be paid off! That is why they would prefer to loan money to a Radcliffe drama major rather than to a future RN attending a CC.

After all, its not like Citi or JP Morgan have a little mom and pop trailer in the student parking lot making the academic equivalent of payday loans. All the money moves electronically through the school's computers.
At a given interest rate, large loans are more profitable than small ones, because it costs the same to qualify and administer the loan no matter what (or at least the increase in costs is less than proportional). And because the monthly payment isn't increased (enough) to compensate, they take longer to repay, which means the bank makes more on interest.

I hate that the banks make so much off of a federally guaranteed loan, so I'm with you there, but they're not withholding funding from CCs just to be mean.
There appears to be a certain class blind spot here. Let me spell it out for some people since I have pretty much lived through this mess.

1. The only way to attain a job that allows one to live on one's own and contribute meaningfully to the gross domestic product is through college.

2. College, even community college, is out of reach financially for most people in the targeted demographic (ie 18-25 year olds or those requiring retraining).

3. Loans are often the *only* available funding source or else are needed to pay for such "extras" as books, child care, and transportation fees. This also reduces the need to work 40+ hours a week at Burgers R Us. Students need time to complete their studies satisfactorily.

4. CC have the best bang for the buck. Low tuition, better instruction, lots of intervention for those students who have weaker academic backgrounds.

There is nothing "free market" about moving all expenditures to the consumption portion of the GDP calculations. It is high time that we collectively understand education as a public investment. The returns on that investment often take 10+ years to be realized but risks of not investing can be seen almost immediately in higher social welfare costs, crime, and other things the upper middle like to purse their lips about without doing anything about it.
Dean Dad:

Why doesn't your school underwrite their own loans?

Why is it the responsibility of the shareholders of the banks in question to jeopardize their own retirement plans to cover the costs of

- high default rates
- small loans (high fixed costs)
- small margins (low revenue)

Seems to me that if the CC is responsible for those risk factors, the CC should absorb those risks.

That would also incentivize (appropriately) the CC and student. Fewer economically unsustainable investments would be made in education that is not valued by society. More investment would be made in high-value education (education with a sustainable rate of return).
"Why doesn't your school underwrite their own loans?"

That's a really interesting question. In a perfect world, it should be possible for a community college to borrow money at x% and lend this money back to students at x+1% in the form of students loans, guaranteed by the government in the same way that the private loans are guaranteed. It's probably unseemly for a college to lend out money to it's "customers", but this may be the most practical solution to the problem.
Or partner with a local lending institution. CC underwrites some of the interest (all of the ihnterest while student is going to school, and maybe 2% upon graduation) and guarantees payment to their banking partner in the case of default.

That way the CC is not illegally participating in the "banking" industry.

And they now have some "skin in the game" in terms of matching the right students to the right programs.
“'joe' needs to notice the rationale quoted in the article is not about economies of scale, but rather a concern that the loan will be paid off! That is why they would prefer to loan money to a Radcliffe drama major rather than to a future RN attending a CC. ”

There were several reasons given in the article. One of them was concern that the loans would be paid off. I think I addressed that in a later point. Also, not every lender is dropping CC service en mass. You seem to be reading only the parts of the article that feed your sense of outrage.
I really like the idea of CCs getting into the loan business; it makes them much more "one stop shops" for students who are unfamiliar with the educational establishment.

On a side note, this is also a consequence of the devaluing of a HS diploma. If folks could get jobs out of high school (and there really just is no good reason why a person can't be trained to be an Assistant Manager level of education by 18), college would be much more of a decision and much less of a hurdle.
No one seems to know that FAFSA (a federal program) manages the qualifying paperwork for these banks.

Yes, 'joe', there were several reasons given, but none of them were that these loans were "unprofitable". They complained that some were "less profitable" and celebrated the ones that were "more profitable and less risky", but no one said they were losing money on them. They probably know that they can't defend "unprofitable" when only 5% of their money is actually at risk. Remember, they can't even lose money if the student goes bankrupt! They have to pay off their student loan except in cases of extreme hardship such as disability.

