The securitization of student loans began in the early 1990s, after the passing of Rule 3(a)(7) of the Investment Company Act of 1940, which exempted sellers of asset-backed securities from registering as investment companies. 17 CFR § 270.3a-7. This rule essentially removed the regulatory constraints and costly registration requirements that previously existed for sellers of asset-backed securities. Id. Asset-backed securities are investments in a pool of underlying assets. In the case of student loan asset-backed securities (SLABS), outstanding student loans are grouped together into pools, which investors purchase and get a return when borrowers make their loan payments. See Jack Du, Student Loan Asset-Backed Securities: Safe or Subprime?, Investopedia (Aug. 15, 2015, 5:37 PM), https://www.investopedia.com/articles/investing/081815/student-loan-assetbacked-securities-safe-or-subprime.asp. This is very similar to the mortgage-backed securities that led to the mortgage crisis of 2008, where securities based on pools of mortgages collapsed when the borrowers began defaulting on their mortgage payments. Id.
What’s the Risk?
On the surface, SLABS seem pretty low risk: borrowers make monthly loan payments and student loans are almost impossible to discharge in bankruptcy proceedings. However, a great majority of student loans are backed by the federal government. Government-backed loans almost never require a credit check or a cosigner to receive loans. See Federal Versus Private Loans, Federal Student Aid, https://studentaid.ed.gov/sa/types/loans/federal-vs-private. Much like the subprime and predatory lending practices that occurred during the mortgage crisis, many of the student loans backing these securities have been given to borrowers with no assessment of whether or not there is an ability to repay the loans. Investors in SLABS face the possibility of delinquency and default on the underlying loan.
Additionally, unlike mortgages, student loans cannot be collateralized. See Jack Du, Student Loan Asset-Backed Securities: Safe or Subprime?, Investopedia (Aug. 15, 2015, 5:37 PM), https://www.investopedia.com/articles/investing/081815/student-loan-assetbacked-securities-safe-or-subprime.asp. Collateral works to secure loans; with mortgages the collateral is the home and if a borrower does not make mortgage payments, the mortgage lender is able to take possession of the home. See Collateral, Investopedia (last visited May 8, 2017), https://www.investopedia.com/terms/c/collateral.asp. Whereas a home can be foreclosed on, no one is coming to foreclose on your degree. This makes student loans risky, and thus SLABS, because the loans are unsecure and recouping losses if a borrower fails to repay is difficult because a lender cannot seize the educational degree and resell it.
SLABS investors and any student borrower who is frustrated with the mere notion that money is being made off our student loans may find some relief in an unexpected place: bankruptcy reform. Possible changes in the area of bankruptcy law have the potential to not only alleviate fears of borrowers of being able to pay back their loans, but also provide solutions for investors who have invested in SLABS based on the idea that student loan debt is nearly impossible to discharge.
A class action suit pending in a Texas Bankruptcy Court may allow for the discharge of certain education loans. A case brought by plaintiffs who have had their loans discharged in bankruptcy against student loan servicer Navient who has tried to collect on outstanding education loans, In Re Crocker rests on the definition of “an obligation to repay funds received as an educational benefit.” Crocker v. Navient (In re Crocker), No. 15-35886, slip op., 2018 WL 1626245 (Bankr. S.D. Tex. Mar. 26, 2018), at *4. The plaintiffs argue their loans do not fall under the “educational benefit” definition, while Navient contends that these loans do and are therefore nondischargeable loans. Id. While the case is still pending, the Bankruptcy judge recently denied Navient’s motion for summary judgment, and relied heavily on legislative intent in choosing “obligation to repay” instead of “loan” as reasoning for why there is merit in plaintiff’s argument. Id. at *4-*5.
If the plaintiffs prevail, this could mean many more states will follow in allowing for the discharge of loans in bankruptcy that were previously believed to have been nondischargeable student loans. However, this impacts SLABS investors because these loans are part of the underlying assets backing their securities. See Navient Student Loan Trusts, Navient.com, https://www.navient.com/about/investors/debtasset/navientsltrusts/. Investors will similarly be impacted if issuers like Navient have not adequately disclosed the risk of bankruptcy to investors.
Other areas of possible bankruptcy reform can borrow from mortgage lending reform. Reforms such as a repayment program for student loans, would allow for student loan borrowers to modify the terms of their loan to keep making smaller payments over a longer period of time, much like the Home Affordable Modification Program (HAMP) did for mortgages. See Andrew Woodman, Note: The Student Loan Bubble: How the Mortgage Crisis Can Inform the Bankruptcy Courts, 6 Alb. Gov’t L. Rev. 179, 218-20 (2013). Investors would continue to earn return while student borrowers would be able to decrease their monthly payments.
Creative lawyering in the area of bankruptcy is necessary to help both student borrowers and investors in SLABS. Using lessons learned from the recent mortgage crisis in the SLABS market can help investors avoid losing money as well as protect student borrowers.