Rohit Chopra, Consumer Financial Protection Bureau, Keynote

NOVEMBER 18, 2013

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   Julie Stackhouse, Federal Reserve Bank of St. Louis (4:20)

now playing   Rohit Chopra, Consumer Financial Protection Bureau (30:08)
   Keynote Q&A (8:06)
   Interview with Rohit Chopra (6:40)

Resources for Managing Student Loans
   Introductions (2:12)
   Paul Combe, American Student Assistance (7:02)
   Interview with Paul Combe (12:58)
   Vicki Jacobson, Center for Excellence in Financial Counseling (5:46)
   Marilyn Landrum, Missouri Department of Higher Education (3:58)

Resources for Economics and Personal Finance
   Mary C. Suiter, Federal Reserve Bank of St. Louis (3:10)

Research Panel:
What We Know About Student Loans in the Eighth District and Nationwide
   MODERATOR: William R. Emmons, Federal Reserve Bank of St. Louis (4:14)
   Bryan J. Noeth, Federal Reserve Bank of St. Louis (13:53)
   Kelly D. Edmiston, Federal Reserve Bank of Kansas City (9:17)
   Caroline Ratcliffe, Urban Institute (14:22)
   Research Panel Discussion (35:46)

The Future of Student Loans and Financing Higher Education
   MODERATOR: Ray Boshara, Federal Reserve Bank of St. Louis (7:32)
   Sandy Baum, Urban Institute and George Washington University (11:06)
   Interview with Sandy Baum (7:23)
   William Elliott III, University of Kansas (13:12)
   Jen Mishory, Young Invincibles (8:37)
   Interview with Jen Mishory (8:01)
   Gary A. Ransdell, Western Kentucky University (11:35)
   Roundtable Discussion (40:21)


Rohit Chopra: Hi, everyone. So thanks, Julie. Thanks, Ray. And thank you to President Jim Bullard and everyone at the Federal Reserve Bank of St. Louis for inviting me to speak today on the impact of rising student debt on the balance sheets of young American households.

As the name of the St. Louis Fed’s Center’s name indicates, household financial stability is a key ingredient to the health of our economy and financial system. So first, I will outline some of the debt and wage trends among young Americans and then discuss some of the striking structural similarities between the mortgage and student loan markets, particularly in the years leading up to the crisis.

Finally, I will argue that we must resist the temptation to address these concerns solely through an education policy lens, when in fact they may require very significant attention from financial regulators and the financial services industry. And, as always, these views are my own and do not necessarily represent the views of the CFPB.

The Bureau estimates that there is approximately 1.2 trillion dollars in student loan debt owed by about 40 million Americans. This equates to roughly $30,000 in outstanding debt per existing borrower, and does not include what may be a substantial amount of education-related debt in the form of credit cards, home equity loans and retirement account borrowings.

And while conventional wisdom has focused heavily on rising tuition as the primary driver of debt, this may be too simplistic. There is no question that the decline in state support for public higher education has been a long running trend that has impacted tuition. But according to the College Board, average debt for new bachelor’s degree recipients at public institutions has risen more rapidly than tuition, room and board, and fees after grants and scholarships. Outstanding student loan debt has doubled since 2007, a stark contrast to the credit card and mortgage markets.

Enrollment patterns and tuition increases alone do not explain this dramatic increase. The deterioration of household balance sheets seems to be a culprit. Over that same period millions of American households experienced severe economic shocks, including unemployment, large declines in home values, and big drops in retirement savings. This reduced the wealth and credit capacity for so many families who are looking to fund the cost of higher education. In other words, rising student debt levels aren’t just the result of a cost shift from the public to the individual family, but from within the household, from the family to the individual student.

As of 2010, 40% of households headed by an American under 35 are on the hook for a student loan. And I expect this portion to rise. Rising student debt burdens may prove to be one of the more striking aftershocks of the Great Recession, especially if we continue to leave it unaddressed.

But are rising debt levels necessarily a bad thing? After all, the public frequently issues bonds to fund transportation, energy and other infrastructure, which yields substantial benefits that make the debt worthwhile. And as Julie mentioned, student loans can be the key to a college education which has so many positive effects.

