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The Student Loan Warranty

Updated on January 25, 2012
Source

Getting What You Bargained For

There's something happening here

What it is ain't exactly clear

There's a man with a gun over there Telling me I got to beware

I think it's time we stop, children, what's that sound Everybody look what's going down

Buffalo Springfield "For What It's Worth" 1967


Occupy Walls Street's spin-off, Occupy Student Loans/Debt has started.

The winter has lead to a respite from the crowds of protesters in most cities. Whether the movement reaches the fever pitch of the late fall ever again is a mystery presently but what they are taking umbrage with will likely play heavily in the presidential campaign of 2012 and the issue is not ephemeral--it is here to stay for the foreseeable future.

The protesters making up this wing of the Occupy movement demand that student loans be forgiven. Why? It may not be as unreasonable as you might think; it goes back to getting what you paid for and what you were told you were buying for your hard earned presumed future cash.

STARTING POINT

Fist of all, let me be clear where I stand. As an attorney I represent my clients zealously. I have represented both debtors and creditors and I have done plenty of work for banks from closing to foreclosure to credit card debt collection to mechanics liens and judgment enforcement. Who I represent is the most important thing and vigorously representing their interest, achieving their priorities and getting them what they have a right to under the law is my goal. This post isn't about right and wrong so much as an attempt at diagnosis. There is clearly something that is driving people into the streets, we need to know what that is.

Just as the position of a particle can not be determined until it is observed, the act of analyzing OWS defines it at a point in time that may not be entirely representative of the realities on the ground. I do not speak for anyone and I accept that because of the diffuse and amorphous nature of the movement the act of observation in this essay will misrepresent where some people are coming from. This is not a top down movement and so it is different for each participant. This is an effort to distill the main themes in relation to the student loan industry. As an outsider looking in I am bound to see it through a different lens. Some might argue that the effort to define and understand is really just pigeon-holing. Well, sorry, what else can one do? All I can say is that I don't have an agenda and this simply a good faith effort.

This is not intended to be an exhaustive discussion of the subject matter nor it is intended for scholarly publication. Time, resources and access to raw data prevent that I am afraid.


OCCUPY WALL STREET: CONTEXT

Occupy Wall Street (OWS) has not sent their "leaders" to MSNBC and Fox to take up the pulpit and explain what is going on and why. In a sense, why should they? This is a social media driven movement with no clear hierarchical structure--they bypass the main stream media (MSM) and avoid being defined and dissected by cable news. To OWS it doesn't matter what the MSM says, the people who are involved and continue to join the movement are not getting their information there.

For those not in the movement it can be difficult to discern what it is really about if you are not tapped into the OWS social network. This essay is an objective analysis attempting to understand the underpinning forces and ideals of a movement.

At the core of the movement it would seem that there is the perception of a systematic breakdown and fundamental injustice in the social and economic structures in America. The "Left" and "Right" both perceive this threat, there just happens to be differing opinions on the cause. Demonizing the opposition with terms like "communists" or "fascists," respectively, is not constructive, but the propensity to do so by some speaks to the fact there is a significant conversation (even if it is not always civil) going on to what it means to live in the United States and what it means to be American. Just as there was social unrest during the industrial revolution we are looking at similar tectonic shifts in our society due to current trends and economic conditions and these forces are driving people into the streets around the world. These forces can not be dismissed by instructing people to "go get a job after you take a bath." We need to understand the pressures upon the American worker and what it is that is causing Americans, who are usually apolitical and, frankly, apathetic, to stand in front of police and get pepper sprayed or beaten into compliance with the orders of authority. We have not seen this type of behavior since the late 1960s. What side you or your parents took there may telegraph what side you take now I would wager. The divides that are exposed now have been present for a long time and resurface in times of struggle with different masks.

Lets face it, unemployment is at a high point in recent history and it is only slowly abating, if at all. Presently economists are not bullish on the economy and with debt crisis in Europe threatening to negatively affect us here in the States, the transformational effects of globalization on our economy and fundamental changes in technology, there are opportunities but also real pressures on the American economy and therefore the American worker. High employment works to the advantage of industry to a point by driving down wages and making employment a luxury, allowing for increased leverage in negotiations on working conditions resulting in higher productivity for lower wages. This works to a point--we are now a service and consumption economy having moved away from primarily a manufacturing economy--good wages are required to support good consumption. This requires a balance and the U.S. economy is out of balance currently.

