The Law School Bubble

[sallyawp]

<p>Though this has been much discussed on this board of late, I thought it might be interesting to some that the American Bar Association published an article on “The Law School Bubble” in the January 2012 edition of the ABA Journal. Interestingly, the perspective of the article is that the tremendously high amount of student loans that many law students take on may threaten the futures of some law schools. I’ve attached some selections from the article for those who may be interested. </p>

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In 2010, 85 percent of law graduates from ABA-accredited schools boasted an average debt load of $98,500, according to data collected from law schools by U.S. News & World Report. At 29 schools, that amount exceeded $120,000. In contrast, only 68 percent of those grads reported employment in positions that require a JD nine months after commencement. Less than 51 percent found employment in private law firms.</p>

<p>The influx of so many law school graduates—44,258 in 2010 alone, according to the ABA—into a declining job market creates serious repercussions that will reverberate for decades to come.

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<p>

Very few critics, however, have examined the part played by the federal government through its student loan policies in creating a law school bubble that may be on the verge of bursting—one strikingly similar to the mortgage crisis that cratered the economy in 2008.</p>

<p>Direct federal loans have become the lifeblood of graduate education, and they shelter law schools financially from the structural changes affecting the profession. The bills are now coming due for many young lawyers, and their inability to pay will likely bring the scrutiny of lawmakers already moaning about government spending.

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In 2010 Congress passed the Student Aid and Fiscal Responsibility Act, part of President Barack Obama’s final health care overhaul, which ended federally guaranteed student loans and replaced them with direct loans made through the Education Department. In effect, by converting the loan guarantees into an income-producing asset, the federal budget was reduced by $61 billion over 10 years.</p>

<p>Some of that savings was earmarked for additional educational grants and funding for community colleges. But some was allocated to help fund the national health care plan, hence its inclusion as part of the health care bill.</p>

<p>In the short term, the student loan overhaul may have been brilliant political maneuvering. But in the longer term, if a large portion of students don’t repay their full loans, the perceived benefits of interest income on direct federal student loans will become an enormous financial liability. And there are good reasons to believe this might happen.

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The protections for the U.S. Treasury are largely on the back end: Changes to the federal bankruptcy code over the last 15 years have made it extremely difficult to discharge student debt.

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Though the latest loan default rates are far below the 22.4 percent peak in 1990, according to Education Department figures, they have been rising since 2003.

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<p>

Likewise, the Congressional Budget Office may have underestimated the extent to which students will be eligible for the federal Income-Based Repayment plan, a relatively new innovation. IBR caps student loan repayment at 15 percent of adjusted gross income. Extensive use of that plan would both reduce revenues and create a shortfall in program funding for new loans.

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<p>

The federal government’s gamble that higher education will continue to result in higher personal incomes eerily echoes Wall Street’s risky assumption that historical patterns in real estate values would carry forward forever and enable many sliced-and-diced mortgage-backed securities to attain AAA ratings.

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<p>

For law students who have not defaulted on prior federal student loans, the first $20,500 per year in loan funding is typically a federal Stafford loan at an annual interest rate of 6.8 percent. Because the yearly cost of law school attendance often far exceeds $20,500, a large proportion of students take out federal Direct PLUS loans, which carry a 7.9 percent yearly interest rate plus a 4 percent one-time charge at the time of disbursal. The only limit imposed is the cost of attendance minus any other financial assistance.</p>

<p>Students who choose the highest-ranked school to accept them tend to be the biggest borrowers because their LSAT scores and undergraduate GPAs are more likely to be below the school’s median statistics. As a result, these students get less merit scholarship aid, which pushes their cost of attendance to $40,000-$65,000 per year. After three years, the cumulative debt is $120,000-$195,000, with a blended interest rate of roughly 7.3 percent.</p>

<p>Assuming a total debt of $150,000 (the amount currently carried by several thousand law graduates), the total monthly payment is $1,743.46 a month for 10 years, according to the Education Department’s repayment calculator. For law graduates who opt for the 25-year graduated payment plan, which starts at about $930 a month and increases over time, that amortizes to $357,229, more than double the original amount.

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<p>

According to NALP, the association for legal career professionals, the median starting salary for a lawyer who graduated from law school in 2010 is $63,000. For a recent, unmarried law school graduate making $63,000 and getting single-digit-percent annual pay increases, the chasm between income and prospective repayment is impractical for both the student and the government.</p>

<p>This combination of high debt and moderate income makes this all-too-typical law graduate eligible for the federal government’s income-based repayment program. According to FinAid’s IBR calculator, used by many law school financial aid counselors, the student will make monthly payments of $584 the first year and $1,605 in year 25. After 25 years, the loan is forgiven. At that time, more than half of the principal, $76,000, will not have been repaid, along with $26,000 in capitalized interest.</p>

<p>The government write-down for this student is about $103,000, which may be offset by an eventual tax payment: Under the current Internal Revenue Code, the law school grad would have $103,000 in imputed income for the debt forgiveness. Of course, the government would have to collect it from someone near enough to retirement to be eligible for membership in AARP.

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[crankyoldman]

<p>Everyone thinking of attending law school should read this article. It’s available on-line, and while the focus is more on the “bubble” aspect of the endless loans-and endless student debt-it clearly lays out the financial hazards of attending law school.</p>