So looking at labor market indicators could give us some clues. So much has been made of the college wage premium. That is the difference between incomes of college graduates and those who are not college graduates. According to analyses of Census Bureau surveys, a bachelor’s degree recipient can expect to earn an average of $1 million dollars more in lifetime income than a wage earner without a degree.

But behind that headline number is a much more troubling trend. The growing gap between college graduates and others is not really due to rising starting wages for college graduates. It’s that the wages of those without a degree are falling rapidly. In fact, when accounting for inflation young college graduates are seeing their starting wages fall. According to an analysis of the current population surveyed, between 2000 and 2011 the real wages of young high school graduates declined by 11.1%. And the real wages of young college graduates declined by 5.4%. So, again, that gap is growing because wages for non-graduates are falling faster.

Even if we focus on the pre-crisis period, from 2000 to 2007, the same trend holds, where young college graduates’ wages slipped, but not as fast as their high school graduate counterparts.

Among young workers the unemployment rate for non-degree holders is twice that of college graduates. So ironically, it is more important than ever to go to college to ensure a secure middle class life. But in terms of wages, the return on investment is declining. A college degree is turning out to be a very valuable insurance policy whose premiums keep going up. The combination of more debt and lower incomes means more risk. And many young workers are walking on an economic tightrope.

So what are the implications of a large portion of the population entering the labor force with all of this debt on their balance sheets and elevated debt-to-income levels? In March of 2012 my colleagues and I found that outstanding student debt was much higher than previously reported, crossing the trillion dollar threshold in 2011. I expressed concern at the time that student debt levels may impede the recovery of the housing market since borrowers with that debt on their balance sheet may be less able to accumulate a down payment or even qualify for a mortgage . Since that time senior executives in the financial services industry and other financial monitors have also expressed worry about the impact of student debt on household formation, consumption of consumer durable goods, and credit creation.

In 2012 for the first time in at least 10 years, 30-year-olds with no history of student loans were more likely to have mortgage debt than those with student debt. According to a recent survey by the National Association of Realtors, 49% of respondents described student debt as a “huge obstacle” to affording a home.

Last year Chairman Bernanke remarked that, “Lending to potential first-time home buyers has dropped precipitously, even in parts of the country where unemployment rates and housing conditions are better than the national average.” Indeed, the propensity of younger households headed by adults age 29 to 34 to take out their first mortgage has been much lower recently than it was 10 years ago. A period well before the most recent run-up in home prices.

And two weeks ago he noted that student debt may be impacting the ability of many young people to buy their first home. The student loan housing connection is actually much deeper than the first-time home buyer problem. It may be useful to note some of the similarities between the mortgage and student loan markets in the years leading up to the crisis. Both the student loan market and the mortgage market made heavy use of explicit or implicit government guarantees. In other words, a lender could make a loan, but it was ultimately guaranteed by a government-sponsored entity or the federal government themselves.

The credit risk on most mortgages had traditionally conformed to the underwriting standards set forth by Fannie Mae and Freddie Mac. Similarly, the Federal Family Education Loan Program allowed financial institutions to originate and securitize student loans meeting certain guidelines for students attending qualifying institutions. As noted in the report by the Financial Crisis Inquiry Commission, underwriting standards for conforming mortgages purchased by those government-sponsored entities had become less stringent. Mortgages originated to the lower credit tiers grew quickly.

The parallel to the student loan market is striking here. Over the same period financial institutions originated an increasing share of loans under the federally guaranteed program to students attending for-profit colleges. In the two thousands, for-profit college enrollment increased five-fold to 1.2 million students in 2009. And while this is a good option for some, the sector continues to have higher rates of borrowing and lower graduation rates, along with significantly higher default rates.

Mortgage brokers, for-profit college admissions personnel, and other loan originators were able to arrange enormous loan volumes with little to no skin in the game. The similarities are not just limited to guaranteed mortgages and student loans. The two thousands also saw the expansion of private credit in both markets. That is, not arranged through some sort of federal program.