Debt was used to drive consumption and that drove the economy of the1990's and 2000's. This framework has been upended and now we are struggling to deal with it. Debt is needed to allow for the liquidity of assets necessary to support the consumer economy as we know it. Think of all the computers and televisions bought with home equity mortgages, for example. That system was whacked out of equilibrium in a significant manner in the crisis of 2008 and will remain so for the foreseeable future. Without high liquidity in the corporate setting there isn't the capital to hire and an aversion to corporate risk taking. While credit markets for corporations have eased most corporations are sitting on a higher degree of cash and moving assets to what they consider safe havens. These factors, along with the ancillary costs of employment such as health care being quite high and the relative high cost of employing a U.S. worker in comparison to most other markets along with an increase in automation, an ability to squeeze more productivity out of fewer employees and the increasing use of unpaid interns as free labor has spelled disaster for the labor market.

STUDENT LOANS: NECESSARY ENCUMBRANCE ON FUTURE EARNINGS

When it comes to student loans these factors create a major disconnect. The student essentially takes out a mortgage with their economic life as collateral on a loan to obtain an education. It is a mortgage on your brain. The loan providers are betting that you will be able to get a job with that education and so is the student. What happens when the labor market is disrupted? You get what you have here--the inability to pay back the debt and a sense that the system is unjust.

Is the refrain "get a job you bum" really applicable here? I don't know many folks that really don't want to pay back their debts. No one wants to live in debt, everyone wants to get out of it and most want to have a job that pays enough to do so. Asking the government to bail them out is only a means of last resort because there are so few options in the employment market. To say otherwise would beg the question of why in times of prosperity is there not unrest on this scale in relation to the forgiveness of debt. There just isn't a history of civil unrest when there is money from high employment to pay the mortgage, and thus the thing driving people into the streets is desperation, not an unwillingness to pay. So, saying "go get a job" is true as an ideal solution to the problem but it is a gross oversimplification that is not useful for analyzing the motivations of protesters. In fact, this line of thought strikes me a poison rhetoric intentionally crafted to marginalize the movement and differentiate the audience from the protesters, thus allowing for disassociation from the movement's underling principles and creating a schism that divides people with similar economic interests along illusory lines. One of the primary means of combating a movement is to define it negatively in relation to your audience using stereotyping of your opponents by citing demographic differences and ascribing to it qualities that are opposite to the presumed virtues of your audience. This divide and conquer routine has been used consistently in this country throughout its history. One of the examples is the use of divisions along racial lines to suppress issues of class. Poor whites and poor Latinos and poor African-Americans have similar if not identical economic interests but as long as there is argument among them over skin color there is not a threat to the economic system, so some would posit. Class has always been the intentionally ignored elephant in the room in this country.

Why is class the real third rail of American politics? It is the most dangerous spark of social unrest. In America we have dealt with gross class inequality by accepting it as a necessary element of the unarguably greatest system for the improvement of the standard of living and creation of wealth ever devised: capitalism. Some might go so far as to accept economic inequality as a virtue of capitalism but for the most part we accept it as a necessary evil that is mitigated by this country's allowance for social mobility. The Horatio Alger, rags-to-riches story, coming out of a period of similar economic conditions, is a social necessity for our society to justify economic inequality and define that inequality as just. Combine economic class mobility with democratic involvement in a representative government and you get a relatively stable society of satisfied citizens. Socially, what we are dealing with presently is a sense, real or imagined, that the Horatio Alger story is a myth, if not an outright lie, meant to keep "the People" foolishly placated. There is a feeling that with corporate power in the economy and corporate money and influence in politics that we are in reality an oligarchy with the intent of subjugating the populace into producing money more for their masters. If one watches Mike Judge's 1999 film Office Space one can get the sense of the beginnings of the American workers dissatisfaction with being a cog in the corporate machine. Sure, working in a cubicle is much better than working in a mine or a 1890s bakery for 16 hours straight six days a week but the existential dissatisfaction with labor is a relative thing and defined by each generation within the context of that era's working conditions. And why not? Our society prides itself on progress, individual fulfillment and the pursuit of happiness which begs the question why should one accept a soul devouring job as a cog in a vast machine that treats its workers as machines? Formerly, this could be justified by discretionary income and leisure, not so much anymore. This all amounts to a crisis of faith in the American Dream. Whether one identifies with the Tea Party or OWS isn't that what all this unrest is about?

