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Introduction
As of April 2016, the total outstanding balance of student loans is estimated to be approximately $1.35 trillion. Throughout the recent period of economic crisis from the late 2000s until 2014, the student loan balance quadrupled, and default rates among student borrowers reached their highest levels in 20 years.
The rule proposed by ED would make several amendments to the regulations governing its Federal Direct Loan Program. Among the most significant changes are 1) an expansion of the conditions wherein ED would forgive borrowers’ loan balances, 2) additional provisions that would broaden ED’s ability to recover losses directly from institutions resulting from approved borrower defenses, and 3) the addition of automatic triggers for postsecondary schools that would apply under certain conditions and events. Schools would be required to comply with these provisions to continue being eligible to be paid by borrowers using federal funds appropriated under title IV of the Higher Education Act (HEA).
ED estimates this rule would have annual federal budget impacts of anywhere between $199 million to an upper-bound estimate of $4.23 billion. Although the rule is intended to mitigate some of the risks to taxpayers by making schools responsible for paying the cost of loans for which ED approves borrower nonpayment, the upper-bound estimate of its potential annual cost should serve as a cautionary indication that any estimation of positive net benefits may vary considerably given the assumptions underlying the analysis.
Although several of the changes apply to all postsecondary institutions, including ED’s new language defining what constitutes “misconduct” by schools—behavior which entitles borrowers to submit claims for nonpayment—the majority of this rule’s efforts focus on improvements to outcomes within the for-profit school sector. ED invited public comment and specifically welcomed input regarding 1) “ways [it] could reduce potential costs or increase potential benefits while preserving the effective and efficient administration of the Department’s programs” and 2) “complying with the specific requirements of E.O. 12866 and 13563.”
This comment suggests that this rule might preserve a more effective and efficient administration of the Department’s treatment of borrower defenses by retaining the original language in §668.71 regarding the definition of a “misrepresentation” concerning misconduct by postsecondary schools. Alternatively, ED should modify the language in its current proposal to increase its clarity and narrow its scope so that it clearly reflects intent to hold accountable those institutions attempting to take advantage of information asymmetries and defraud their students. As ED points out in the preamble to the proposed rule, courts have upheld (borrowers’) claims of common law misrepresentation based on false statements in cases where the definition required establishing a case based on the much narrower definition of fraud.
Additionally, although the academic literature is clear that “non-traditional” borrowers (predominantly those attending for-profit schools) historically experience higher default rates on their loans vs. traditional borrowers, it is less clear what causal mechanisms are responsible for these defaults. It is important to consider the possibly regressive effects or unintended consequences associated with focusing certain provisions strictly on the for-profit sector. As experts point out: “a challenge for federal regulation of the for-profit sector is to design incentives for improved quality, while still preserving access for students from disadvantaged and nontraditional backgrounds.”
In addition to calling on agencies to identify a compelling public need before issuing new regulations and to examine the benefits and costs of alternatives, Executive Orders 12866 and 13563 emphasize the importance of ex post evaluation. Before issuing a final rule, ED should provide details of how it intends to conduct retrospective analysis of the ex post results of this rule. Although it may seem that simply comparing student default rates would indicate the overall effectiveness of this rule, there may be several other confounding factors that result in a lower default rate but also an overall reduction in consumer welfare.