In the mortgage market Fannie Mae and Freddie Mac’s market share rapidly shrank, and taking their place were private label securitizations. And a securitization is essentially where a lender offers a loan but ultimately doesn’t hold it, and transfers it to be converted into bonds for investors. As the CFPB and the Department of Education noted in our 2012 report, origination and securitization of private student loans boomed, quadrupling from less than $5 billion in 2001 to over 20 billion dollars in 2008, growing at a faster rate than the federally guaranteed program. Private label mortgage backed securitization fueled origination of the so-called Alt A mortgages where credit scores may have been high, but other factors precluded them from meeting the GSE guidelines, as well as sub-prime mortgages, which frequently had flimsy documentation requirements.

Demand for private student loan asset backed securities from investors increased not only the co-signed, school-certified loans, but also sub-prime style lending where loans were often originated in excess of tuition and fees. In many cases private lenders didn’t even verify whether the student had already borrowed federal loans, or even if the student was enrolled.

Given these similarities it should not be surprising to find common problems when loans came due for repayment. A tough job market meant that many Americans needed to find options to honor their mortgage and student loan obligations. But both mortgage and student loan borrowers faced two key problems with their servicers, the companies that collect payments.

First, when borrowers do have options they can still be stymied. In the mortgage market, borrowers whose loans were owned by these government-sponsored entities had options available to them to modify or refinance their mortgages. Even though some sort of modification may have been in the best interest of the investor holding the mortgage and the borrower, many mortgage servicers were unable to successfully work with troubled homeowners. Fed Governor Sarah Bloom Raskin lamented the quote, “Agonizingly slow pace of mortgage modifications and repeated breakdowns in the foreclosure process.” In the student loan market many borrowers with government guaranteed student loans owned and serviced by financial institutions also report difficulty enrolling in income-based repayment and other programs for borrowers facing hardship. An income-based repayment and pay-as-you-earn, these programs essentially allow a borrower to cap their payment as a percentage of their income and avoid default.

While comprehensive data is not available, several major market participants in the federally guaranteed program do not appear to be succeeding in enrolling struggling student loan borrowers in these income contingent plans.

In the servicing of government guaranteed mortgages and student loans, incentives may be misaligned. A default may sometimes be more beneficial or less costly for the servicer compared to enrolling a borrower in a loan modification program.

Second, borrowers in many cases have simply run out of options. For homeowners whose mortgages were ultimately sold into a pool for investors in those private label mortgage-backed securities, servicers generally offered little or even no help for the borrower to find an affordable payment. The same is true with private student loan borrowers who may be facing temporary hardship and looking for an alternative repayment option to get through tough times.

And like a business, a consumer’s ability to manage cash flow to really budget and cover expenses and income is really critical to your financial health. We all know that as families or as individuals that knowing what’s coming in and knowing what’s coming out is so important. And so when you hit a tough time and can’t manage that cash flow on your student loan or your mortgage, trouble could be coming.

Private student loan providers generally do not offer these cash flow management options which are available to borrowers of federal student loans. For struggling homeowners and student loan borrowers the consequence of being unable to find an affordable repayment option are severe. The impacts of foreclosures may not just be felt by the former homeowner but actually the entire neighborhood. And for student loan borrowers who default early in their lives, the negative impact on their credit profile can make it more difficult to pass employment verification checks. Many employers run credit reports for new college grads to determine if they have a sufficient character to be employed. Many landlords check credit reports. And you may not be able to get an apartment or even reaching their dream of a college graduate to buy a home.

Now given that student loan obligations became due after a student leaves school, so when all this lending was happening payments weren’t immediately due. So there was some delay. The signs of distress emerged after the similar signs we saw in the mortgage market.

Congress enacted a wide range of reforms to the mortgage market and they may shed light on options to address the significant structural deficiencies in the student loan market. I’ll mention a few of these along with how they might relate to student lending. The first in the mortgage context refers to the ability to repay. Many policymakers have viewed the lack of an explicit federal requirement for lenders to consider a borrower’s ability to repay as a critical flaw in the housing finance system prior to the crisis, which essentially enabled lenders to make unaffordable loans to borrowers.