So there is the perceived landscape: dismal employment rates, the end of easy credit to drive the market, highly leveraged individuals, economic collapse of the middle class, vast disparities in income, the loss of homes to foreclosure, dissatisfaction with employment that is available, a loss of economic and political power, the specter of an oppressive leviathan in the form of government or corporations and at the root, a crisis of faith in the American Dream and a sense of enslavement. That is quite a plate to deal with.

MULTI-SECTOR COLLAPSE OF EARNING POWER

It is important to note that the economic difficulties have reached beyond traditional employment loss leaders of the past such as manufacturing. The middle class has been defined, among other things, as the group of people that has 1/3rd of their income as discretionary spending. By that measure and based on the number of people living paycheck to paycheck in the U.S. today one has to wonder if without easy credit to supplement income there are many left in this group (credit should not be an" income supplement" but lets face it is has been used that way). The middle class was formerly populated with the likes of steel and auto workers earning a decent living. At $16/hr there is a yearly wage of about $33,000 before taxes, pension deductions and health insurance. If that is a families sole income you can see how quickly that income gets swallowed up. In the past families could have a sole breadwinner and be considered middle class. That era is long gone; there really needs to be dual incomes today. The two income family is the status quo, more families are working multiple jobs and work hours are increasing and yet the middle class is still shrinking.

(Please note, the "declining middle class" is an area of heated debate as it is a fairly politicized concept. Consensus is apparently that there is real pressure on the middle class but causes are in dispute. See links below.)

Manufacturing as a principle economic driver has been replaced with white collar clerical and professional workers in a consumer/service economy based on debt. While the wages for this class of work are presumably higher, the costs in terms of education are also higher. This amounts to an offset during the first decade or two of a workers employment and is a required aspect of obtaining a job with equal buying power from two generations ago. (This, even though inflation is relatively low.) It is a common belief that everyone should go to college today. A college degree is the new high school diploma. To get into the job market with incomes formerly equivalent to blue collar work available with a high school diploma one needs a college degree. We as a society decided long ago that education is a right and should be subsidized through grade 12 by public schools and decided that anything beyond that is on the back of the individual. Those decisions were made when a college degree was a luxury and an elite item. Things have changed. Students today are essentially mandated to accept debt to enter the job market. This means that one spends the first two decades of employment working for the bank regardless of who writes the paycheck. We can see who wins there.

THE STUDENT LOAN AS ENTRY FEE

As can be seen, the need for a college education is paramount to success in the job market. It has been presumed for some time now that while blue collar jobs are no longer an optimal employment option nor as readily available, that a college degree will get you to the middle class, make you marketable to employers and that there will be white collar jobs available. Yet, even white collar employment is under significant pressure and provides diminishing returns currently.

The situation is some fields is so dire that that new and novel solutions are being proposed. For example: Should law schools pay their students to quit?

There seems to be a clear trend towards even more school presently. The masters degree is fast becoming the new bachelor's degree just as the bachelor's degree became the new high school diploma. The PhD, M.D. and J.D. are still considered optional but if one wants to presumably move from middle class to upper middle class or above it is somewhat of a prerequisite in many fields and there is a trend towards demanding this level of education to receive the benefits of "lower" degrees even here. How does one get such an education? One goes to school, of course, and unlike high school that schooling costs money and lots of it. This money usually comes from future earnings in the form of student loans.

STUDENT LOANS: WHAT DO YOU GET FOR YOUR MONEY?

