Flunking Out, at a Price - In Corinthian Colleges' downfall, taxpayers and borrowers will again pay for regulatory lapses

From The New York Times:

In the years before the mortgage crisis, financial regulators often looked the other way as banks and other lenders pursued reckless activities that cost investors, taxpayers and borrowers billions of dollars. When trouble hit, these regulators had to scramble to fix the mess that their inertia had helped create.

This same dismal pattern is now playing out in the for-profit education arena.

For years, federal and state regulators have done little as dubious operators of for-profit colleges and trade schools have pocketed tuitions funded by taxpayer-backed loans. Many students left these colleges with questionable educations and onerous debt loads that cannot be erased in bankruptcy.

Regulators have finally woken up to this ugly reality. And, once again, taxpayers and borrowers will pay the price of regulatory failures.

Last week, after years of being on the financial precipice and facing accusations of improper recruiting practices by authorities in several states, Corinthian Colleges, a for-profit education company with 74,000 students in more than 100 locations around the country, began to wind down its operations. In an agreement with the federal Department of Education, Corinthian said it would halt admissions and try to sell 85 of its campuses.

At another 12 Corinthian campuses, students can continue their studies until they graduate. Certain students who choose to stop attending classes will receive refunds, the company said.

Even as the company’s fortunes faded in recent years, Corinthian’s five top executives piled up real money: Over the last three years, they’ve shared $12.5 million in salaries and cash bonuses.

But taxpayers and Corinthian students — a vast majority of whom have borrowed to finance their educations — will be the biggest losers. When Corinthian eventually vanishes, its graduates will be left holding degrees from a defunct institution. This will make it even tougher for them to get jobs, resulting in higher default rates on their federal student loans.

What kind of losses might the taxpayers incur? Let’s do some arithmetic: Corinthian students received approximately $1 billion a year in federal financial aid. So if default rates on the last two years of aid were to rise by 20 percent, that would generate $400 million in losses.

“Many of the students who have already graduated will default on their loans and will be followed by the federal government for the rest of their lives,” said Robyn Smith, of counsel to the National Consumer Law Center and author of a recent report on how states can improve oversight of for-profit schools. “If the regulators had been better at doing their jobs, this could have been avoided.”

For example, Ms. Smith pointed out that while the Department of Education had cited Corinthian in November 2012 for falling below the department’s financial responsibility standards, it still allowed the company to recruit students until last month. That put an additional $1.5 billion in taxpayer money at risk.

Even before the department placed Corinthian on the watch list, the company’s financial woes were evident, said Bradley Safalow, founder and chief executive of PAA Research, an independent research firm in New York.

In 2011, Mr. Safalow began advising clients that he expected Corinthian Colleges’ stock to fall to zero. It closed on Friday at 22 cents.

But he is not celebrating the company’s demise.

“The human impact here is fairly significant and unfortunate,” he said in an interview last week. “You would hope there would be some hard lessons learned by the Department of Education, Congress, the states and accreditors about how long this company was allowed to exist when outcomes were quite poor and major financial distress was evident.”

It isn’t clear, though, that those lessons have been learned. Given that other for-profit institutions are also facing difficulties, I asked the Department of Education in an email what it planned to do in the future to avoid a repeat of the Corinthian disaster.

Denise Horn, a spokeswoman for the department, said in a statement that its responsibility “is to ensure effective administration of Title IV programs for students and taxpayers.” She added: “The actions the department has taken are directly related to the necessary oversight when there are serious indications of fraud or noncompliance with federal regulations. The steps we took provide students the opportunity to continue their education at minimal disruption and prevent immediate closure of the schools and the loss of jobs for 12,000 employees.”

But Ms. Smith said the agreement struck between Corinthian and the department does not provide enough protection for students.

For example, she said, while the deal allows full refunds for students who enrolled after June 22, this might not cover the entire amount of a federal loan. Many loans cover living expenses in addition to tuition, but the refund provision may not.

And students would not be entitled to a loan discharge if they are enrolled in a school program that is discontinued when the school is bought by another company.

The agreement is also problematic because Corinthian will decide on any refund that students who enrolled before June 22 will receive, Ms. Smith said.

“Why is Corinthian making the decision when it is the party at fault?” she asked. It’s unclear that the Department of Education can override those decisions.

Neither is the department doing much to ensure that students understand their rights in the complex Corinthian agreement, Ms. Smith said. For example, it is not funding a legal aid program to help students apply for loan discharges, a difficult and complicated process when a school like Corinthian closes.

It’s not clear what kind of an education Corinthian students have received, and it’s too soon to determine the total taxpayer burden in the collapse. Tallying that bill will depend on whether the company can sell its colleges and keep students in place.

Perhaps Corinthian’s fall will become a teaching moment for both state and federal regulators. Here is one suggestion from Mr. Safalow: The Department of Education should monitor the financial position of for-profit colleges more closely, to protect both students and taxpayers.

“If an institution receives above $100 million in federal financial aid, maybe it should have to get a corporate financial rating from a third party,” he said. Corinthian would have been downgraded at least a year ago if it had been subjected to a sophisticated credit analysis, he added.

“Two years ago, Corinthian was deemed to have fallen short of the standards of financial responsibility,” Mr. Safalow said. “But the D.O.E. blinked. They could have accelerated the situation, but they didn’t want to close schools because that hurts students and taxpayers.”

Looking the other way also harms students and taxpayers. Can we all agree that something about this regulatory construct needs to change?