In 2017, the Consumer Financial Protection Bureau (CFPB) sued the National College Student Loan Trusts (NCSLT) and their debt collector, Transworld Systems, accusing the two defendants of illegal student-loan debt collection. Specifically, the CFPB accused NCSLT and Transworld of collecting on private student loans after the statute of limitations had expired and of suing debtors for unpaid student loans even though NCSLT could not prove it owned the debt.
CFPB and NCSLT quickly entered into a settlement agreement subject to a federal court’s approval. These are the essential terms of the settlement:
- National Collegiate and Transworld must conduct an independent audit of all 800,000 student loans in its various trusts.
- National Collegiate will stop trying to collect on student loans if it cannot prove it owns the debt.
- NCSLT will stop filing lawsuits on student loan debt after the statute of limitations has expired.
- NCSLT and its debt collecting agency will stop reporting negative credit information on borrowers that NCSLT improperly sued.
- NCST will stop filing false or improperly notarized legal documents.
- NCST will pay substantial monetary penalties.
Unfortunately for the litigants, Federal Judge Maryellen Noreika refused to approve the settlement because the parties involved did not have the authority to settle the lawsuit.
If this glitch gets worked out and the deal is finally approved, it could lead to $5 billion in debt relief for people who defaulted on private student loans. In the meantime, the lawsuit provides a window into the world of private student loans.
The Securitization of Private Student Loans
Most students finance their college education through government loans, and the total amount of outstanding federal student-loan debt is now $1.74 trillion. The private student-loan market is much smaller. According to Nerdwallet, college borrowers only owe about $125 billion in private student-loan debt.
Private banks and financial institutions (Sallie Mae, SoFi, Wells Fargo, etc.) issue student loans, but private lenders generally do not hold the loans on their books for very long. Instead, the loans are securitized. In other words, the loans are packaged and sold to investors as securities called student-loan asset-backed securities (SLABS).
SLABS is attractive to institutional investors because they produce a reasonable return rate and are considered low risk. Historically, default rates have been lower for private student loans than federal loans because the banks usually require the student borrower to find a guarantor to co-sign a private student loan—often a parent or grandparent. Thus, if a student borrower defaults on a private loan, the lender can sue Mom or Granny.
Also, student loans are difficult to discharge in bankruptcy because the same “undue hardship” standard that applies to federal loans also applies to private student loans.
Nevertheless, defaults on private student loans have shot up recently. National Collegiate Student Loan Trusts owns 800,000 private student loans. According to Bloomberg, more than half of the principal on those loans was in default at the time of the proposed settlement between CFPB and NCSLT in 2017.
All these private student loans are managed by loan servicing companies, and when borrowers default, collection companies usually file suit on the creditors’ behalf in a state court. In recent years, there have been thousands of lawsuits filed against private student-loan defaulters all over the United States. Transworld Systems alone has filed 38,000 debt-collection lawsuits.
Unfortunately for the creditors (the owners of the SLABS), statutes of limitation apply to collection efforts on private debt. Unless the creditor sues before the statutory limitation period expires, it cannot legally recover on student loans in default.
Moreover, the SLABS owners must prove they own the debt. In some cases, creditors have gone to court and found themselves unable to produce the paperwork that shows they are the legal owners of the debt they are trying to collect.
Why is CFPB v NCSLT important?
If you’ve seen the movie The Big Short, you know that the financial crisis of 2008 was triggered by a wave of defaults on home mortgages. Financial institutions had bundled thousands of home loans into securities call ABS (asset-backed securities), which were represented as being low-risk investments.
In fact, many of the underlying mortgages were subprime loans on homes that had been overvalued. When the housing market collapsed in 2008, millions of homeowners defaulted on their mortgages, and the ABS investors lost tons of money.
Also, when creditors sued the defaulting homeowners, they often could not prove they owned the debt. A lot of the paperwork on these mortgages had been “robo-signed” and improperly notarized. In many instances, the courts refused to hold defaulting homeowners liable on their home loans.
Something like that is happening now in the private student-loan market. People who have private student loans are defaulting at a surprisingly high rate. Creditors are filing suit against defaulters but often cannot show they own the debt. In some instances, paperwork has been improperly”robo-signed,” causing some judges to rule in favor of debtors.
Financial commentators have warned for years that the student-loan program is in a bubble, much like the housing bubble of 2008, and that a major financial crisis in the student-loan industry is on the horizon. The coronavirus has put millions of Americans out of work, leaving them unable to make monthly payments on their federal and private student loans. In other words, the bubble may be about to burst.
What this means is hard to say. In the private student-loan market, investors in SLABS will undoubtedly lose money, but the federal government holds more than 90 percent of all student loans. The Department of Education can maintain the status quo in the short term by merely continuing to issue student loans as it has for the past 50 years. But even Education Secretary Betsy DeVos admitted publicly in 2018 that only a minority of student borrowers are current on their loans.
Presumptive Democratic Presidential nominee Joe Biden has proposed forgiving all federal student debt acquired to attend public colleges. But a more straightforward way to deal with this massive debt crisis is to allow insolvent student-loan debtors to discharge their debt in the bankruptcy courts.