So what do you get for $100,000 in student loans? If you think that the government is unbiased and isn't trying to sell you an education then you can take hope in this: the good news is that life time earnings do go up with an education:

http://www.census.gov/prod/2002pubs/p23-210.pdf

However, this doesn't mean that everyone receives the optimum benefit, obviously. Given the disparity of incomes among the most affluent and the "I am doing okay" in the upper middle class (meaning I am living paycheck to paycheck but have 5% equity in a $180,000.00 house perhaps) I question if that 4.4 million over a lifetime a professional degree gets you is really accurate or whether a group (say 1% of the sample) is dramatically throwing that figure off. Despite this, there is clear evidence that an education pays. Does it offset the cost? In the long run, yes, and provided the job market is humming along.

Now for some specifics: everyone knows that lawyers are rich right? Well, I am sorry to say, that is not true in the least. There are significant economic problems in the legal community, especially regarding getting your value out of your education. I know that most people will shed few tears for the lawyers but this industry is illustrative of pressures in once "safe" employment fields. The American Bar Association recently was presented with this paper on the cost effectiveness of Law School:

The Value Proposition of Attending Law School

ABA Commission on the impact of the Economic Crises on the Profession and Legal Needs

[Excerpt]

The combination of the rising cost of a legal education and the realities of the legal job market mean that going to law school may not pay off for a large number of law students. Dean David Van Zandt of Northwestern Law School estimates that to make a positive return on the investment of going to law school, given the current costs, the average law student must earn an average annual salary of at least $65,315.[1] As the data above show, however, over 40% of law school graduates have starting salaries below this threshold. Thus, many students start out in a position from which it may be difficult to recoup their investment in legal education. Even students who do ultimately prosper over the course of a career face difficulties from high debt loads during the beginning of their career. High debt can limit career choices, prevent employment in the public service sector, or delay home ownership or marriage.[2] In short, going to law school can bring more financial difficulty than many law students expect.

[1] Dean Van Zandt’s estimate is based on the assumption that students would make $60,000 per year without going to law school, that law school tuition is $30,000 per year, that the student works for thirty years as a lawyer, and that the discount rate is 5%. His estimate does not take into account the opportunity cost of three years of foregone income, nor does he consider the cost of debt service on law school loans.

[2] See The ABA Commission on Loan Repayment and Forgiveness, Lifting the Burden: Law Student Debt as a Barrier to Public Service (Chicago 2003).


This paper was prepared by the ABA Commission on the Impact of the Economic Crisis on the Profession and Legal Needs. The views expressed herein only reflect the views of the Commission. No resolution presented in the paper represents the policy of the association until it has been approved by the House of Delegates.

http://www.americanbar.org/aba.html

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CCMQFjAA&url=http%3A%2F%2Fwww.americanbar.org%2Fcontent%2Fdam%2Faba%2Fmigrated%2Flegaled%2Fprelaw%2FThe_Value_Proposition_of_Attending_Law_School.doc&ei=ix_NTtf9FIrg0QGi8JX6Dw&usg=AFQjCNF1RFDgo0Z2KUaztRFWiHCA9o2z0A&sig2=pf0Z0OmQHQFE9NBewkGsjw

(Google paper title for full text)

Lets break it down a bit. $100,000.00 in loans equals 198,793.33 over the course of a 30 year 5.25% loan (many student loans are less than this but the point being it comes up to $98,793.33 in interest in this example).

http://www.myamortizationchart.com/30-year/100000-dollars/5_25-percent/

So lets say the new lawyer makes $50,000.00 a year at the District Attorney's Office. That is $4,266.67 per month before taxes. After health care, taxes and pension that easily can amount to $2,800.00/month gross (representing a loss of 35% to taxes, etc.). Subtract the $550.00/ month in student loans (if you are lucky to have only one) and you get $2,250.00 per month to spend. If you spend no more than the recommended 1/3rd of your income on housing you have rent at $1,388.00. That leaves $862.00. Throw in a car loan, groceries, utilities and credit card payments and you quickly get to $0.00 before you get to entertainment even.*

So, loans+shelter+food=$0.00 at the pay grade of Assistant District Attorney. There are those that will say that these educated kids sure have a sense of entitlement, but I think the above numbers call that into question, especially when you look at what they thought they were buying.

So that great law school diploma and the certificate of admission to the bar on your wall does not mean that you will be able to start raking it in. Of course, who guaranteed that it would--I'll get to that in a moment.

