Prepared Remarks of CFPB Director Rohit Chopra at Rutgers Law School Center for Corporate Law and Governance

It’s been a pleasure to be back in Philadelphia and Camden today. Thank you to the Rutgers Law School Center for Corporate Law and Governance for having me.

Today, I want to talk about the subprime-style lending powered by securitization that plagued the country twenty years ago. I am not talking about mortgages. I'm referring to another subprime machine that got less attention at the time, but is more front-and-center today: student loans.

First, I am going to explain a bit about student-loan securitization. Then, I want to tell you about a lawsuit the CFPB filed that was focused on a securitization trust, including a recent opinion issued in the Third Circuit Court of Appeals, which covers where we are sitting today. I'll close with some thoughts about how the CFPB and other law enforcement agencies are thinking about other corporate forms and their responsibilities under the law.

Student-Loan Securitization

Law students across the country are taking on enormous debt. According to one study, the average law student owes $160,000 in student loan debt, with nearly three-quarters of that debt coming from the cost of law school.¹ This is particularly challenging for those attending private and for-profit institutions. Indeed, the same study found Rutgers to be one of the more affordable top-tier law schools to attend.

Student debt now tops $1.6 trillion², and many law students feel the anxiety of debt and how it may distort their career choices.

The size of the student loan market unsurprisingly has attracted investors over the years. One way loan originators can take advantage of interest from investors is through securitization.

Here’s how securitization works: while there are a couple of technical intermediate steps, the loan originator – the firm who actually lent consumers the money – sells the bundle of loans to a trust, which is just a separate legal entity set up for this purpose.

The trust turns the loans into bonds by issuing certificates to investors that promise to pay them some portion of the cash flows, the principal and interest, generated by the loans owned by the trust. Now, these securities can slice and dice the cash flows produced by the loans in all sorts of complex ways to provide the investor with more or less risk than the loans carry themselves. And to close the loop, the trust uses the money investors pay to purchase the loans from the originator.

At this point, the investors own bonds based on the loans, but the trust owns the loans themselves. The trust is in charge of collecting interest and servicing the loans, including by hiring third parties.

Turning loans into bonds – or securitization – enables banks and other loan originators to gain immediate liquidity. That is to say, after originating a loan and selling a loan to a trust, it now has money freed up to go make another loan. And, instead of keeping the risk on their own books, the originator can sell to a trust that then spreads the risk across a broader universe of willing investors. In theory, this should drive down borrowing costs for consumers – so long as there are willing buyers for the loans.

While slicing and dicing cash flows is an old concept, modern securitization, which started with mortgages, can trace its roots to right after the Second World War. A housing crunch followed the millions of servicemembers returning home once the war ended. One reason for the housing crunch was that banks did not have the liquidity to make and hold all the mortgages that the economy needed. Bankers eventually developed an investment vehicle that isolated defined mortgage pools, segmented the credit risk, and structured the cash flows from the underlying loans.³ In other words, they developed securitized assets. Over time, the product class has moved beyond mortgages and even beyond lending products with fixed terms.

Securities backed by student loans have seen significant growth. In 2007, about half-a-trillion dollars of student loans were owned and securitized. At the end of last year, that figure stood at more than $1.7 trillion.⁴

Securitization of student loans began in November 1992. One of the first types of student loans to be securitized were those issued through the Federal Family Education Loan (FFEL) Program. These loans were federally guaranteed but issued through private lenders. Securitizing student loans opened the door to similar problems seen in the mortgage market in the lead up to the Great Recession. Specifically, that lenders become incentivized to make as many loans as possible – i.e., make the loans, sell them off, and use the raised money to make more student loans.

These incentives and weak oversight by federal regulators led to a number of scandals, involving kickbacks from lenders to schools and financial aid offices. In 2008, Congress banned many of these practices. Congress also ended the FFEL program with the 2009-2010 school year, though many still owe on these loans.

Private student loans were also able to be securitized beginning in 1992. However, at the time, private student loans were not a significant portion of the market. While government-guaranteed loans were established expressly to support people’s ability to attend college, private student loans really came into existence to bridge the gap between what students received from the government and the actual cost of college. And private student loans generally offered worse terms. There was not a reason to take out private loans so long as college was affordable.

As the cost of college steadily increased, so too did the share of private student loans. While private student loans do come with some underwriting standards, we saw those standards fall along with mortgage standards in the lead-up to the 2008 crisis.

Specifically, in the lead-up to the crisis, some lenders bypassed school financial aid offices and marketed loans directly to students. As a result, in many cases, the school could not review the borrower’s financial need, compare it to the loan amount, or even verify that the borrower was enrolled. Many lenders also lowered the minimum credit score required to receive a private student loan so that they could originate and then sell off more loans. Many students did not understand the differences and features between federal and private loans. They ended up using riskier private loans before exhausting their safer federal options.

