How The Government Plans To ‘Claw Back’ Loan Money From Shady Colleges

Defraud a student borrower and you’ll be paying up. That’s the message the U.S. Department of Education sent earlier this week when it announced a plan to establish regulations that would “claw back” taxpayer dollars from colleges whose borrowers have their loans forgiven due to fraud. As Education Undersecretary Ted Mitchell told Inside Higher Ed, “We want institutions to know, in no uncertain terms, that they are responsible for the malfeasance that they create.”

The Department’s announcement is just the latest indication that federal policymakers believe greater institutional accountability for loans is one key part of tackling the rising student debt crisis. The head of the Senate committee that tackles education issues has expressed a strong desire to adopt some form of “risk-sharing” that would require colleges to pay back some of the federal funds they receive when students cannot afford their loans. Earlier this month, a bipartisan pair of senators introduced a bill to do just that.

Holding colleges accountable for their risk and their actions is long overdue. But making such a system work requires understanding where the problems actually come from; otherwise, any proposed solution is likely to result in another set of ineffective accountability measures.

Under current federal law, institutions are only held accountable for loans if 30 percent or more of recent borrowers default within three years of entering repayment. It’s an extremely low bar that is easy to avoid and does not even address important questions like whether borrowers are actually able to pay down their loans and start to reap the benefits of completing college. The result is that, for years, colleges have been given a largely free hand to load students up with unaffordable debt with minimal repercussions.

A risk-sharing or “claw back” system as proposed by the Senate and Department, respectively, would probably be effective at getting middling institutions to improve as a way of avoiding small financial penalties. But so-so student loan results are just one of the debt problems that higher education faces. We are also facing the unwinding of more than a decade of widespread questionable if not fraudulent behavior. And here retroactive schemes are simply insufficient.

Mainly, the problem with risk-sharing and dollar clawback schemes in the face of massive fraud is that by the time the institution is held accountable, it will also likely be broke and headed to bankruptcy. Demanding money from these institutions may help speed a bad school’s demise, but you can’t claw money back from a place that no longer has any.

The case of Corinthian Colleges—the very institution that prompted the Department’s desire for a new “claw back” requirement—showcases the need for and insufficiency of risk-sharing regulations. A publicly traded company that at its peak enrolled as many as 110,000 students, Corinthian declared bankruptcy in April following years of allegations of wrongdoing. The government is now in the process of forgiving loans held by borrowers at some Corinthian campuses with demonstrated evidence of fraud, a process that will potentially cost taxpayers millions of dollars. The company is the very reason the Department is looking to hold colleges more financially accountable for their actions.

Making Corinthian pay for its years of sins sounds great, but it’s impossible to wring money out of a company that’s already broke. When the Department agreed to help Corinthian avoid an immediate shutdown last summer, it required the college to set aside at least $30 million for student refunds in exchange for freeing up about $35 million in additional federal dollars. Not only does it look like Corinthian may never have set aside all the dollars it was supposed to, the company appears to have misspent the additional federal funds it received. And an attempt to secure an additional $30 million through a fine for misdeeds at some California schools pushed the company into bankruptcy a few weeks later.

Even if the Department had succeeded in getting all the money it sought, that sum would have been little more than a drop in the bucket compared with the $3.5 billion in federal dollars already spent on Corinthian over the past five years. For a place the size and scale of Corinthian, or other troubled national actors, retroactive punishment is insufficient. By the time they are caught, the money is long gone. Just look at how well such a strategy worked with big banks in the aftermath of the great recession.

At the biggest colleges, the answer cannot be retroactive risk-sharing, but front-end capital requirements, as others have argued. Requiring large universities to provide bonds or letters of credit based on their size ensures that enough money will always be there if things go bad. It also should discourage bad behavior like growth at all costs since the company will have to show it has the money to reach the scale it desires.

But this alone is not enough; we cannot ignore that state choices are also part of the debt problem. For years, states have pulled public dollars out of higher education systems, driving up prices that are increasingly being paid down with debt. Not only is the result greater debt loads for graduates to manage, but it increases the risk of going to college for vulnerable students who have lower odds of finishing. Research shows that dropouts with student debt make up over 60 percent of all loan defaulters; continued price increases will likely make the situation worse. Institutions must be held accountable for their results, but states must also be compelled to support colleges.

The increasing reliance on student loans adds a lot more risk in America’s higher education system. We’re long overdue for making more than just students share in those costs. It will only work if we recognize everyone’s responsibility in the system and hold them accountable while there’s still time to prevent catastrophes.

Lead photo: Jeramey Jannene on Flickr

Ben Miller is the Senior Director for Postsecondary Education at the Center for American Progress.