In response to the complaints about the student loan industry I have heard, and agree with in principle, the refrain of "You agreed to sign for the money you pay it back." I have also heard the "You bailed out the banks, what about us." refrain. The later speaks to the sense of the unfairness in the system that weights the importance of corporate well-being above individual's well-being. This is what Occupy Wall Street is so incensed about. Since the 1980s we have heard that wealthy companies mean wealthy citizens and while you don't hear the term "trickle-down economics" anymore, it seems clear that that is the fundamental premise working here and now. I don't want to debate the relative merits of differing economic models here, that is a much bigger discussion; lets save the value judgments for later and simply state that Occupy Wall Street (OWS) sees this as economic injustice and that is what is at the root of the protests. Thus, economic injustice as OWS sees it applies the 1% vs 99% issue to the underpinning factors that create it, among them is the student loan crisis.

STUDENT LOAN WARRANTY OF MECHANTABILITY

So what is it about the student loan industry that could be considered unjust? The debtor signed the note after all.

Once executed the contract must be upheld. Each party is bound to the promises made and enumerated in the contract. Failure to abide by the agreement results in default and the non-defaulting party has various remedies to try to make them whole again. Against this principal there is the offsetting concept of a justified breach of contract. This takes the form of claims and affirmative defenses such as fraud in the inducement and detrimental reliance. These claims stem from misrepresentations during the negotiation and formation of the contract.

Some might claim a fraud in the inducement in regard to student loans, however, this strikes me a tenuous at best. Perhaps it can be used in the law school cases discussed below but absent some direct material misrepresentation or lie there is a real up-hill battle for this argument.

The heart of argument Occupy Student Loans is trying to articulate in my estimation is better categorized under another legal theory. It boils down to an old concept that was fashioned into law: the warranty.

"The warranty of merchantability is implied, unless expressly disclaimed by name, or the sale is identified with the phrase "as is" or "with all faults." To be "merchantable", the goods must reasonably conform to an ordinary buyer's expectations, i.e., they are what they say they are. For example, a fruit that looks and smells good but has hidden defects would violate the implied warranty of merchantability if its quality does not meet the standards for such fruit "as passes ordinarily in the trade".

"The warranty of fitness for a particular purpose is implied when a buyer relies upon the seller to select the goods to fit a specific request. For example, this warranty is violated when a buyer asks a mechanic to provide snow tires and receives tires that are unsafe to use in snow."

http://en.wikipedia.org/wiki/Implied_warranty

Let us say that you buy a toaster. You expect that it will toast bread. It is implied that it does so. Failure to toast bread is a breach of that warranty. The same holds true when you buy a house. You have warranty of title, i.e. you own the property and the improvements thereon. So when you take out a mortgage you get a check to buy the house and in return you get a house and the obligation to pay it back or they take the house from you.

With student loans the creditor can't reposses the education and you don't have an income yet so what they do is make sure that you can never undermine the debt, ever. That is why there is no bankruptcy on student loan debt. So, fine, there is no real collateral so the methods of collection are strengthened. When you take out a mortgage you get a house. What do you get when you take out a student loan? It is something much more ephemeral called an education. Is it simply that when you buy a house you get a warranty that you own the house and when you take out a student loan you get a warranty of some kind of education? Perhaps, but I don't think that is how most students see it.

You see, when you read stats like those found in the census report above you get the impression that one will be able to convert this "education" thing into something tangible--money. To the average student, especially as universities have narrowed down their offerings to more and more vocational areas of study and away from the liberal arts, an education is not about self improvement, it is to get you a job, it will provide the means to make money and colleges cite stats saying what percentage of their grads make x amount of dollars. Isn't this a warranty of increased earnings? The warranty is not the content of the product (education) but what the product will do (increase earnings). We don't warrant that the toaster is a toaster but that it toasts.

Now when the economy was booming the" toaster" worked well enough. There is no individual guarantee that all that money spent will make you more money later, but systematically that seemed true. With the numbers of young people flooding the market outnumbering the jobs for them however, we have a situation where there is no job and no money to pay the loan back, thus a failure of the expectation of what an education will provide and crushing life long debt to boot. We have heard anecdotes for years about the English major who now sells vacuum cleaners but that has become a wholesale experience for a generation.