In a joint report with the U.S. Department of Education, the CFPB found students were yet another group of consumers that were hurt by the boom and bust of the financial crisis. Specifically, as private student loans were funded in large part by the asset-backed securities market, many lenders made money by originating and then selling private student loans with less regard for borrowers’ creditworthiness. In terms of overall outstanding student loan volumes, the private student loan market grew from less than $5 billion in 2001 to over $20 billion in 2008, and then rapidly contracted to less than $6 billion in 2011.⁵

When Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which created the CFPB, it established a number of responsibilities for the CFPB in the student loan market.

That leads me into discussing the Third Circuit decision in CFPB v. National Collegiate Student Loan Trusts.

The CFPB’s Enforcement Action against the National Collegiate Student Loan Trusts

In September 2017, the CFPB took action against a group of 15 securitization trusts known as the National Collegiate Student Loan Trusts and their debt collection servicer, Transworld Systems, for unfair and deceptive practices in debt collection lawsuits against defaulted student loan borrowers.

In 2017, the Trusts owned more than 800,000 student loans. Between 2001 and 2007, the Trusts purchased and securitized the loans, and then sold notes secured by the loans to investors. Over time, some of the borrowers on those student loans fell behind on their payments and ultimately defaulted. In order to sue to collect on a debt, the person or company filing suit must be able to prove that the consumer owed the debt and that they own the loan that is being collected. But by the time Transworld Systems was filing collection lawsuits on the Trusts’ behalf, it lacked documents necessary to prove ownership and the statute of limitations, the deadline for a plaintiff to file a lawsuit, on many loans had expired.

The Trusts and Transworld Systems went forward with debt collection lawsuits anyway. In fact, over 2,000 collections lawsuits were filed on behalf of the Trusts. In these lawsuits, the Trusts did not have or could not find the documentation necessary to prove either that they owned the loans or that the targeted consumers owed the debts.

In some of these cases, the Trusts could not even produce evidence the consumer ever agreed to pay back the loan. Nonetheless, the Trusts filed suit against the consumers to collect the debts. Further, in many of the collections lawsuits, the Trusts filed false and misleading affidavits.

The CFPB sued the trusts for this conduct. We contend that it violates the Consumer Financial Protection Act. They argued that, as trusts, they were not covered persons under the Consumer Financial Protection Act. Their argument was that the CFPB could only sue the people who did the dirty work – the debt collectors and servicers – not the trusts who hired them to do it on the Trusts’ behalf.

The case made its way to the Third Circuit Court of Appeals. A decision against the CFPB could have been read to suggest the law does not cover the institutions actually calling the shots in many financial transactions. In securities markets, a negative decision would have had the potential to be especially dangerous, given the investment nature of securitization.

Decision by the United States Third Circuit Court of Appeals

The Third Circuit resolved that the Trusts are “covered persons” under the Consumer Financial Protection Act because they engage in offering or providing consumer financial products or services.

The Third Circuit cited the 15 trusts’ own intra-trust agreement, and made four key points. First, the Trusts acquired student loans in order to begin an enterprise or activity.

Second, the Trusts entered into agreements with third-party servicers. Those agreements acknowledged that the third parties were carrying out activities that would otherwise be the direct responsibility of the Trusts.

Third, without the third-party servicers, the Trusts could not fulfill their obligations of servicing student loans. The Trusts did not have any employees and made themselves dependent on third-party servicers to carry out servicing requirements.

Fourth, the lawsuits brought against borrowers were done to benefit the Trusts. “As such, the Trusts cannot claim that they did not ‘take part in’ collecting debts.”⁶

In other words, the Trusts engaged in conduct making them a covered person, even though they did so by hiring other companies to act on their behalf. They wanted to collect debts, including through debt collection and lawsuits. The trusts entered into special servicing agreements with others in order to provide for the servicing, collection, and litigation of delinquent and defaulted loans.

The Trusts cannot use the fact that they hired someone else to do the job to avoid coverage under the Consumer Financial Protection Act. Accordingly, the Third Circuit Court of Appeals returned the case to the district court, in order for the Trusts to face accountability.

As the Court affirmed, people and entities can be considered covered persons under the Consumer Financial Protection Act, even if they do not directly perform certain activities themselves. Instead, if they arrange for others to carry out these activities on their behalf, they can still be held liable. Those who control and direct the activities are accountable, not just the third parties they hire.

It is important to ensure that owners and others have the right incentives not to hire people to break the law on their behalf.

This is particularly relevant for securitized trusts, because it means that the owners cannot sidestep their responsibilities under the law. It also means owners and others cannot evade accountability when they hire or contract with lawbreakers to work on their behalf.

Thank you.

References

1. Average Law School Debt [2023]: Student Loan Statistics (educationdata.org)

2. Household Debt and Credit Report - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org)

3. Asset Securitization (occ.treas.gov)

4. FRED Economic Data (fred.stlouisfed.org)

5. CFPB and U.S. Department of Education Joint Report Finds a Cycle of Boom and Bust in Private Student Loan Market (consumerfinance.gov)

6. Consumer Financial Protection Bureau v. National Collegiate Master Student Loan Trust (uscourts.gov)