There are several reasons the Banker’s Boys in the U.S. Congress would like to rip the guts out of the Dodd Frank Act. There’s a reason they fought the creation of the Consumer Finance Protection Bureau, and more reasons why the 113th Congress has tried to grab control of the agency, strip the agency of funding, or otherwise make the Bureau a hollow shell of protective camouflage for the bankers. Here’s one of those reasons: The Securitization of Student Debt.
Flashback: On August 29, 2012 the Consumer Finance Protection Bureau issued a report on student debt. (pdf) One section of the Executive Summary contained information which ought to have triggered some alarms:
“From 2005–2007, lenders increasingly marketed and disbursed loans directly to students, reducing the involvement of schools in the process; indeed during this period, the percentage of loans to undergraduates made without school involvement or certification of need grew from 18% to over 31%. As a result, many students borrowed more than they needed to finance their education. Additionally, during this period, lenders were more likely to originate loans to borrowers with lower credit scores than they had previously been. These trends made private student loans riskier for consumers.”
Sound familiar? Have some of the tonal qualities of the Subprime Mortgage Debacle? Over-extending credit, to the less credit worthy, placing them at greater risk of default, and doing it during the Great Housing Bubble?
Flashback 2005: Indeed, by 2005 there was a new bit of jargon in the world of fixed income investments — SLABS, or Student Loan Asset Based Securities. The definitions can be illustrated by this information from one part of the securities industry:
“Student Loan ABS (SLABS) can be appealing to fixed income investors because they offer high credit quality, credit stability, and low spread volatility. SLABS backed by federally reinsured loans command tight spreads, in roughly the same range as deals backed by credit card receivables or auto loans. SLABS backed by other loans (so-called “private” student loans) command somewhat wider spreads, reflecting incrementally greater perceived credit risk.” [Nomura 2005 pdf]
Not to oversimplify too broadly, but there it was in 2005, a description of asset based securities (packages of student loans securitized into financial products) divided into two parts, the products based on guaranteed student loans and the less secure private student loans. Note, please, that the advice on offer in this report doesn’t apply to the students who took out the loans — it is advice for “fixed income investors.”
Have we mentioned, at least a gazillion times, that one man’s debt is another man’s asset? And so, the student loans were packaged (just like the home mortgages) by such dealers as Nelnet Student Loan Trust, Sallie Mae Student Loan Trust, Northstar Education Finance, Collegiate Funding Services, Access Group Inc., Education Funding Capital Trust, College Loan Corporation Trust, and others. [Nomura 2005 pdf] Here we meet our old friend, the Tranche.
“A piece, portion or slice of a deal or structured financing. This portion is one of several related securities that are offered at the same time but have different risks, rewards and/or maturities.”
Perhaps it was that SLABS were sold as somehow being “safer” investments than their home mortgage cohorts, and maybe safer than the consumer credit securitized assets. After all, the borrower couldn’t walk away from a student loan in most instances. What could go wrong?
Flashback 2012: What, indeed, could go wrong?
“Meanwhile banks have been slicing and dicing student loans into derivative financial instruments called “SLABS” — student-loan asset backed securities. We’ve seen this movie before — the one where big banks mass-market loans to a population with stagnated wages and dwindling economic prospects, then bundle them and sell them to investors who haven’t reviewed the way they were underwritten and sold.” [Eskow, HuffPo]
And, it all worked really well … until it didn’t. There are those “derivative financial instruments” (read financial paper products) again, and again, and again. In the wake of the derivative debacle of 2007-2008 the financial sector did some belt tightening and the CFPB was able to report underwriting and marketing changes which were far more responsible. Additionally, the CFPB ‘autopsy’ of the student loan situation revealed some of the previous practices associated with economic issues:
#1. Some of those who took out private student loans did not understand that they had fewer repayment options than if they had assumed Stafford loans. This sounds remarkably similar to the mortgage sales which didn’t quite lead to an understanding about balloon payments, interest rate changes, etc.
#2. The private student loans were most commonly sold to people who were attending for-profit institutions. While private loans were taken out by only 14% of the total undergraduates, students at for-profit schools held 42%.
And, to make matters even more murky, many of the loans were tied to LIBOR, which was perhaps not as above the board as one might have assumed before 2008. [TP]
July 28, 2014: If a person were thinking the provisions of the Dodd Frank Act, and the activities of the Consumer Financial Protection Bureau may have put more than a damper on the financial sector proclivity to create ways to peddle paper in order to create more ways to peddle paper — please think again.
Enter So-FI, Lending Club, and Prosper. “SoFi’s niche is refinancing student loans. But not just any loans. The kind of schools that are most represented in the program are selective colleges like Harvard, New York University and Northwestern. Their alumni provide the money — The students must also have a job lined up after graduation.” [CNN] But wait, here comes the packaging. Compliments of Eaglewood Capital which securitized loans from Lending Club.
