Consumer Law & Policy Blog

Reflections on the Student Loan Industry: Recent Scandals and Long Meetings at the Department of Education

by Deanne Loonin

[Ed. Note:  Deanne Loonin, a staff attorney at the National Consumer Law Center in Boston, is a leading expert on student loans and the author of Student Loan Law, among other publications.  We asked her to give us her reflections on the ongoing student loan scandal and recent rulemaking at the Department of Education.]

The recent student loan industry scandal has been brewing for years, but is coming to the surface now because of the increasing complexity of the student loan programs (there are over 3,000 lenders offering student loans) AND the explosive growth of private loan products. Lenders clamor to get on school preferred lender lists only partially to capture government loan business. This is not where the big money is these days and if anything, Congress has begun to cut back lender subsidies from the guaranteed loan programs. Rather, high status on a preferred lender list is a way of pulling students toward a lender’s much more lucrative private loan products. These loans are tremendously profitable, especially since there are no loan limits as there are with most government loans. Further, lenders don’t have to worry about the "inconvenient" interest rate and fee caps and consumer protections that come with government loans. The main down side to private loans is the lack of guaranteed pay-offs when borrowers default, but lenders have addressed this by such techniques as requiring co-signers, and most notably, the provision in BAPCPA that made private students loans as difficult to discharge in bankruptcy as government loans.

I do not believe that all schools are in the pockets of lenders nor do I believe that all financial aid administrators are corrupt. However, there are serious issues even with well-intentioned administrators. What was most striking to me during the recent round of Department of Education negotiated rulemaking was how remiss financial aid administrators have been in explaining their practices to borrowers and the public. I got the impression from many that they don’t think they should have to be transparent because they are "good guys." They see themselves as a key buffer between lenders and students. I agree that there is an important role for objective counselors to help students navigate the system. (Would we rather have a system based exclusively on direct marketing from lenders to students??).

The key question is whether financial aid administrators can be objective when they are so tied to lenders, even if there is no explicit quid pro quo arrangement. (We’ve been asking the same question about the credit counseling industry for years). Second, even if they do not have improper ties, are all financial aid administrators savvy and competent enough to understand the complex student loan market and impart this information effectively to students?

At the recent meetings, the financial aid administrators, lenders and schools were so worried that they might face liability for making "bad" recommendations to students that they proposed "immunity from liability" provisions. The reality is that they have been using preferred lender lists and working closely with lenders for years and seem to be reacting now only because they are worried about the spotlight. (The spotlight is thanks mainly to NY’s AG Cuomo, members of Congress such as Sen. Kennedy and Rep. George Miller, and excellent media coverage, especially in the NYT). One participant at the meeting argued that she doesn’t want to change her practices, she just doesn’t want to be transparent because she might be sued.

Consumer Groups Turn Up The Heat On Michael Baroody, President Bush's Nominee To Head The CPSC

by Brian Wolfman

Back on March 1, we blogged about the Bush Administration's nomination of Michael Baroody (pictured here), a longtime high-ranking executive with the National Association of Manufacturers, to chair the Consumer Product Safety Commission.  While at the NAM, Baroody has opposed many health and safety regulations.  If anyone can point to a regulatory initiative in the consumer health and safety arena that he has supported, please let us know.  The CPSC's principal role is to promulgate and enforce those kinds of regulations.

Eight national consumer protection groups, including Public Citizen, the Consumer Federation of America, Consumers Union, and U.S. PIRG, have teamed up to oppose Baroody's nomination.  A discussion of that effort, as well as other information about Baroody, is available here at The Consumerist.

FTC Rebate Debate

The FTC is holding a Workshop today on rebates; you can find more information here and I gather transcripts of the remarks will be available at some point.  Among the participants is Matt Edwards whose article on rebates, The Law, Marketing and Behavioral Economics of Consumer Rebates, 12 Stanford J. L. Bus. & Fin. (2007) can be found here.  Here's the abstract:

This paper deals with the legal regulation of mail-in consumer rebates - a significant, yet controversial marketing practices that has generated thousands of consumer complaints, inspired countless articles in major periodicals, and begun to attract the interest of state and federal legislators. The paper first aims to provide an understanding of the purposes of consumer rebate offerings. It then surveys the main categories of consumer rebate complaints, including that firms impose onerous requirements to discourage rebate redemption and that they fail to pay rebate rewards in a timely manner. The paper then draws on recent marketing, psychological and behavioral economics research to address the potent claim that rebates exploit sub-optimal consumer behavior.

