Back in 2006, contrary to conventional wisdom, many financial professionals were well aware of the subprime bubble, and that the trajectory of home prices was unsustainable. However, because there was no way to know just when it would pop, few if any dared to bet against the herd (those who did, and did so early despite all odds, made greater than 100-1 returns). Fast forward to today, when the most comparable to subprime, cheap credit-induced bubble, is that of student loans (for extended literature on why the non-dischargeable student loan bubble will “create a generation of wage slavery” read this and much of the easily accessible literature on the topic elsewhere) which have now surpassed $1 trillion in notional. Yet oddly enough, just like in the case of the subprime bubble, so in the ongoing expansion of the credit bubble manifested in this case by student loans, we have an early warning that the party is almost over, coming from the most unexpected of sources:JPMorgan.
Recall that in October 2006, 5 months before New Century started the March 2007 collapsing dominoes that ultimately translated to the bursting of both the housing and credit bubbles several short months later, culminating with the failure of Bear, Lehman, AIG, The Reserve Fund, and the near end of capitalism ‘we know it’, it was JPMorgan who sounded a red alert, and proceeded to pull entirely out of the Subprime space. From Fortune, two weeks before the Lehman failure: “It was the second week of October 2006. William King, then J.P. Morgan’s chief of securitized products, was vacationing in Rwanda. One evening CEO Jamie Dimon tracked him down to fire a red alert. “Billy, I really want you to watch out for subprime!” Dimon’s voice crackled over King’s hotel phone. “We need to sell a lot of our positions. I’ve seen it before. This stuff could go up in smoke!” Dimon was right (as was Goldman, but that’s another story), while most of his competitors piled on into this latest ponzi scheme of epic greed, whose only resolution would be a wholesale taxpayer bailout. We all know how that chapter ended (or hasn’t – after all everyone is stilldemanding another $1 trillion from the Fed at least to get their S&P limit up fix, and then another, and another). And now, over 5 years later, history repeats itself: JPM is officially getting out of student loans. If history serves, what happens next will not be pretty.
American Banker brings us the full story:
U.S. Bancorp (USB) is pulling out of the private student loans market and JPMorgan Chase (JPM) is sharply reducing its lending, as banking regulators step up their scrutiny of the products.
JPMorgan Chase will limit student lending to existing customers starting in July, a bank spokesman told American Banker on Friday. The bank laid off 24 employees who make sales calls to colleges as part of its decision.
The official reason:
“The private student loan market is continuing to decline, so we decided to focus on Chase customers,” spokesman Thomas Kelly says.
Ah yes, focusing on customers, and providing liquidity no doubt, courtesy of Blythe Masters. Joking aside, what JPMorgan is explicitly telling us is that it can’t make money lending out to the one group of the population where demand for credit money is virtually infinite (after all 46% of America’s 16-24 year olds are out of a job: what else are they going to?), and furthermore, with debt being non-dischargable, this is about as safe a carry trade as any, even when faced with the prospect of bankruptcy. What JPM is implicitly saying, is that the party is over, and all private sector originators are hunkering down, in anticipation of the hammer falling. Or if they aren’t, they should be.
JPM is not alone:
Minneapolis-based U.S. Bank sent a letter to participating colleges and universities saying that it would no longer be accepting student loan applications as of March 29, a spokesman told American Banker on Friday.
“We are in fact exiting the private student lending business,” U.S. Bank spokesman Thomas Joyce said, adding that the bank’s business was too small to be worthwhile.
“The reasoning is we’re a very small player, less than 1.5% of market share,” Joyce adds. “It’s a very small business for the bank, and we’ve decided to make a strategic shift and move resources.”
Which, however, is not to say that there will be no source of student loans. On Friday alone we found out that in February the US government added another $11 billion in student debt to the Federal tally, a run-rate which is now well over $10 billion a month an accelerating: a rate of change which is almost as great as the increase in Apple market cap. So who will be left picking up the pieces? Why the Consumer Financial Protection Bureau, funded by none other than Ben Bernanke, and headed by the same Richard Cordray that Obama shoved into his spot over Republican protests, when taking advantage of a recessed Congress.
“What we are likely to see over the next few months is a lot of private education lenders rethinking the product, particularly if it appears that the CFPB is going to become more activist,” says Kevin Petrasic, a partner with law firm Paul Hastings.