If they want to run on a pure profit motive, let them loan money to students at the Ivy colleges without a massive guarantee from taxpayers and without any of the other subsidies supplied by people who pay taxes but can't get into a "top university" because they live in Eastern Oregon and can't move because they need to work for living.
Sometime in the last 25 years, banks got into the student loan business. But the first loans (National Defense Student Loans {Eisenhower's administration}) were paid directly to the colleges who chose which students received them. So the government administering the loans directly has been done before with a college middle man. I have no idea why it changed.
A few thoughts --

Joe -- although we disagree pretty strongly on this one, your point about inferring intention is well-taken. Rather than 'snobbish,' they may simply be 'staggeringly incompetent.' I don't buy the 'overhead' argument, since the FAFSA is standardized and banks routinely handle credit card transactions in much smaller amounts. And the subsidies and guarantees seem to drain most of the risk. But I guess it's possible that even with standard protocols, guaranteed payback, and subsidies, they STILL can't figure out a way to make money.

Anything's possible.

I don't know the regs well enough to answer the question about restrictions on colleges being the lenders themselves. On a practical level, I think 'lack of capital' pretty much answers it everywhere outside the Ivy League. Partnering with local banks -- isn't "local banks" an oxymoron these days? -- just gets you right back where you started.

Ccphysicist nailed it with the line about cost-plus contracts. Reward is supposed to go with risk; if there's no risk, what the hell are we rewarding?
DD, yeah, we disagree on this one. BUT, the article screams to me that it's incomplete.

Either many banks decided to exit the business of making loans to CC students, and those like them for primarily malicious reasons.


There's information we don't have which would make this seem more economically rational. If I had to guess, and this is a guess, The banks are running short on money to loan out so the opportunity cost of these sorts of loans has gone up. i.e. the don't have the cash to both make these loans and the sort of profitable loans that keep them in business so they have to prioritize. But that's just a guess. I don't know enough about how these loans show up on the balance sheet to say for sure.
Yes, 'joe', there were several reasons given, but none of them were that these loans were "unprofitable". They complained that some were "less profitable" and celebrated the ones that were "more profitable and less risky", but no one said they were losing money on them. They probably know that they can't defend "unprofitable" when only 5% of their money is actually at risk. Remember, they can't even lose money if the student goes bankrupt! They have to pay off their student loan except in cases of extreme hardship such as disability.

well 'cchysicist' if I'm in the business of loaning money my goal isn't to make any positive value. My goal is to make a 'good' profit on my investment. So if I make 1% return and my competition makes 4% than I'm not doing a very good job.
Mote, meet Beam.

Changing the subject to support our own prejudices . . . now *there's* a solution!

Anyone out there care to guess what the default rate is on students loans? And how much profit there is in the student loan business?

Guess nobody's willing to do any "socially responsible investing" here, huh?
Guess nobody's willing to do any "socially responsible investing" here, huh?

That's the brilliant solution to this problem. If there's a website where
I can go and loan money to an Indian woman who wants to set up a sewing coop with her 5 sisters in Calcutta, why don't we have one where I can donate $500 to be loaned to a poor community college student who's scraping by on hot pockets and ramen? As long as they pay me back I wouldn't be picky about the terms. And I'd be more than happy to do it if the feds gave me the same "we'll pay it off if they don't" guarantee they give banks.

Another thought - are on-line banks giving out student loans? With their lower overhead it might be easier for them to afford to do it....
A student purchases a product - education - from a school. If "diversity" means accepting defective students... don't do it. If the product proves valueless the vendor has liability.

In the event of non-repayment *both* the school and the kid should liable for the full amount plus interest. The banks get 100% profit, the schools suffer minor loss for selling debt to loan collection agencies at discount. The kid gets finally obtains a real-world education (and possibly compassionately donates a kidney to the less fortunate). Win-win-win.

Government is the worst solution for anything. Government is mathematically prohibited from succeeding.
'joe', if you were in the business of lending money and taking on all of the risk yourself, you can already do whatever you want to maximize your profits. Those are the private loans where there are no guarantees from the federal government, so you take on the high risk that might go with those high profits.

But if you were in the business of getting a guaranteed profit because of subsidies from taxpayers like myself, taxpayers could well think you were ripping them off by redlining the neighborhoods that are subsidizing your profits.
You may not have noticed, but there have been a few stories in the news lately about how the banks have gotten really, really, George WMD bad about evaluating risk. So I wouldn't read much at all into their choice of institutions for which they will not make student loans.
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