The latter part of the paper evaluates several possible regulatory options for consumer rebates, including unfair and deceptive trade practices litigation, informational or de-biasing laws aimed at reducing sub-optimal consumer behavior, and legislation that sets mandatory rebate promotion terms. The paper also discusses how the market has already begun to respond to consumer dissatisfaction with rebate promotions. In the end, the paper argues that the most egregious rebate promotion abuses can be managed with a minimum level of paternalistic intervention while preserving the welfare-enhancing benefits of rebate promotions.

My own view of rebates is rather sour: as explained in my article Toward a New Model of Consumer Protection: The Problem of Inflated Transaction Costs, 47 William & Mary L. Rev. 1635 (2006), I believe that sellers often use rebates instead of sales because rebates persuade consumers to purchase the product--but then many consumers (perhaps as many as 97%) never collect the rebate.  The result is that sellers sell their goods at a higher price than consumers intend to pay.  Our casebook raises the question of whether a seller engages in bait and switch tactics when it offers a rebate and imposes onerous conditions for obtaining the rebate or the seller emphasizes the "after rebate" price even though it knows from past experience that many consumers will not obtain the rebate.  [Disclosure: I was initially invited to participate in the Workshop and then was "uninvited;" I also suggested to the FTC Staff that they invite Matt Edwards.]

Incentives and the Secondary Market: Ted Frank Responds to Chris Peterson

by Ted Frank

Christopher Peterson disagrees with my assessment of subprime mortgages:

In [Ted Frank's] view the market is currently adjusting to the problems in mortgage origination. Everything will work out if we just leave the markets alone because "lenders have every incentive to lend only to those who can repay." I disagree. The current legal system creates the incentive for loan brokers and originators to (1)take large commissions and closing costs, (2) pass off bad loans to the secondary market, (3) distribute the revenue from lots of closings to management and employees, (4) wait for the bankruptcy code's preference window to close, then (5) declare bankruptcy when the secondary market tries to exert its recourse options.

Except what Peterson is describing is intentional securities fraud, for which there already exists plenty of civil and criminal deterrent. Management doesn't escape scot-free: in the First Alliance Mortgage case, its chairman and CEO, Brian Chisick, was on the hook for $20 million in an FTC action over that bankrupt company's mortgage practices, even aside from the losses he incurred from the drop in value in his equity interest in the company.

Moreover, in such a scenario, the secondary market investors lose their money in their investments—surely deterrent enough to engage in appropriate due diligence to not invest in a fly-by-night operation that is issuing bogus loans. Why victimize them twice? The only thing that accomplishes is to punish the honest by creating an infeasible risk premium.

The multiply-illegal scam Peterson posits (involving mortgage fraud, securities fraud, and possibly bankruptcy fraud and breaches of fiduciary duty) just is not a viable business model for any reasonable length of time: can we identify anyone who is living high off the hog through these means?

Watson v. Philip Morris Argued in the Supreme Court

Watson v. Philip Morris was argued today in the U.S. Supreme Court.  That's the case in which the 8th Circuit said, believe it or not, that Philip Morris could remove a class action challenging the marketing of "light" tobacco products from state to federal court because the tobacco giant was "acting under" a "federal officer" within the meaning of the federal officer removal statute, 28 U.S.C. 1442(a)(1).  Why, you ask?  Because, according to the 8th Circuit, the company's production and promotion of light cigarettes was heavily regulated by the FTC. We blogged about the case before, including here, here and here.

Now, read the transcript from today's argument.

The Spy Act Protects Corporations, Not Consumers

by Greg Beck

  Ed Foster at Infoworld analyzes H.R. 964, the Spy Act, Congress' latest response to spyware, and finds it seriously lacking.  The bill includes exemptions that would allow hardware and software vendors to spy on their customers and collect private information, without notice, "for network or computer security purposes, diagnostics, technical support, or repair, or for the detection or prevention of fraudulent activities."  Worse, the law explicitly preempts state laws regulating unfair or deceptive conduct similar to that covered by the law.  All private rights of action will be eliminated, and enforcement authority will be exclusively vested in the FTC and state attorneys general.

