By Deanne Loonin
For years, lenders fought and clawed to get into the largely unregulated world of predatory private student lending. During this time, a particularly unholy alliance developed between unlicensed and unaccredited schools, like Silver State Helicopters, and mainstream banks and lenders. The creditors didn’t just provide high-interest private loans to students to attend unscrupulous schools; they actually sought out the schools and partnered with them, helping to lure students into scam operations. They then turned around, and like subprime mortgage providers, made big money on these loans by securitizing them and shifting the risky debt onto unsuspecting investors.
Lenders got away with this because no one was paying attention. Regulatory agencies simply ignored their responsibility to stop unfair lending practices.
As Higher Ed Watch revealed in December, these schemes have been carried out in violation of federal (and in some cases state) laws. This is a national disgrace that requires quick federal action to prevent future abuses and to provide redress for those who have seen their dreams of bettering themselves shattered by greed.
At issue is the FTC Holder Rule (more accurately referred to as the Federal Trade Commission Preservation of Claims Rule), which puts lenders on the hook when they have "referring relationships" with trade schools that defraud students or shut down unexpectedly. Under the provision, students are entitled to recover any payments they have made and to have their remaining indebtedness canceled.
The rationales for the FTC rule include:
- The deterrent effect on creditors. The rule is intended to deter lenders from developing business arrangements with bad merchants and help force the market to police itself. As summarized by the West Virginia Supreme Court in 1995, without the rule, a financial institution could "run in effect a ‘laundry’ for ‘fly-by-night’ retailers."
- A possible "deep pocket" for victims of consumer fraud. A victimized student cannot recover from a school that is collection proof, insolvent, or in bankruptcy, but this individual can often collect from a related creditor.
- A means of leveling the playing field for consumers. Even if the school is solvent, it is very difficult for a student who has been ripped off to simultaneously fight a collection action by the lender and bring a lawsuit against the school. By far the most practical and efficient action for the student is to fight the collection activity by holding the lender responsible for the school’s actions.
At the National Consumer Law Center’s Student Loan Borrower Assistance Project, we have found that most private student loan providers flaunt the rule. In a March 2008 report surveying 28 private loan agreements, we found that 40 percent didn’t include the holder notice in them at all. Nearly all the rest contained the notice but undermined it by including contradictory clauses – saying, for example, that students would be responsible for repaying the loans in full no matter how dissatisfied they were with the schools.
A favorite tactic of national banks is to simply ignore the holder rule, saying that it doesn’t apply to them. Among other arguments, they claim that they are outside the reach of FTC enforcement. They also argue that state versions of the rule don’t apply to them because such laws are preempted. The banks make these dubious arguments, knowing full well that their direct federal regulators, like the Office of Comptroller of the Currency, have neither the desire nor the incentive to hold them accountable. [The OCC, for example, is financed primarily by the fees it collects from the banks it regulates.]
The creditors have also exploited a technicality in the FTC rule. The main problem is that the FTC rule obligates only the schools, not the lenders, to include the notice. In other words, the FTC can enforce the law only against schools that fail to include the notice, not the lenders.
This is a problem that must be fixed, but in the meantime it should not be used as an excuse for doing nothing. Regardless of who is required to insert the notice, the lenders are still engaged in unfair and deceptive business practices when they partner with schools that fail to include it . If banks are routinely being referred loans by schools and the schools are not arranging for the banks to put the notice in the notes as they are required to do, then the banks are using notes that violate federal law and should be liable for unfair practices.
Banking regulators must act to fill in the jurisdictional and legal gaps. They can do this by enforcing the FTC holder rule. The trade commission, state attorney generals, state licensing and accreditation agencies must review loan documents provided to students by schools and sue schools that violate federal law by not including the holder notice. Meanwhile, government agencies supervising lenders must monitor school notes and sue lenders that violate federal law by contradicting or otherwise trying to evade the holder requirement.
Accomplishing all of that would be a tremendous first step, but it would not be enough. The FTC rule must also be amended so that lenders in addition to schools are obligated to include the notice. Other federal agencies must also adopt the FTC rule so that there is absolutely no doubt that loan providers outside of the FTC’s jurisdiction, including all national banks, can be held liable. There are various ways to make this happen. The Federal Reserve Board could adopt the rule by issuing regulations. Congress could also act by requiring these rules be put in place.
These unscrupulous arrangements between schools and lenders may have slowed down for now, but not because the creditors did the right thing and started vetting their business partners and not because the government finally said enough is enough. Instead, any current slowdown is simply because the money has stopped flowing, at least for now.
This is hardly a cause for celebration. Bailouts could potentially give these same creditors the funds to start ripping off students again. In the meantime, thousands of students have been harmed and left in the cold trying to figure out how to get out from under incapacitating debt for worthless educations.
Lenders that poured resources into ripping off students have spared no expense in trying to silence students who fight back. In the current environment where creditors are rewarded with bailouts for prior bad acts and where no one wants to take responsibility for the meltdown, taking action in this area is one small way to hold creditors liable for the damage they have done.
Deanne Loonin is a staff attorney with the National Consumer Law Center and the director of the center’s Student Loan Borrower Assistance Project. She focuses on consumer credit issues generally and more specifically on student loans, credit counseling, and credit discrimination. She is the principal author of numerous publications, including "Paying the Price: the High Cost of Private Student Loans and the Dangers for Student Borrowers." Her views are her own and do not necessarily reflect those of the New America Foundation.
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