SCOTUS Weighs In On Student Loans

The Supreme Court has until June to determine the fate of President Joe Biden’s student loan forgiveness plan, with hundreds of billions of dollars at stake.

The US Supreme Court will determine whether Biden’s student loan relief plan exceeds the authority of the federal government. There is no precedent in recent history for the sweeping federal student loan forgiveness policy Biden is trying to carry out. With a conservative majority in the highest court in the country, it may be considered unconstitutional.

Biden promised as presidential candidate in 2020 that he would cancel up to $10,000 of federal student loan debt per borrower. After winning the election, the Biden administration announced its intent to forgive, via executive action, $10,000 in student loans for borrowers with an annual income of less than $125,000, and forgives up to $20,000 in loans for students who attended college with Pell grants.

To push the policy through, Biden deployed the Higher Education Relief Opportunities for Students Act.

National Emergency

The act gives Secretary of Education Miguel Cardona the discretion to waive or modify any regulation to student financial assistance programs “as deemed necessary” as long as the changes occur under specific criteria listed in the law. This includes a person who “resides or is employed in an area that is declared a disaster area by any Federal State or local official in connection with a national emergency.”

“Is this a national emergency?,” Douglas Harris, a nonresident Senior Fellow in the Brown Center on Education Policy at Brookings, wrote on September 20. “And is the policy narrowly tailored to address it? It wasn’t hard to use this law to justify a pause on loan payments during the pandemic, but that emergency has largely passed.”

SCOTUS has already heard two separate oral challenges on February 28 about the scope of Biden’s HEROES Act in Biden vs. Nebraska and Department of Education vs. Brown.

The justices will rule on the authoritative scope of the Department of Education and evaluate whether states challenging the relief plan have the legal right to file a lawsuit.

The case DOE v. Brown, which involves two student-loan borrowers who did not qualify for maximum forgiveness, questions whether Cardona possesses the legal authority to enact the program. The other case which saw oral arguments, Biden v. Nebraska, is a challenge by six Republican-led states, including Arkansas, Iowa, Kansas, Missouri, Nebraska and South Carolina.

The challenge debates whether the relief plan exceeds the Secretary of Education’s statutory authority and if six states have the right to sue over potential financial harm towards the Higher Education Loan Authority of the State of Missouri.

The Supreme Court “appeared skeptical of the Biden administration’s student-loan debt-relief program,”

Amy Howe, Independent Contractor and Reporter, wrote on the SCOTUS Blog website. “During nearly three and a half hours of oral arguments, a majority of the justices appeared unconvinced that Congress intended to give the secretary of education the power to adopt the program, which has an estimated price tag of $400 billion.”

The Justices

Given the conservative majority in the Supreme Court, 6-3, the Biden’s administration’s loan forgiveness act may not be passed. It was clear from the hearings on February 28 that the conservatives justices had reservations about it.

“On the legal front, there is a question of constitutionality,” Harris wrote. “While I’m not a lawyer, it doesn’t take an expert to realize that the current Supreme Court is on guard against anything that hints at executive overreach.”

Justice Clarence Thomas questioned in the Biden v. Nebraska hearing on February 28 the proper label for the Biden administration’s actions. “In effect,” Thomas said, “this is a grant of $400 billion, and it runs headlong into” the Constitution’s requirement that only Congress can appropriate money.

Chief Justice John Roberts was also skeptical that the loan-forgiveness program was a mere “modification” of existing student-loan loans. “We’re talking about half a trillion dollars and 43 million Americans,” Roberts observed. “How does that fit under the normal understanding of ‘modifying’?”

What's At Stake?

If every eligible borrower applies for the relief, Biden’s student loan forgiveness plan is estimated to wipe out $400 billion in federal student debt, according to the Congressional Budget Office. That would reduce the country’s $1.7 trillion outstanding education debt balance to $1.3 trillion.

Roughly a third of those with federal student loans, or 14 million people, would have their balances entirely forgiven by the president’s program, according to an estimate by higher education expert Mark Kantrowitz.

Biden’s relief is limited to borrowers who make under $125,000 a year as individuals or less than $250,000 as a couple. That means around 37 million people would be eligible for loan cancellation, CNBC reported, citing Kantrowitz.

One prominent investor has already warned about the consequences, and constitutionality, of the administration’s loan forgiveness plan.

Scion Capital chief, Michael Burry, said there will be "terrible consequences" if student debt is canceled. A bailout would lead to higher college tuition and only compound the problem further, the fund manager of "Big Short" fame warned.

"Bailing generations out of those bad choices will mean more bad choices, tuition hikes, and terrible consequences for America," Burry tweeted. “When I left residency at Stanford to gamble my future on what was to become, I had well into six figures of educational debt. I was damned sure I was going to pay it off."

Student Loan Backed Securities

Student Loan Asset Backed Securities, or SLABS for short, comprise nearly 100% of the private student debt market. When private student loans are issued, they are often sold to and securitized by Sallie Mae and resold on the fixed income markets for a profit. Like Mortgage Backed Securities, SLABS rely on borrower repayments to satisfy investor claims at a predetermined interest rate, based on borrowing size and risk.

Today, Sallie Mae is the largest lender and servicer of student loans in the United States, though many other lenders are also important participants.

Like RMBS, SLABS are securities backed by income streams generated by loans to individuals. RMBS are generated from collateralized mortgages, while SLABS are based on non-collateralized (but sometimes government-guaranteed) student loan debt. Ironically, the rise of SLABS has not only coincided with a relative decline in RMBS, but might have played a role.

Though most student loans are federally-guaranteed, about $118.7 billion are non-guaranteed private loans. Some analysts have been bullish on SLABS, viewing private lender asset-backed securities as a good investment because private loans are generally perceived to be of higher quality, at least as compared to government-backed student loans, which focus not only on creditworthiness, but also on need.

Meanwhile, with incomes stagnating and tuition soaring, defaults are on the rise. Among all household debt, student debt has the highest 90-plus day delinquency rate. Some projections suggest that 40% of all borrowers are expected to miss payments by 2023. Students often do not realize that private loans tend to be more expensive, and can be more stringent with respect to missed payments. Private student debt is also more difficult to discharge in bankruptcy.

Given the popularity of SLABS among financial institutions, another worry is the potential impact of student loan write offs on this market. If hundreds of billions of dollars of student loans were suddenly written off, the impact to bank balance sheets, and consequently Tier 1 Capital Ratios would be felt in shockwaves throughout the US economy.

Now, SCOTUS must balance the potential threat of mass defaults against the potential for massive financial losses among the financial institutions which provide liquidity to securitized student loans as SLABS.