“Historically there’s been a patchwork of regulation towards private student lenders,” he adds. “The CFPB allows for a more uniform and consistent approach and identification of the issues. It also provides a network, effectively a data-gathering base that is going to enable the agency to get all the stories that are out there.”
The CFPB recently began accepting student loan complaints on its website.
“I think there’s going to be a lot of emphasis and focus … in terms of what is deemed to be fair and what is over the line with collections and marketing,” Petrasic says, warning that “the challenge for the CFPB in this area is going to be trying to figure out how to set consumer protection standards without essentially eviscerating availability of the product.”
And with all private players stepping out very actively, it only leaves the government, with itsextensive system of ‘checks and balances’, to hand out loans to America’s ever more destitute students, with the reckless abandon of a Wells Fargo NINJA-specialized loan officer in 2005. What will be hilarious in 2014, when taxpayers are fuming at the latest multi-trillion bailout, now that we know that $270 billion in student loans are at least 30 days delinquent which can only have one very sad ending, is that the government will have no evil banker scapegoats to blame loose lending standards on. And why would they: after all it is this administration’s sworn Keynesian duty to make every student a debt slave in perpetuity, but only after they buy a lifetime supply of iPads. Then again by 2014 we will have far greater problems (and for most in the administration, it will be “someone else’s problem”).
For now, our advice – just do what Jamie Dimon is doing: duck and hide for cover.
Oh, and if there is a cheap student loan synthetic short out there, which has the same upside potential as the ABX did in late 2006, please advise.
Under the Bankruptcy Code passed in 1978 (along with the 1979 and 1984 modifications), student loans were made nondischargeable for at first only five years, and then seven years. After that waiting period, student loans were only excepted from discharge in Chapter Seven proceedings, not Chapter Thirteen cases. That would be Carter (and Reagan for the second mod).
In Chapter Thirteen actions, debtors were required to pay only a fraction of the principal – as little as one percent of their loans in some Chapter Thirteen cases. Such rare but glaring cases brought politicization, with calls to “stop the rampant abuse.”
Congress amended the Bankruptcy Code again 1998. That would be Clinton. In this amendment, the provision limiting nondischargeability to the first seven years after a student loan becomes due was completely wiped out. Since 1998, federal student loans can only be discharged in bankruptcy if the debtor can show that repayment of the student loans would constitute an “undue hardship” on the
debtor and his dependents.
In a further amendment in 2005, private student loans were swept into the same nondischargeable regime as federal loans. This was under Bush.
When the bubble starts a poppin’, I expect a Constitutional challenge to be mounted, under the theory that nondischargeable student loans violate the 13th amendment.
Judge for yourself:
Section 1. Neither slavery nor involuntary servitude, except as a punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction.
Involuntary servitude refers to a person held by actual force, threats of force, or threats of legal coercion in a condition of slavery – compulsory service or labor against his or her will. This also includes the condition in which people are compelled to work against their will by a “climate of fear” evoked by the use of force, the threat of force, or the threat of legal coercion (i.e., suffer legal consequences unless compliant with demands made upon them) which is sufficient to compel service against a person’s will.
When the government is scaring people by garnishing their Social Security and Disability checks for something they did forty or fifty years earlier, I’d say the Constitutional standard is being met. (Yes, this is already happening.)
Student Loan Bankruptcy Exception
The US Bankruptcy Code at 11 USC 523(a)(8) provides an exception to bankruptcy discharge for education loans. This page provides a history of the legislative language in this section of the US Bankruptcy Code.
Student loans were dischargeable in bankruptcy prior to 1976. With the introduction of the US Bankruptcy Code (11 USC 101 et seq) in 1978, the ability to discharge education loans was limited. Subsequent changes in the law have further narrowed the dischargeability of education debt.
The exception to discharge for private student loans evolved over time. Prior to 1984, only private student loans made by a “nonprofit institution of higher education” were excepted from discharge. This was intended to protect the National Defense Student Loan Program (NDSL), the predecessor to the Perkins Loan Program. Those loans were made by colleges using a revolving loan fund created using matching federal contributions. The Bankruptcy Amendments and Federal Judgeship Act of 1984 made private student loans from all nonprofit lenders excepted from discharge, not just colleges, by striking the words “of higher education”. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 expanded this to include all “qualified education loans”, regardless of whether a nonprofit institution was involved in making the loans.