Private student loans tend to fill funding gaps that federal planners allocate to PLUS loans. If circumstances divert the financial burden from parent to student, as often happens, then private loans sometimes enter the student loan mix. Since 67% of private loan borrowers are dependent students, one might tentatively expand on “sometimes,” or even wonder if the federal PLUS loan vision has failed.

Private student loans come from commercial lenders and are not federally insured against default, nor do they offer the wide range of benefits available from federal loans. Private student loans also operate on an entirely different interest rate schedule, which immediately confuses most students. A common example:

Citibank offers a private loan for undergraduates at an advertised 4.5% interest rate. Looking further, first, that rate only applies to students with near-perfect credit. Many students will qualify for 8%-13% rates. Second, it’s a variable interest rate calculated from current PRIME rates that may rise over the term of the loan. Third, repayment relief options are significantly less than federal loans. Unlike federal loan programs, no forgiveness programs exist for private student loans, and the loan will not be canceled if a school shut down or the borrower suffers a life-altering disability (federal loans offer this protection).

And this is Citibank, a reputable bank, offering an honest loan. Even if students understand the terms, they seem systematically to misjudge market fluctuations and ignore the risk of debilitating injury or prolonged joblessness.

One scenario:  interest rates have risen and students lose jobs due to recession.  When job markets stagnate, many scramble into deferral or forbearance – allowing principals to bloat from accrued interest – and seek interim jobs or shoot back to school with new loans.

This is a pure gamble, rolling dice for one’s life. Few understand what they’re doing. Soon deferral and forbearance will vanish, all years expended, and moving forward, forever, those swollen loans must be paid at even higher rates  with no graces for illness or unemployment. Whether or not a graduate can manage depends on how well his career has proceeded, an outcome tied to economics and fortune and so often beyond one’s control. Thousands of loan stories end here, in default.

Private loans troubles lurk beyond government data, steadily underreported. Private loans are not formally tracked. Students have no motive to report loans, and many firms do not disclose them.

The distinction of lending firm matters greatly. The large private lenders, banks, like Citibank, run publicly-traded businesses with rigorous rules and public disclosure. Their financial reports are widely read and basically tell the truth.

A separate set of lending institutions are privately traded and sparsely regulated – a tremendous edge for crooks. Deception is the only edge that smaller firms have on Citibank-sized institutions. Almost by rule, these firms are smaller and seedier, marketing loans directly to students and with a devil’s regard for students’ wellbeing.

They escape notice like this.

Now, recent buzz on HR4137 involves unrelated language jammed into the bill about file-sharing. CNET writes well on the P2P changes snuck into HR4137. Why does this happen? Clauses like this have major lobbies beyond them and often drive compromises in committee. Powerful legislators in committee can often force controversial language into large, important bills and so avoid an individual vote on their controversial issue. If you recall, something similar happened when Senators hijacked a Port Security bill to legislate online gambling in 2006.

Anyway, the controversy remains moot. Just as before, with the gambling bill, the chatter comes a bit too late for recourse. This is terrific for student loan reform, and just slightly poor for file-sharing college students.

The new ruckus comes from loan markets and HR4137, soon to be law. Dry markets frighten FFEL banks, who cannot flip loans to investors; just so, more than 100 FFEL lenders have dropped out this year. Now, HR4137 will remove all remnants of lender-college kickbacks. See where this leads?

The FFEL program always lacked the student benefits of FDL, because FDL had one source, the government, that managed loans and laws. FDL was always cheaper for taxpayers too. It seems like FFEL’s popularity sprang from the dodgy incentives passed to universities from private, profit-seeking banks. These incentives have vanished.

Recall the behemoth Sallie Mae. Under FFEL, Sallie Mae receives full federal reimbursement on each defaulted loan. Still, tenacious Sallie Mae spends millions to shadow defaulted loans through courts and collection for pure excess profit. Ideally, defaulted loans pay twice. Competing banks profit similarly, on smaller scales.

FFEL charges go on. The program encourages students to compare federal loans between banks, which certainly helps banks to sell slick private loans in their place. There’s more, but why bother.

Today, attention shifts to the Federal Direct Loan program. Some question FDL’s capacity to absorb new loan volume, despite its allegedly smaller taxpayer burden. Others claim that direct loans allow increased default. In any case, more FDL participation shifts authority from private banks to central government. With enough flight to FDL, the dynamics of student loans could change sharply.

Forget broad beliefs about markets and governments. Consider loan forgiveness.

Under the centralized FDL, policymakers can shift burdens with exhilarating efficiency. Loan forgiveness works. Any loan can be canceled or eased, in full or in part, in whichever way, as a product of federal policy. Recall the cadres of students sinking in debt, paralyzed by poor economics and risk. They have reason to soften their debts, but no obvious method

Now, FDL has tremendous upside for worried students: potential loan forgiveness for public service. The government can build an incentive apparatus to direct a post-college class of capable students, willingly, into much-needed service work. These jobs are worth more to society than their salaries pay; they also demand an educated employee who expects, post-college, to earn more. With the carrot of loan-forgiveness, these jobs pay substantially more to students and should swiftly be filled. In return, the government subsidizes these students by canceling loans. The public service work is a short-term gain, and the students’ softened debt is a long-run boon to the nation – socially, economically, even inspirationally, with whirlwind uplifting effect.

