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Very Disturbing UPDATE: Student Loan Bubble and Seeking Arrangements

Posted by Larry Doyle on August 4, 2011 7:11 AM |

I have a soft spot for those within our society whom I believe are preyed upon and ultimately victimized by the perils and pitfalls of modern day finance.

I fully appreciate that people need to be held responsible for their personal behaviors and decisions, but we need to acknowledge that the tangled financial web that our nation has woven has placed many members of our society in untenable positions.

The story I address today is perhaps one of the saddest I have encountered since launching Sense on Cents in early 2009.  Sophisticated investors get little sympathy here and elsewhere when they lose money from taking excessive risks. What about the unsophisticated within our society, though?

Our elderly, our poor, our youth, our students? Are we doing enough to protect these “unsophisticated”? I think not.

Specifically in regard to college and university students, I have highlighted twice the enormous and excessive debts run up by so many as they pursued their degrees. I wrote over the last few months:

1. Are Student Loans a Bubble? Is Higher Education a Scam?; April 26, 2011

2. Are Student Loans a Bubble? Is Higher Education a Scam? Part II; June 22, 2011

I wrote in my initial piece on this topic,

Have we learned our lessons from the sub-prime housing nightmare? Could we possibly be going down the same path in another segment of our economy? Yesterday a reader inquired if I had addressed the potential impending fiasco in student loans.

This morning I discussed the cost of higher education with my better half. Will our economy be able to generate both the jobs and income levels for students to manage their increasing levels of indebtedness?

I am a huge proponent of the need for quality education in our nation. That said, as this expose reveals there are MANY serious problems, conflicts of interest, and assorted other issues in higher education today. A racket, you might ask?

Yes, in a manner of speaking, there are certainly elements of a racket within higher education today. Let’s navigate.

Well, for those involved in the higher education field, the student loan industry, and for every citizen of our nation, let me further highlight the levels to which some students in our nation feel compelled to go in order to pay their student loans.

As the Huffington Post recently exposed, Seeking Arrangement: College Students Using ‘Sugar Daddies’ To Pay Off Student Loan Debt,

On a Sunday morning in late May, Taylor left her Harlem apartment and boarded a train for Greenwich, Conn. She planned on spending the day with a man she had met online, but not in person. Taylor, a 22-year-old student at Hunter College, had confided in her roommate about the trip and they agreed to swap text messages during the day to make sure she was safe. Once in Greenwich, a man who appeared significantly older than his advertised age of 42 greeted Taylor at the train station and then drove her to the largest house she had ever seen.

He changed into his swimming trunks, she put on a skimpy bathing suit, and then, by the side of his pool, she rubbed sunscreen into the folds of his sagging back — bracing herself to endure an afternoon of sex with someone she suspected was actually about 30 years her senior.

Taylor doubted that her client could relate to someone who had grown up black and poor in the South Bronx. While he summered on Martha’s Vineyard, she’d likely pass another July and August working retail in Times Square.

A love match it wasn’t.

But then again, this was no ordinary date. A month prior, faced with about $15,000 in unpaid tuition and overdue bills, Taylor and her roommate typed “tuition,” “debt,” and “money for school” into Google.

A website called SeekingArrangement.com popped up. Intrigued by the promise of what the site billed as a “college tuition sugar daddy,” Taylor created a “sugar baby” profile and eventually connected with the man from Greenwich. (“Taylor” is the pseudonym she uses with men she meets online. Neither she nor any of the other women interviewed for this article permitted their real names be used.)

In her profile on the site, Taylor describes herself as “a full-time college student studying psychology and looking to meet someone to help pay the bills.”

Some within our society may view this activity as a natural outgrowth of our current economic condition. That would be unfortunate.

I am not here to get involved in personal judgments of the students involved. I am here to bring attention to this reality and hope it will cause those within the fields of higher education and student lending to question, “what the hell are we doing?”

If young women prostituting themselves is not a SCREAMING INDICATION and MAJOR RED FLAG that our nation has sunk to an entirely new depth in terms of our financial turmoil, I do not know what is.

As for the SCUMBAGS who prey upon these women, I recommend you find a local community college, make a donation to their financial aid fund in the same amount you’d spend on these activities, and then go for a long run.

I hope people will want to spread this story and bring some transparency to the unseemly side and impact of the student loan bubble.

Questions, comments, constructive criticisms always encouraged and appreciated.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.

  • DM: RECOMMENDED

    Larry,

    Your comments on the impending student loan debacle got my attention. The debt incurred by students who never graduate is another angle on this story.

    I worked at a small, private 4-year Christian college for several years. I was often troubled by our recruiting practices. We advertised a quality education for under-prepared students who would benefit from our emphasis on tutoring and low faculty-to-student ratios.