It is pretty apparent that the law is not designed to protect consumers, but to protect companies from liability for spying on their customers.  For example, it appears that Sony would be immune from liability under the law for its secret installation of its software "rootkit" on customers' computers, which in 2005 opened the computers up to attacks by viruses and sparked multiple lawsuits.

The bill was approved last week by a subcommittee of the Energy and Commerce Committee and now goes to the full committee for approval with strong bipartisan support.

What happens when lenders don't care if they are repaid?

by Christopher Peterson

In today's Wall Street Journal, Ted Frank, with the American Enterprise Institute, argues that the current meltdown in the subprime mortgage market justifies neither legislative nor judicial reform. In his view the market is currently adjusting to the problems in mortgage origination.  Everything will work out if we just leave the markets alone because "lenders have every incentive to lend only to those who can repay."

I disagree.  The current legal system creates the incentive for loan brokers and originators to (1)take large commissions and closing costs, (2) pass off bad loans to the secondary market, (3) distribute the revenue from lots of closings to management and employees, (4) wait for the bankruptcy code's preference window to close, then (5) declare bankruptcy when the secondary market tries to exert its recourse options.

Mr. Frank’s analysis ignores the agency costs of front line players in the industry, and it conflates the profitability of loan originating companies with the profits kept by the management of those companies.  While there is nothing inherently wrong with securitization of mortgage loans, or other financial assets, we must accept the reality that the current system of funding subprime mortgages does not preserve the traditional mortgage market’s underwriting incentives.  Instability and predatory lending will persist as long as the secondary market, and in particular, the investment banks that package mortgage backed securities can pass off bad loans to investors without fear of liability.

Another Brief In The California Supreme Court UDAP Case

Earlier today, I blogged about an important consumer protection case pending in the California Supreme Court.  Here's another brief in the case - - this one filed by the National Consumer Law Center and the National Association of Consumer Advocates.

More on Punitive Damages in Exxon Valdez Litigation

We previously blogged here about the Ninth Circuit's ruling cutting in half (to $2.5 billion) the punitive damages award in the Exxon Valdez oil spill litigation, and here about Exxon's petition for rehearing en banc.  We've recently been sent the plaintiffs' response.  Plaintiffs' counsel informs us that the Ninth Circuit has yet to rule on the petition.

More Google Privacy Fears

By Greg Beck

Google won at least partial praise from privacy advocates last month with its announcement that it plans to purge identifying information from its database of web searches after 18 to 24 months.  But recent news again raises concerns about Google's privacy policies.

First, Google announced that it plans to acquire DoubleClick, Inc., which distributes Internet-based ads and tracks which ads web browsers click.  The merger raises fears that Google could combine its existing massive databases of its users' search habits with Doubleclick's equally massive database on users' behavior to create a combined database of Web users and their browsing habits. 

Google and DoubleClick claim that they will not merge the data in this way, but critics are not mollified.  The merger prompted three consumer groups, the Electronic Privacy Information Center, PIRG, and the Center for Digital Democracy, to file a complaint with the Federal Trade Commission raising privacy and antitrust concerns.  Although Google's privacy policy discloses that it saves personally identifying information, the objecting consumer groups argue that Google's practices are nevertheless deceptive because the disclosure is difficult to find and because survey data shows that most Google users don't know that Google stores personally identifiable data along with a user's search history.

Second, Google has announced a new service to track every website that web browsers click on from its search results.  The service includes one critical feature that is worthy of praise:  it is completely voluntary.  Google's privacy policy, however, doesn't rule out saving this data even without a user's consent, and, in fact, specifically provides that "Google may present links in a format that enables us to keep track of whether these links have been followed."  Google does store information about which websites users visit in at least some circumstances.  Moreover, when a user clicks on a link from Google's search results, the user's browser is sent to Google's own server before being sent to the requested web page, in a way that would allow Google to track which sites users click.  Google's policy raises concerns that it can link data on which websites its users visit with personally identifying information and that, once again, consumers might not realize the amount of privacy they are sacrificing whenever they search the web.