This time is slightly different. Did we notice that the packaged loans aren’t from the for-profit educational sector? Or, that most undergraduates won’t get re-financed via this new securitization scheme? Low risk, coupled with above average returns and who might be interested in this newly peddled paper? If you’re thinking we have the rich bailing out the rich for the benefit of the richer, the conclusion might be close to the target. Fitch explores the prospects:
“In our view, most future securitizations are likely to be concentrated with large non-bank servicers, who are also the traditional FFELP buyers. Of the 13 Fitch-rated FFELP deals that closed in first-half 2014, 10 were issued by Navient Corporation, Nelnet Inc. and the Pennsylvania Higher Education Assistance Agency (PHEAA). As some portfolio acquisitions include servicing transfers, we believe some small NFPs could experience lower account volume and profitability. These servicers are already facing sustainability issues, as some may not have the scale to weather the pressures brought by the Budget Control Act of 2011 and the termination of FFELP. They may also be pressured in the near term by rules proposed by Congress that would establish a common set of performance metrics, incentive pricing for servicers and allocate accounts to NFPs that meet the requirements.” [Reuters] *NFP = not for profit servicers
Those major players from 2008 (Nelnet, PHEAA, etc.) are still playing, and some of the newer participants in the game may not be so profitable in the long run because someone might be watching over their shoulders. “Under a law that took effect in March 2010, the government stopped making student loans through private companies that funded themselves in the market. The government now issues loans directly. Lenders sold $20 billion of student-loan securities last year, down from $62.2 billion in 2005, according to Wells Fargo.” [BloombergNews]
The good news may be that there is less Casino Activity among the bankers in the securitization of student loans, or the creation of SLABS. The bad news is that the bankers are going full bore to get rid of those pesky regulations and the CFPB which serve to put a lid on the Bubble Behavior of the recent past.
The July 23, 2014 session of the House Financial Services Committee took testimony from all the usual suspects on “Dodd Frank: Four Years Later.” Rep. Hensarling’s Committee heard from the CEO of First State Bank, a partner in Treasury Strategies, an FMC representative on behalf of the Coalition of Derivative End Users, and a ‘resident scholar’ of the American Enterprise Institute. The counter-balance? Former Representative Barney Frank. The AEI testimony is instructive, [Pdf] if predictably repetitive. A summary:
Regulation creates uncertainty, discourages investor due diligence, increases regulatory burdens, gives too much power with too little Congressional oversight, promotes a ‘naive strategy for promoting financial stability, and doesn’t solve the Too Big to Fail problem.
There is nothing new here, merely the recital of every anti-regulation talking point since the dawn of time. However, redundant as the arguments may be, the Republicans in the House of Representatives would very much like to repeal the Dodd Frank Act. During the 112th Congress H.R 87, H.R. 1062, H.R. 1539, H.R. 1082, H.R. 1610, H.R. 1573, H.R. 1121, H.R. 1315, H.R. 836, H.R. 1223, @. 746, and S. 712 were all introduced intending to either repeal or diminish the regulations in the Dodd Frank Act. In the 113th Congress, H.R. 46 is an outright repeal bill coming from Rep. Michele Bachmann (R-MN) Rep. Ted Yoho (R-FL) and Rep. Adrian Smith (R-NE)
The prospect of a wholesale repeal is dim, but not the notion that the statute could be ‘nibbled to death by ducks.’ [Hill] House Republicans did manage to get one bill passed in June 2013 to restrict SEC and CFTC rule making capacities — arguing ironically that the agencies had 3 years to get the rules done and had not made enough progress — in the face of nearly overwhelming stalling tactics by financial sector interests and their litigators.
While the CFPB attempts to alleviate the more obvious abuses perpetrated by unscrupulous or unethical lenders, and issues annual reports (most recent 2013) noting that there were 3,800 consumer complaints about student loans, 87% of which were directed at 8 companies. The House Republicans persist in attempts to subject the agency to Congressional micro-management, if not outright dissolution.
We should expect the mid-term election rhetoric to mirror the testimony of the AEI in the most recent House Financial Services Committee hearing. The Dodd Frank Act will be attacked “in general.” It’s reasonable to predict much will be made of the Too Big To Fail Argument, as if the consolidation of the financial sector is a function of federal statute rather than processes associated with the cyclical nature of financial enterprises. It will be attacked as “too burdensome” for small banks. It isn’t. It will be attacked as “big government.” Any attempt to reign in the Bankers will always be so characterized.
What opponents of financial regulatory reform won’t discuss is how the Consumer Financial Protection Bureau is attempting to guide the lenders and by extension their secondary markets into the construction of a more equitable, operable, less volatile, and more sustainable student loan sector.