    A large part of our entering classes were kids who were completely unprepared for college, and who didn’t really want to be in school, but who also didn’t want to quit playing sports (especially football).

    They flunked out after one or two semesters and had huge debt (my guess is > $15,000 or more).

    I questioned the Christian ethics of that practice.

    According to the chart in the following link, just over half (55.5%) of the students nationwide who enter college graduate within six years.

    If I remember correctly, that number at the college where I worked was less than 1-in-4. My hunch is that nationwide, the students who do not graduate are saddled with huge debt and no degree.

    That will make it even harder to land the job they will
    need to pay the debt off.

    Higher Education Graduation Rates

    Thanks for the great work you do!!

  • Nora

    OMG, Larry, this story made me cry and I usually don’t cry that easily. How sad it is for our youth, and how ugly of a situation for this country’s educational system. I don’t know much about students loans, but I know people who were loaning money to students and who sold those loan on Wall Street very much in the same manner as the mortgage securitization process; in other words FRAUD!

    Those people have made so much money of that process that I was amazed and shocked. I know Larry that you are very familiar with that concept, may be you can explain it to me. I am sure that you have written about this in earlier blogs and I did not get a chance to read them.

    I just want to know how on earth can anyone make Millions Dollars of student loans. Once they were dirt poor, now they live in luxury, they have a private plane large house in La Jolla, CA, and one in Phoenix AZ, just by operating a student loan office?

    So many unscrupulous people have caught this money fever thing, they have grown so hard and careless, not to mention conscious-less. How can they sleep the nights knowing in their heart that they screwed some student who will have to work his/her tail off for years to pay that debt. Not only that but they are responsible for prostituting these young student.

    But the other side to this story is even more heartbreaking, to have to go to the length of prostitution in order to pay for schooling is just insane. It’s not even the age difference so much that matters it’s the idea that gets me in the guts. There are less affluent countries and even less developed countries that pay for higher education through government programs.

    Shame on us, and I don’t just mean us personally, our system, our government and the society as a whole! Our youth are the future generations of bankers, politicians, ceos, and teachers and are getting just the kind of education that will not help us improve if we don’t make changes. Imagine those young girls and boys going through these horrific learning processes of lessons totally unnecessary, and totally unfair.

    Yes this has to be brought to the attention of everyone, because this needs to stop. Once again Larry, you bring the stories that need to be told to our attention, I thank you and everyone is grateful for having you and people like you who do have that soft spot in their hearts for those who are less privileged and most definitely needing our attention.

    • LD

      Nora,

      I always appreciate your messages. Back in November 2008 prior to my launching Sense on Cents in January 2009, I wrote a lengthy blog post about the Wall Street securitization business, that is the Wall Street model, at No Quarter.

      The post entitled, The Wall Street Model Is Broken….and Won’t Soon Be Fixed!! explains the origination, bundling, securitization, distribution, and growth of Wall Street’s enterprise initiating in residential mortgages and then branching out into a wide array of other types of loans.

      I wrote,

      Posted by Larry Doyle on November 12, 2008 12:15 PM

      Despite billions and now trillions of dollars in capital injections and equity investments made by our government, private equity, and sovereign wealth funds, our economic turmoil is a long way from being over. I do find it interesting that despite numerous Wall Street titans having indicated to us at different points over the last year that we were in the 7th inning of this fiasco, now a recurring theme is that we should not expect any real economic recovery until 2010. Actually, maybe we were in the 7th inning but it was the 7th inning of the first game of a 4 game series.

      Well, if we want to figure out where and when we are moving forward, I think it would be beneficial to know from where and when we came.

      For those over 50 years of age, perhaps you remember when mortgage money dried up. Perhaps you also recall the days of putting down 20% before you even thought of buying a home. In any event, the growth of the secondary mortgage market in the mid 1980s was a result of some very sharp financial minds on Wall St. who engineered a product called a Collateralized Mortgage Obligation (CMO).

      CMOS, and their cousins that grew from that model, were and are not necessarily bad structures. However, much like prescription drugs, if and when they are abused, they can be deadly.

      CMOs used the stream of cash flows from a standard fixed rate mortgage to create specific bonds which met the investment desires of a wide array of investors, including money market funds, bank portfolios, insurance companies, money managers, and pension funds. Prior to the development of the CMO, mortgages were an investment that typically only met the needs of bank portfolios.

      As the CMO market grew, two developments occurred. First and foremost, Wall St. firms (which were making on average 1 point on each deal . . . on an average deal size of 300 million, the Wall St. underwriter made $3 million dollars . . . not too shabby) had an appetite for more and more mortgage collateral to do more and more deals.