Now this changed centuries of what we thought about finance, where creditors would earn a profit only if a borrower could pay it back with interest. But modern structured finance allows a number of market participants to profit from a loan even if they might have known the borrower couldn’t repay it.

And while housing GSEs were providing the credit guarantee for a substantial share of the mortgage market, lenders may not have had a strong incentive to ensure that borrowers could repay their loans. As a Countrywide Financial corporation executive noted to the Financial Crisis Inquiry Commission, the companies’ essential business strategy was, “originating what was saleable in the secondary market.” In other words, they would make loans only if investors would buy it.

The Dodd-Frank Act seeks to address the moral hazard implicit in this arrangement. More specifically, the qualified mortgage provision generally requires that lenders make a reasonable and good faith determination that a borrower has the ability to repay a mortgage loan. Now admittedly this ability to repay framework is not totally applicable to student lending. Given that the purpose of the credit obligation is for investing in human capital, so there won’t be that immediate income to pay that loan.

Now most federal student loans currently have a safeguard to ensure a borrower can repay, namely in the form of the various income-contingent plans I mentioned earlier. But as noted before, private student lenders don’t offer these features and their loans were disproportionately utilized by students enrolled in programs with low graduation rates and high default rates. The Department of Education is currently seeking to address these moral hazard issues by addressing program eligibility for schools that may not be preparing graduates for employment that helps them repay their debt.

The second area is incentive alignment. Other provisions of the financial reform law seek to align the incentives across the various participants in a credit transaction. The so-called risk retention requirement for securitizers is worth noting.

Now essentially Dodd-Frank requires that a securitizer of asset-backed securities, this is the entity that arranges converting the bundle of loans into securities, that they hold not less than five percent of the credit risk of the assets collateralizing those securities. Now theoretically if a securitizer has skin in the game more attention will be paid to the credit characteristics of that underlying loan.

A report to Congress from the Fed noted that, “by retaining a portion of the credit risk, the securitizer and/or originator will have an incentive to exercise due care.” In 2010 Congress enacted a law suspending origination under the government guaranteed FFEL program, shifting almost exclusively to direct lending.

The incentive misalignment in the market today seems to primarily exist between some schools and the federal government. Program eligibility for federal loan and grant programs is generally binary, meaning you’re in or you’re out as long as you meet certain default rate thresholds. But regardless of whether a student graduates or drops out, the school’s revenue from those programs doesn’t vary. The same is true of revenue derived from veterans qualifying for benefits under the post-911 GI Bill.

Now unfortunately this may provide an incentive for schools, particularly for those who owe a fiduciary duty to shareholders, to focus primarily on enrollment rather than outcomes. And the similarity to a mortgage originator whose compensation is not dependent on loan performance is quite striking.

The third area is servicing. And as I mentioned earlier, many large servicers in the mortgage context faced issues with a range of troubling practices, including a practice known as robo-signing where banks would submit foreclosure documents that were not properly reviewed or notarized. There was also cases of improper treatment of military families who faced foreclosure which are restricted under the Service Members Civil Relief Act.

Now the CFPB has received a number of complaints from private student loan borrowers indicating that some market participants may not always have adequate proof that they own a loan which is in default, as well as potentially improper conduct when it comes to active duty service members seeking their interest rate cap on their student loans as entitled by law. And many of the complaints from borrowers are arrestingly similar in nature to the troubles faced by struggling homeowners.

The Dodd-Frank Act included a number of provisions that seek to correct weaknesses in the mortgage servicing industry, including changes to servicing transfers, payoff statements, records retention, interventions for troubled borrowers and others. And many market participants and policymakers in the student loan servicing industry are looking closely at these reforms to see whether they might also provide some clues.

We also published a report this year that discussed potential options for creating a broader framework and consistent framework to accelerate the process of private student loan restructuring and loan modification. But there still has been little progress to date in the industry.

Many student loan subsidiaries are actually small parts of larger financial institutions and so in some cases executives and directors may lack the incentive to devote enough attention to this sector.