Loan forgiveness happens today at modest rates and popular programs have more applications than capacity. New legislation, in the spirit of HR4137, can expand the ease and reach of loan forgiveness. It’s a compelling chance.

A flight from FFEL into FDL is a big, inscrutable deal. FDL has advantages, but is federal control so wonderful? Is it fiscally possible? Etc.!

Still; for students, for now, it’s terrific.

Aid boosts to neglected constituencies: low-income, veteran, disabled, minority. Important, but basically boring. Congress boosts aid all the time, modestly, to combat tuition and inflation and to seem busy. And yet the numbers stretch into tens of billions.

No more kickbacks from lenders to colleges. Also, schools must explain how their “preferred” lenders offer the best deals to students. A direct response to harrowing kickback scandals from last year.

Fewer hidden costs to students. Universities must disclose textbook titles early enough for students to seek deals; also, no more bundled software scams. Tuition hikes would be declared earlier too, with price-gouging colleges placed on a federal shame list. All fine steps towards transparency.

FAFSA becomes quicker and easier; a blow for those predatory lenders pitching no-FAFSA loans to exasperated students.

Expanded loan forgiveness programs.  A huge deal. There are intriguing new loan forgiveness clauses up to $10,000 for a wide range of public service work, including volunteer mentoring at $10/hour in federal loan forgiveness.

HR 4137 is a sprawling bill that demands scrutiny, especially as it slinks through Congress carrying billions in new spending tags. This is a dear, deeply Democratic bill with no buzz. The transparency reforms deserve applause, but elsewhere the bill attacks college finance with naked subsidies worth $34 billion per year, a huge sum. And this after an emergency move in May to ‘subsidize’ federal student loan markets. Could funds disappear?

Something is up, but loan holders should cheer.

These are mostly large banks clamping down on portfolio risk. Savvy from sub-prime’s collapse, investors fear unprecedented student default rates and are rejecting the sort of student loan bonds that banks used to aggregate and sell profitably. This secondary market, where lenders sell to investors, has dried up.

Nearly 100 lenders have ceased to offer federal loans to students. An even worse indicator follows: 30% are abandoning low-interest private loans too. If banks are struggling to profit from private student loans, which are more expensive and more profitable than federal loans, then students are basically screwed.

Luckily, the federal government has decided to purchase student loan bonds, the federal ones, from approved banks. This acts like a subsidy, buying assets poised to tank; now certain banks can offer federal loans to students without fear.

This is all very complicated for students. Many will have to change banks, and quickly. Though there are no federal deadlines for student loans, most universities set their own. Some have passed, and many more approach. If students miss them and universities reject pleas for extension, the last resort is a private loan. No subsidies there. The new wave of private student loan instruments will aggressively pass risk onto students.

Now, a survey like IPEDS depends on the data volunteered by institutions. There are fewer interesting questions (most are broad) and far fewer missing variables; and more, much of the data can be (or even has been) independently verified. But the data is banal on loans. IPEDS will condense grant aid results a dozen ways, and it looks comprehensive, but after loan aid it isn’t. The numbers reflect known federal aid packages, excluding PLUS loans. The school doesn’t know about private loans.

Stephen Burd, of the New America Foundation, said as much in a NY Times article last year:

“We find it very alarming. Colleges may not be aware the students are taking out the loans, so there is nobody giving any guidance.”

In fact, universities haven’t a clue. How could they? NPSAS-type surveys have scant data on private lending, a recent craze, and what data exists is prohibitively riddled with problems. The IPEDS class says nothing.

Perhaps we should look at student loan markets and volume?

An Institute for Higher Education study claims over $16 billion in private student loans for the 2005-06 year, compared to nearly $69 billion in federal. That puts private lending at almost 19% of total volume. Projected growth rates are notoriously unreliable but see federal loans at 8% and private loans at 25% for the year just passed. This report found real scandals too. Most alarming? More than 20% of all private student loan borrowers do not receive any federal Stafford loans. And among independent private loan borrowers who actually used their federal loans, nearly half received less than their maximum allocated amount. In another area, IHEP notes that private lenders have been marketing to students before they have filled out the sprawling but crucial FAFSA, the official application for federal aid. Seems many are skipping it.

So please: do not underestimate the threat of private loans for students.

Students lack equal information and guidance, and yet all must assess a dizzying array of rates. So they make mistakes. They trust too quickly, or sign out of weariness, or fail to discern a lender’s deceit. Ask yourself, without numbers, but knowing the interests involved: how can this not be happening?

Anecdotes say it happens. New studies agree. And now, waiting on “government data,” are we not like those victims of high-interest loans, hearing no money down, and pay nothing for now ? Oh but then.

