What do student loans, the 2008 bank bailout and credit card debt have in common? They all have cost Americans dearly. What are their differences? In America, if you are a banker on Wall Street that crashes the global economy or a person who cannot pay off their credit card bill, we’ll bail you out and forgive you for your sins. If, however, you are a college graduate with student loan debt:
2008 Wall Street Bailout
During the most recent financial crisis there were a number of players involved. This was the perfect storm where willful ignorance and overconfidence that the fast rising market would never crash, combined with good old fashioned American greed to create one of the worst financial crises in history. There were warnings of a storm off the horizon, and much like a hurricane, those who heard the warnings could have prevented catastrophic loss by boarding up their financial “windows.” Instead, they looked to the sky and thought about how it had not rained on Wall Street for over a decade, and it was unlikely to ever rain again.
In 2008, our government approved a tax-payer-financed-bailout plan to save huge, unregulated banks that gutted private and public sector retirement accounts and made speculative bets against everyday Americans’ ability to pay their mortgages just to make a profit. By the time all relief programs had been rolled out by the federal government, the total estimated cost of the Wall Street bailout was $14.4 trillion. And although most banks who took bailout money have paid back the government back, those payments are merely a drop in the bucket.
What exactly did Wall Street do that almost tanked the global financial markets? The answer is relatively complex, but not impossible, so I will attempt to break it down here.
First, America was in a pattern of stable growth and low interest rates. This seems to have caused the old white guys on Wall Street to have a false sense of security and banks began handing out mortgages to millions of people who would not otherwise qualify for the amount borrowed. In other words, if you make $50,000/year, you probably cannot afford a $300,000 house. During this time, though, variable interest rates on mortgages were at an all-time low. But the problem with variable interest rates is that they vary! As interest rates rose, more and more people could not afford the mortgage payment that they never should have been approved for in the first place.
Next, in an effort to continue the American tradition of making something out of nothing, financial experts began “pooling” these bad mortgages together with other mortgages. It was like a Goldie Locks-type of arrangement. The pools of mortgages were then used to secure collateralized debt obligations (the details of which are not important for our discussion) and divided into tranches of (1) the risk and the likelihood of default is too high; a.k.a. the soup is too hot; (2) the risk is a little lower, but the return is not expected to be high enough, a.k.a. the soup is too cold; and (3) the risk of default looks low, but the returns look high, a.k.a. the soup is just right.
What happened, though, was that although these tranches looked “just right,” nobody actually tasted the soup to see if that was true. Rather, they relied on a credit rating agency to tell them what kind of soup they were eating and if the temperature was appropriate. So, Wall Street, instead of trying the soup, opted to have it fed through a tube in their stomachs. They had no idea how hot or cold the soup was that was being pumped into their system. When they recommended the soup to other investors, the investors assumed that Wall Street had tested their soup. They themselves did not taste the soup; rather, more feeding tubes were inserted as the soup was passed around the market. This pattern flooded our markets and eventually, it turned out that the soup was not worth the ingredients used to make it. The soup was toxic.
As all of our soup connoisseurs began to realize that their soup was not worth a thing, they began taking out insurance policies to protect the value of their soup stockpiles called credit default swaps. Enter AIG. When it was discovered that the soup was worthless, AIG could not afford to pay all of the insurance accounts that now had a claim. There were too many people with spoiled soup. AIG did not have enough money to cover the tab. “In effect they had bet on themselves with borrowed money, a gamble that had paid off in good times but proved catastrophic in bad.”
This is not where our story ends, though. Uncle Sam rode in on a white horse and promised billions of tax payer dollars. Uncle Sam exclaimed,
“Old white men of Wall Street, it doesn’t matter what you do.
We’ll bail you out, we’ll figure it out. We don’t care about all those you screwed.
You’re too big to fail and we need you too much.
We’ll front you some money to use as a crutch.
The tax payers have your back, and we know they’ll agree,
America: where white men can steal and get off scot-free.”
~Lindsey Mears, 2015
Crash the global economy with your greed? Forgiven.
Credit Card Debt in America
Credit card debt in the United States is valued at approximately $60 billion. What happens to ordinary American people who spend too much money on their credit cards and cannot pay it back? If you spend recklessly (or out of necessity) on your credit card, there are a variety of programs available in order to lower, and even absolve, your debt. You can renegotiate your interest rates, stop making monthly payments until the credit card company deems your account to be “uncollectible,” offer a settlement to your credit card company or collections agency, or file for bankruptcy and have your debt eliminated entirely. Sure, if you file for bankruptcy, your credit will be ruined for seven years and this is not something to take lightly. Compared to 25 years, however, it seems like a walk in the park.
Can’t afford your credit card payments? Forgiven.
The Hand That Holds Us Down
Federal student loan debt, on the other hand, can only be forgiven in four practical ways. I will cover the details of the various repayment options on student loans in a later post but the four following options have the most practical applicability for most students wanting to have their student loan debt forgiven.