      In the mid-1980s, most CMO deals were done with private homebuilders such as Pulte Homes, Centex, Ryland et al. The second development was more substantial. If Wall St. could use mortgage collateral to execute CMOs, why couldn’t they use other forms of loans/assets to create similar sorts of structured products? Thus, in the late 1980s, the Asset Backed Securities market was launched using credit card loans, auto loans, computer leases, equipment leases, and the like. Again, all Wall St. was doing was using the stream of cash flows from these well underwritten loans to create securities that met the guidelines and needs of a wide array of investors. Prior to the developments of these markets, the banks underwrote these loans at rates and terms that met their own portfolio needs (REMEMBER THIS POINT!!).

      In the late ’80s, Freddie Mac and Fannie Mae got a whiff of the profitability of these CMO deals and used their significant lobbying power to get legislation passed that made it advantageous from a tax standpoint for CMOs to be launched through them. While some Wall St. firms were reluctant to support Freddie and Fannie in this process, given F/F ‘s position in the business they won out. (REMEMBER THIS POINT!!)

      As the CMO and ABS engines grew ever stronger throughout the early to mid 90s, Wall St. needed to find more and more collateral to continue to feed this profit monster. Some Wall St. firms either purchased or made strategic alliances with originators (Lehman Bros bought Aurora Mortgage in Aurora, Colorado . . . Bear Stearns owned EMC Mortgage in Texas . . . Merrill Lynch purchased First Franklin, a sub-prime originator, from National City Bank), while other originators formed their own broker dealers to retain the profits of distributing these products (Countrywide Mortgage formed Countrywide Securities, JPM Chase grew its own investment banking presence in the late ’90s, as did Bank of America).

      In the midst of this growth, Wall St. continued to use this CMO model not only across other consumer asset classes but then branched out and used it with corporate loans as well. Thus Wall St. structured CLOs (collateralized loan obligations) using the same financial engineering.

      While there were hiccups with different deals, for the most part the machine ran smoothly. The machine, though, was built on the premise of strict underwriting of the underlying loans and a robust ratings process.

      At the turn of the century, however, there were two critically important developments that occurred to truly escalate the disastrous situation we have currently. A number of individuals from Wall St. realized that they could form their own firms (hedge funds) which allowed them a greater share of the profits from this structured financial engineering with less internal or external oversight. (REMEMBER THIS POINT!!)

      A large number of qualified analysts from the rating agencies left those firms to come to Wall St. to participate in the profit machine. This shift of talent both to hedge funds and from ratings agencies dramatically exacerbated and accelerated the financial meltdown of the last two years. (***Given the amount of money in these hedge funds, as well as the amount “earned” by the hedge fund managers, it should be no surprise that they became very influential in currying political favor . . . especially with Barack this go round!!)

      At the turn of the century, the Wall Street model was a pure “originate to distribute” model with little to no residual risk on behalf of the originators or underwriters. When there is no residual risk, those who “WIN” are the players that can purely process the most volume. Well, how does one get volume? Lower the credit standards, put fewer restrictions on borrowers, little to no covenants (NINA Loans: no income, no asset check). WOW!!! What were we thinking?? Well, Wall St. felt, “let’s worry about it tomorrow or maybe not at all because we are making too much money today.”

      I hope this makes some semblance of ‘sense‘.

      Nora, in my opinion, the model was a great one. It worked. For a number of years consumers did truly benefit. However, Wall Street abused the model and the regulators and pols were not smart enough nor seemingly interested enough in slowing the abuse …so the rest is history, including this story about college girls now prostituting themselves.

      Sad, very sad.

  • Nora

    Larry,

    Thank you for explaining this process for me, I truly appreciate it and I appreciate that you always respond to my questions.

    It makes sense to me how the model began and good for those who have the smarts to come up with a plan that worked well and made a profit, it’s what made America head above the rest. I am all for good business sense, smart innovative ideas, etc. so long as it’s not based on greed and corruption; and that’s what happened within that process.

    It’s true everything you said, I just did not realize how wide spread things were. Back in the Early 1990′s my ex-husband and I worked for Pulte Homes, then with Centex, now he’s back with PH, when they purchased CTX. I never realized that our mortgages was securitized back then, but as I go through the paperwork I see that they were, and by CTX at first.

    It was so easy to fall a victim to this type of crime, although, I understand that it did not start out being a crime, but it ended up that way. And not everyone was truly a victim, during the sub-prime loan madness, but there are many who were.

    What’s really sad is that the government participated with and allowed the scheme to continue until it literally BROKE THE BANK! May be this was all meant to be, perhaps things needed to get to that point in order to turn around. And for all our sakes I pray that the game will end with score for the good team.

    Thanks again Larry, and thank you for being one of the good guys,
    god Bless.






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