Lately, law schools have been getting stuck in the tar pit of massaging their post grad employment data. It seems like the more they evade the worse it gets. The company that collects the data is on the carpet for this as well (that company makes the LSAT). The legal arguments in these cases revolve around this specific alleged misrepresentation and the detrimental reliance upon those statistics for students decision to spend their money thusly. Some claim that this is a fraud in the inducement. These arguments can also be framed more broadly, that the school breached its warranty or misrepresented that warranty.

It will be asserted that the Note doesn't warrant anything but delivery of the agreed upon sum and therefore there is no further warranty as the money is fungible. However, student loans require the sum to be spent on education. You can not, like in a home equity loan or credit line mortgage, spend it on just anything. Therefore, the purpose of the loan is for "education." Is there a warranty for education? How do you quantify that? Is it simply that you know more information at the end of college than before? Is it really money for education for the sake of education and we don't care how you pay it back or whether your degree is remotely useful to the job you ultimately found? The loan companies certainly will argue that they don't make any promises or warranties about future employment. What you do with the education your hard earned future income pays for is up to you, right. This is caveat emptor at work folks. While many will disagree, because the people in the streets are forcing us to, we have to ask the question: does the "purpose" of the loan go farther to extend beyond merely an education to imply that there is a job good enough to pay the loan back waiting for the debtor? Does not viewing it that way square with economic reality? I expect that issue to be hotly debated.

Is there a Breach of Warranty for Student Loans

Do you believe that student loans should be forgiven because they don't provide what they promised they would?

See results

CONCLUSION

So what it the takeaway from Occupy Student Loans? It is part of a larger movement that is aimed at perceived economic injustice and inequality. Whether one agrees with the idea that students are sold a false bill of goods and that the warranty of education is breached or that if you agreed to take the money you simply must pay it back and just because you have a degree doesn't mean you are entitled to a well paying job, we can see what the larger tensions at work here are.

At its core, and perhaps the core of both the tea party movement and OWS is a sense that modern America has lost touch with its Horatio Alger, rags to riches roots and that we as Americans are being crushed under the weight of some oppressive power. The Tea Party's malefactor it is the government, for OWS its big money and big corporations. Regardless of the cause, the problem is equally visceral to both groups--that problem manifests in a sense of powerlessness, lack of hope, sense of oppression, poverty and fear. It is evidenced by the grave economic inequalities in this country. Whether you feel that those inequalities are "unjust" or just part of capitalism is really neither here nor there, they exist and the civil unrest we are experiencing exists and must be dealt with. The solution for some is to enforce the status quo with aerosol Oleoresin Capsicum. The solution for others is reform. Both solutions take us into uncharted waters and uncertainty.

Our nation is based on laws. One of the most sacrosanct is that when you make a contract you fulfill what you promised. When you accept a loan you agree to pay it back on the terms agreed at the time of signing the note. That is a core, fundamental concept that we can not walk away from. Enforcing those agreements is a large part of my practice. Implicit in the agreement is that when you purchase something that it does what it says it does and the Occupy Student Loan movement says they were sold a false bill of goods. Whether later trumps the former has yet to be decided and our society is struggling mightily with the debate.


Footnote

*[For those that scoff at that total for rent please remember that for a house rent is usually set at 1% of the value of the house. If you live in NYC it is worse, $1,000.00/month isn't much there:

"In Manhattan specifically, the average rent came in at a whopping $48.33 per square foot--an estimate supported by July figures from Citi Habitats, a New York City-area real estate agency. The median monthly rent for a studio apartment in Manhattan is more than $1,900, according to Citi Habitats. If it's a three-bedroom spread that you're after, prepare to fork over somewhere in the neighborhood of $5,000."

http://www.forbes.com/2006/08/14/expensive-homes-apartments_cx_lr_0815rental.html

Sure, you can live in Queens, but even then you are looking at over $1,000.00 for 500 sq/ft in a safe neighborhood. Even if you move upstate New York you are looking at $1.00+/ sq foot realistically.]

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