1. Student loans may be forgiven after 10 years of public service work. Some of the jobs that qualify for this program are public school teachers, police officers, public defenders, etc.
2. Die. Death will absolve federal student loans (assuming your parents did not cosign).
3. A student can attempt to have her loans eliminated through the bankruptcy process. But unlike credit card debt, it is extremely difficult to have your student loan debt forgiven through bankruptcy. Unlike a bankruptcy proceeding involving credit card debt, however, in addition to filing for bankruptcy, a student must undertake another separate process for the discharge of her student loans. This increases the cost of the bankruptcy proceeding. Then, to make matters worse, the student must then show “undue hardship” to have their loans forgiven. Three factors are considered to show undue hardship.
- If you are forced to repay the loan, you would not be able to maintain a minimal standard of living.
- There is evidence that this hardship will continue for a significant portion of the loan repayment period.
- You made good-faith efforts to repay the loan before filing bankruptcy (usually this means you have been in repayment for a minimum of five years).
The problems with this test are readily apparent. What is a “minimal standard of living,” who gets to decide what is minimally acceptable? What evidence can a person present that hardship will continue for a “significant portion of the loan repayment period”? What is significant and insignificant? Are we not just asking students to predict their own future? Finally, did you make a “good-faith effort” to repay your loan—for at least five years—before you filed for bankruptcy? Does that mean all of the payments have to be on time? Or, does that mean that you just really tried to make those payments for five years even if you never succeeded?
Each judge presented with these factors attempts to apply them with the best of their ability, but inconsistency is rampant in this area of the law. And some brave judges are writing new rules of their own. Unfortunately, it is still the rare exception and not the rule.
4. A student may switch to an income based repayment plan that forgives the remaining debt balance at the end of a 20-25 year repayment period. Even though these new repayment options have been touted by the Obama administration, this law does not do what you think.
If you still have a balance on your loans at the end of that term, you are taxed on the remaining balance, plus your income. Here is a great explanation of this phenomenon by Jantz Hoffman of Advantage Group, “Let’s say your debt has grown to $180,000 over 20 years, and by that point, you’re making $120,000[.] If $180,000 is being forgiven, then you are looking at paying taxes on $300,000 in total income in one year. At that point, you’re over the $250,000 income category, my friend.”
By using current tax rates, a single student who makes $120,000/year and has a remaining student loan balance of $180,000, that student’s out-of-pocket tax liability would be approximately $33,166. I married student’s tax burden would be approximately $39,710.
Remember, that on your $120,000 salary, you are having taxes withheld from your paycheck and most people do not owe more taxes in April. Instead, most Americans look forward to their tax refund every year. Thus, in addition to the taxes you have withheld every pay check, you would owe an additional $35,000+ in taxes the year that your student loans are finally “forgiven.” Who has that kind of cash lying around?
There is literally no escaping this debt for the majority of students. We came out of school in debt because we could not afford our tuition. If we cannot afford to pay off our loans we may have our balance “forgiven” so long as we follow the strict rules in place to achieve this goal. In the meantime, we will hope that we stay healthy, that we can continue to work. We will abstain from taking vacation and will work ourselves to the bone trying to make ends meet.
Then, if we can make it 20-25 years in this pattern without keeling over, the U.S. government will finally “forgive” our ballooned student loan balance. Then, to add insult to injury, the federal government will tax our forgiven balance as income.
The structure of this program tells you everything you need to know about the higher education crisis in America. A remaining student loan balance at the end of a 25-year repayment term–a quarter of a century–is a product of financial distress over a 20-25 year period. We have millions of college students that will still be paying their student loans off well into their forties and fifties. How can we expect them to ever save for retirement, raise children, invest in real estate and purchase more than bare essentials?
If we finally get desperate enough and file for bankruptcy, we run the risk of ruining our credit scores and walking out of the court room with an unchanged student loan balance. Where else do you go if you have already been through the arduous process of bankruptcy to find relief? A judge has decided you are not suffering quite enough yet to be forgiven for your crime of seeking an education. Don’t let the door hit ya’ where the good Lord split ya’.
How Big is this Problem?
Student loan debt in America is estimated to exceed $1.2 trillion and the cost of college tuition is still rising at an alarming rate. To illustrate how obscene that number is, credit card debt in this country is equal to 5% of $1.2 trillion. If we invested in bailing out all Americans with student loans, it would cost approximately 8% of the total price of the Wall Street bailout.
They may not be able to put you in jail for defaulting on your student loans, but in America needing help to pay for a college education is an offense punishable by a lifetime of insurmountable debt. College students have committed no crime by seeking an education. Unlike Wall Street, we have done nothing that warrants punitive consequences.
It is time to send a message. WE are too big to fail.