There is fierce debate on whether these universities should even exist. Nobody seems to agree on the macroeconomics, and few laws exist to regulate behavior (the stigma of non-accreditation seems less and less a barrier to skill-seeking students).

How much are these degree really worth? Results vary. Empirical data suggests that many for-profit graduates don’t understand that graduate and professional schools might not recognize their non-accredited degrees. Some are suing 2 3 4 their former educators, and those lawsuits claim a frightening range of unethical practices, including outright deceit.

The situation, according to a NY Times article:

“The problem is, from the hypothetical student’s standpoint, you’re out there, you want to improve your life, and you see this advertisement, with these great numbers,” he said. “You sign up, and to complete the course you need a student loan, which can get into the tens of thousands of dollars. You graduate and you find out they lied, and you can’t get a decent job. So now you’re in a situation where you have enormous debt.”

Note the loan debt. Wasting years on a worthless degree is a sunk cost, theoretically leaving you no worse off than you started. But the loan debt never expires, despite the lie.

Deceit, in its various guises, is an infamous attribute of private profit-seeking behavior in its ugliest, most unregulated form. You tend to see it in markets where competitive forces have failed or never developed and when governments have not addressed the market failures.

Already you can smell it here, in the market for for-profit private education. Didn’t you know? Education stocks are a smart pick in tough times.

Across the country, large lenders are fleeing the student loan business at its margins – among middle and lower tier schools. These students presumably have lower income horizons and higher default risks, which frightens away those banks now sloughing off portfolio risk in the wake of the sub-prime disaster. Right now, default risk terrifies the market. The mortgage market showed us complex loans, calibrated for short-term grace periods and long-term exploitation, that defaulted in droves and changed the entire risk calculus for banks. Since more risk –> less profit, lenders abandoned their riskiest loans, now unprofitable, and cut back fiercely on similar loans. Banks still don’t know what the real risk might be; they do know, however, that default risk will rise in recession.

Unfortunately student loans work the same way, and most analysts foresee recession. Riskier students will have a tough time with loans. They will pay more interest and be forced to deal with less and less scrupulous lenders. It doesn’t help to have inflation and surging tuition either.

In a laissez-faire world, vast numbers of students would forgo college for lack of funds. Some of the lesser schools would close, or slash prices in response, but only after a generation of would-be collegians prematurely entered the overfilled unskilled workforce. From here, you can extrapolate as much nastiness as you need.

Reality is a bit worse. Without support, many students will still go to college with high-interest rate loans they do not fully understand. As is already happening, debt will destroy their freedom and livelihood. The college dream is a potent narcotic, and don’t those loan banks know it.

What to do? The federal government needs to act fast, and has shown signs of trying. The Globe article mentions the widely unexplored Federal Direct Loan program as a possible solution (it’s not). The Wall Street Journal mentions steps toward the nationalization of student loans. We need big decisions, else middle-class students are doomed.

I care mainly about student loan data. Each year, national trends show more undergraduate students taking out loans for education. They seek these loans in haphazard ways.

Most unsettling is the upswing in private, predatory financing; for lenders, private loans are substantially easier to market and fiercely profitable. In the seediest areas, often for-profit universities, college counselors and predatory lenders conspire to fleece unwitting students by promoting expensive private, or “alternative,” loans instead of cheaper, safer federal options (that the firm does not offer). These are private lending firms like loan sharks that market deceptive, proprietary products as an instant solution for students of all incomes and credit ratings. On television and radio. In college counseling offices. Of course prospective students typically know little of finance. They ask for advice and are eaten.

Private loans also attract students who have exhausted their federal options but still have more to pay. If parents will not co-sign a federal PLUS loan, the leftover private options loom. Their complex structures and sly marketing – the speediest lenders are the craftiest – offer terms that mimic a federal loan for four years, accruing interest at crushing speed, and then spiraling into unmanageable debt. An easy short-term decision becomes a relentless long-term burden.

Not all private loans are like scams; many reputable banks package federal and private loans for students. But the temptations to lenders look as dangerous here as they proved in mortgage markets. Intricate loan instruments with little short-term burden thrust upon naive loan-seekers…

There are even signs that reputable lenders are exiting the student loan business entirely. Student loans, complex ones especially, are harder to flip on secondary markets. Unsettling echoes of sub-prime.

One concern is that high school graduates with low income horizons (whether by career choice, college eligibility, or merit) feel undue pressure to attend a college beyond their means. This impulse seems to funnel financially-naive students into unmanageable debt. Students with poor credit history accept higher interest rates. Independent students, excluded from PLUS, and often without any guidance at all, suffer disproportionately.

Private loans are the most recent and dangerous development in college finance, and yet students’ loan dependence in general is unsettling. University tuitions are racing beyond federal loan programs, and federal loans are not safe havens. They can be structured too; if mishandled, they bear all the life-ruining potential of private loans. And students are mishandling them too.