Student-Loan Mess

Enrique Ponce, a construction laborer from El Puente, Calif., and Michael Ward, a resident physician at the University of California Hospital in Los Angeles, exemplify two reasons that a federal program to guarantee loans to needy students is in deep trouble. Ponce borrowed $1,500 from a trade school that offered to teach him to become a TV repairman, but dropped out after two weeks because he found the courses too difficult. The school by then had already sold the loan to a credit union, which is now trying to collect the $1,500 from the Government. Dr. Ward and his wife Cheryl, a lawyer, declared themselves bankrupt at the start of their careers and thus unable to repay $32,000 in student loans, so the Government was stuck with that bill too.

Neither experience is uncommon. Under the Federally Insured Student Loan (FISL) program, the Government since 1965 has directly guaranteed repayment of almost $4 billion in loans made to students by banks or other lenders--often schools themselves. All students attending institutions approved by the program are eligible for loans. Students are charged no more than 7% annual interest; the Government pays as much as 3% more to make the interest rate competitive with that of other kinds of loans. Repayment begins nine months after a student's graduation.

Default Rate. In addition, the Government has reinsured student loans of about $4.9 billion guaranteed by 25 states, the District of Columbia and one private nonprofit agency; Washington reimburses the states for 80% of any money they lose paying off defaulted loans. To date, the Government has lost nearly $400 million on the two programs; states have apparently lost almost $47 million more. And the losses are mounting; this year the default rate on student loans guaranteed by Washington is running at a startling 19%.

Why? According to testimony taken by the Senate Permanent Subcommittee on Investigations, about half of last year's losses involved specialized or technical schools, most of them privately owned and operated for profit. Such schools have burgeoned since FISL began, in large part because the Office of Education of the Department of Health, Education and Welfare, which administers FISL, has allowed many of them to lend to their students directly. Although many of these "proprietary" schools do a valuable job of educating, others victimize both their students and the Government. In too many cases, a high-pressure salesman working on a commission basis recruits students from low-income backgrounds by offering career-improving courses to be financed by federally guaranteed loans. Many of the students quickly drop out, but the school neglects to inform anyone that they have left. The dropouts, of course, do not feel obliged to pay for an education they never received, so the Government is left to pay the school or an institution that has bought the loan. "It's a field day for foxes," says Richard Gibbons of the Federal Trade Commission. Last year the default rate on student loans made by privately owned schools was a shocking 46.3%.

One case: Los Angeles-based West Coast Schools recruited mostly black and Chicano students--"because that's where the gravy is," as President Fred Peters told his exwife, according to subcommittee testimony. It then sold nearly $5.4 million in federally insured loans to financial institutions for cash, leaving the institutions to dun dropouts like Ponce for the money or collect from the Government. The Senators heard testimony that at least $312,000 of the school's money found its way into Peters' personal accounts. W.C.S. folded in 1973. Peters was excused from testifying because of ill health. His lawyer told TIME that Peters feels "he is a victim of a gigantic bureaucracy."

Another 5% of the losses are caused by students who, like Dr. Ward, declare bankruptcy shortly after finishing their education. In most cases the bankruptcies are quite legal: a recent graduate may have very high future earning potential, but his assets immediately after leaving school may well total less than the student loan and other debts, thus fulfilling the legal requirements for bankruptcy. Though the bankruptcy problem is small compared with the one represented by privately owned schools, it is growing. In California, Federal Bankruptcy Judge Robert Hughes estimates that as many as 20% of all personal bankruptcy claims are filed by student borrowers.

Many defaults, of course, come about because, at a time of high unemployment, new graduates either cannot find jobs or earn too little to pay off their loans. Still, the default rate obviously indicates lax Government administration of FISL. John J. Walsh, an investigator for the subcommittee, reported to the Senators that he found files on student loans strewn all over some HEW regional offices. HEW officials told the Senators that they have not kept track of the total number of loans outstanding, much less the amount of insured loans at any one school, or whether any particular student borrower is still in class.

HEW now is belatedly tightening up. It has charged nine schools with violations of loan-program rules, begun testing in California a computerized system of monitoring the status of loans, added 70 new field investigators, and established a staff of eleven people to keep a close eye on lenders who have outrageous default records. In addition, several bills before Congress would forbid students to declare bankruptcy shortly after graduation simply because their student loans exceed their assets. The Nunn subcommittee is expected to recommend prohibiting many schools from making Government-guaranteed student loans, and making it a federal crime for a school to falsify data to obtain grants and loans, or to divert such funds for personal use.

The efforts come none too soon. Says Howard Feldman, chief counsel of the subcommitee: "Unless we reform the program, conservatives, liberals, everyone is going to take a look at that half-billion-dollar default and say, 'Let's get rid of the whole goddam program!'' That would be a tragedy for needy and well-intentioned students--still the great majority--who fully intend to repay their loans, and for the society that needs their educated skills.

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