Business: 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%.