There are a number of lessons to be learned from the mortgage market that may provide some clues to improving the student loan market. Now education policymakers are rightfully focused, and many of you may talk about this today, on ways to increase college completion rates, lower college costs, prepare students for the labor force. And this is a very good thing to look at. But this can’t be the sole focus. These policy interventions will not address the numerous problems posed by the debt already owed by tens of millions of Americans. And it would be irresponsible for regulators, financial regulators and others to ignore the existing trillion.

I was asked to briefly discuss some specific areas where the Federal Reserve System might devote attention, and two are worth noting. First, the existing structure of the student loan market may prove to be an obstacle in the transmission of monetary policy. A significant trouble spot in the market is the lack of refinance options. Borrowers, even after graduating and attaining employment, find themselves unable to take advantage of their improved credit profile or today’s historically low rates.

A white paper last year from the Fed submitted to Congress noted that barriers to refinancing blunt the transmission of monetary policy to the household sector. Further attention to easing some of these obstacles could contribute to the gradual recovery in housing markets and thus help speed the overall economic recovery.

Now given that a large portion of younger households have student debt that is difficult to refinance, the benefits accrued to these households from today’s interest rate policies may be limited compared to a household with a mortgage that they could refinance.

Second, Fed Vice Chair Yellen noted last week that prior to the crisis, financial regulators “missed some of the important linkages whereby problems in mortgages would rebound through the financial system.” Now I believe that the student loan market relative to other consumer asset classes is actually quite opaque and difficult to understand, adding further uncertainty about the spillovers on the rest of household balance sheets and the broader economy. I’m quite concerned that financial regulators in the public lack some basic fundamental data on student loan origination and performance. For example, my colleagues and I published an analysis on the status of a wide range of student loans, and the data reveals something surprising to some researchers, which is the average balance on loans in a default status was actually much smaller than the average balance in forbearance or repayment.

To me this suggests that borrowers who default are overwhelmingly non-completers. These borrowers take on some debt but do not benefit from the wage increases associated with a degree. But without robust performance data we cannot know for sure whether this is the case, or whether borrowers are successfully paying down principle early on and defaulting only when experiencing an income shock later. And most loan level mortgage origination data is currently subject to public disclosure stripped of borrower identifiable information under the Home Mortgage Disclosure Act.

Data from the housing GSEs and mortgage-backed securities filing shed significant light on loan level performance. Bank regulators collect reports from banks and credit unions on their balance sheet holdings. But student loans are aggregated with other types of non-mortgage credit products. And SEC filings from banks rarely report key data on student loans. Student loans securities filings and service or performance reports are much less granular than similar mortgage reports. The drivers of pre-payment, delinquency and default in the student loan market are not well understood. Questionable accuracy of credit reporting data in the student loan industry adds further noise and uncertainty.

So the CFPB and other regulators have made significant strides to assemble mortgage data to better monitor the market. But similar efforts are needed to better understand the drivers of student loan origination and performance, as well as the impact on the mortgage market and household balance sheets.

The CFPB is the primary financial regulator of most participants in the student loan industry and the Department of Education as administer of federal aid programs have worked closely to provide consumers with better decision tools. The new financial aid shopping sheet gives clear information to prospective students on loans and grants and it’s been voluntarily adopted by nearly 2,000 colleges and universities. The Department of Education’s College Score card and the CFPB’s Repay Student Debt Tool, available at, are already helping consumers make smarter choices.

In conclusion, I do not believe that the student loan market poses an immediate threat to the solvency of the financial system like the mortgage market posed in the period leading up to the crisis. But in some ways this reduces the urgency for action since there is not a specific cataclysmic event. But inaction bears the risk of economic drag.

The upcoming expiration of The Higher Education Act, which is the authorizing law for most student loan programs, presents an opportunity for creating a better-functioning student loan market, but this will require the close cooperation of not only education policymakers but also financial regulators and financial policymakers to address the incentive misalignments, servicing infrastructure and data gaps in the student loan market. There may be important lessons that we can learn from recent efforts to address similar deficiencies in the mortgage market.

So thank you again for this opportunity and I really look forward to working with many of you, whether you be institutions of higher education, financial institutions, and others to ensure that young American households with student debt are able to fully participate in the economic recovery in years to come. Thank you.


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