Cliff Peale, The Cincinnati Enquirer
Four years after a federal takeover of most of the trillion-dollar student loan industry, opportunities are emerging for private investors to make money.
One could be the business of restructuring loans to lower interest rate years after a student graduates.
"Our idea would be to do that as a fixed-rate loan," said Ted Franzeim, senior vice president of the Kentucky Higher Education Student Loan Corp., which operates a self-supporting student loan program. "I'd like to think that as the cost of college grows, you'll be able to kind of get back into the market."
But that's one of only a few niches in a market that the government now dominates with direct lending to students.
By making the direct loans, it also reaps most of the benefits: Profits of $51 billion a year, most of it poured into Pell Grants for low-income students.
In the short term, the takeover has shrunk availability of private loans, which can carry higher interest rates and onerous repayment terms.
But as both volumes and defaults multiply, that government-dominated market also creates risk, economists say.
"Taxpayers are looking at a much riskier portfolio than a private lender would support," said Amy Crews Cutts, chief economist at credit agency Equifax. "It's risky because of the volumes. The government stepped in during a crisis to make sure those funds would be available. But we've over-stimulated that part of the market without the quality of underwriting you need."
Students and families trying to afford tuition, fees, housing and books say the system doesn't serve them well.
The top complaint: Students generally don't know how much federal aid they can expect before applying to colleges.
Since the loans essentially cannot be rejected, that leads to over-borrowing, many students and families said.
"Until you start making those monthly payments, you're really just kind of playing with fake money," said Adam Harris, a 2010 Miami University graduate who says he'll pay $90,000, counting interest, on his student loans.
"The universities know who's borrowing," he said. "There should be some sort of debt-to-income ratio. Folks need to be accountable across the board."
They say that has led to increased delinquency and default. About 17 percent of borrowers are at least 90 days past due, not counting millions with payments deferred, according to the Federal Reserve Bank of New York.
Some experts say the system is ripe for a crisis on the order of the Internet bubble of the late 1990s or the housing bubble that popped in 2009.
In effect, the student loan industry already has gone through its federal bailout. Some advocates say that has improved things, as federal programs such as income-based repayment take hold.
"We think that's a better way to target the assistance," said Jason Delisle, director of the Federal Education Budget Project for the New America Foundation in Washington, D.C.
But others say interest rates on direct federal loans still are too high.
Chris Lindstrom, director of the Higher Education program for the Public Interest Research Group, said interest rates currently are lower to buy homes or cars, compared to any kind of student loan.
"The average taxpayer expects an educational loan to be better than a car loan or a home loan," she said. "To the borrower who took out a loan 10 years ago at 8 percent, it's really ridiculous."
Federal loans now account for about 85 percent of the trillion-dollar industry.
One of the few types of consumer debt to increase during the Great Recession, total student debt has nearly tripled during the last eight years, according to data from the Federal Reserve Bank of New York.
In 2009, President Barack Obama pushed through legislation ending the subsidizing of banks to lend money, converting the biggest programs to direct student lending.
The government now lends about $108 billion a year through 19 million separate loans, the PIRG said.
That has solidified Pell Grants and also led to changes such as income-based repayment, where a borrower can cap monthly payments at 10 percent of discretionary income.
But it also has put student loans even more squarely in federal budget fights, most prominently the current battle on how to keep subsidized Stafford Loan rates from doubling to 6.8 percent.
Private lending, meanwhile, has consolidated to big providers, led by Sallie Mae and including financial services goliaths such as Wells Fargo or JPMorgan Chase.
It's still possible for the biggest private lenders to make money. For the first quarter that ended March 31, Sallie Mae originated $1.4 billion in loans, up 22 percent from the year before, and collected profits of $88 million on that business.
But the opportunities for smaller lenders are virtually gone, said Bob Niehaus, chief lending officer at Cinco Credit Union, with three offices in Greater Cincinnati.
It only makes a couple of dozen loans a year since it can only lend to members.
"For us, the student loans are pretty much unprofitable after all the fees are paid," Niehaus said.
According to the federal Consumer Financial Protection Bureau, private loans total about $150 billion nationally. More than 850,000 individual loans totaling at least $8 billion are in default, the agency said.
Securitization of student loans, or packaging them into bundles to be sold, has withered since the financial crisis as their investment value has plunged.
"The government has chased out a lot of the private money," said Cutts, the Equifax economist. "It's hard to underwrite student loans, because the capacity to repay is not there yet. They (lenders) are extraordinarily picky, because their cost of funds is very high."
Even though the federal government has taken over most loans formerly made by private lenders through the Federal Family Education Loan Program, Tri-State lenders still hold millions of dollars of those loans.
Those include the Kentucky Higher Ed Student Loan Corp. with $1.4 billion, Graduate Leverage LLC with $822 million, KnowledgeFunding Ohio with $250 million, Northstar with $109.1 million and ECMC Group with $101.4 million.
KnowledgeFunding was an affiliate of the Cincinnati-based KnowledgeWorks Foundation, but officials there said they got out of the student loan business several years ago.
Franzeim, of the Kentucky program, said the agency hasn't had to issue new bonds to support expansion.
It has made almost 1,300 loans for nearly $14 million. It offers fixed-rate loans at 7.75 percent if repayment begins immediately, but Franzeim said the group will soon offer lower rates.
"I think it (private loan market) is growing. Is it huge right now? No. A lot depends on what direction the federal government goes," he said.