Gregory McNeil, 49, is living out his days at a veterans home in Grand Rapids, Michigan. His room is so cramped he can barely fit his twin bed, dresser, and the computer desk he had to sneak in because it was against regulations. His only income comes from the Social Security disability payments he began receiving last year after undergoing quadruple-bypass heart surgery. These payments go directly to the veterans home, which then gives him $100a month for his expenses. McNeil fears that if he leaves the home, the government will seize a portion of his Social Security to pay off the federal student loan he defaulted on two decades ago. “This veterans home may become my financial prison,” he says. “And this is no way to live.”

McNeil’s fears are well grounded. For years, private collection companies acting under contract with the U.S. Department of Education have hounded him. The government garnisheed his wages for a time, and threatened to sue him. He says he always wanted to repay, but has never had the income he would need. Meanwhile, interest continues to accrue on his debt, and has already tripled the amount he owes.

McNeil’s troubles date back to the late 1980s, when, after leaving the Navy, he decided to go back to school to study electronics. He borrowed about $15,000 in federal student loans to attend a local branch of National Education Centers, a for-profit trade school chain that claimed an exceptional track record in helping students find employment. He soon realized, however, that the training was much less than advertised. And he discovered that the company—which later shut down, due in part to a high default rate among its former students that threatened its access to federal funding—would do little to help him find a job. “They considered you placed if you were flipping burgers part time at McDonald’s,” he says.

School officials arranged one interview for him, but after that didn’t pan out he didn’t hear from them again. Mc-Neil tried to carry on with a low-paying factory job, but couldn’t keep up with his loan payments and ended up defaulting. He tried rehabilitating his loan, but after he lost his job in the recession of the early 1990s he couldn’t manage even the reduced payments. In 1994, with only $23 to his name, he felt he had no choice but to file for bankruptcy.

At the time, he thought the judge had discharged all his debts, but in 2001 collection agencies started calling at all hours, demanding payments on his student loans. The government subpoenaed him to appear in court, and the IRS threatened to seize money from his paychecks. Collection agents told him that his loans had not been discharged through bankruptcy after all, because at the time there was a seven-year waiting period before student loans could be erased through that process. In 2002, he filed for bankruptcy again to force the government’s debt collectors to back off. That worked for a while, but in 2007, the calls resumed, and they haven’t stopped since.

For a brief moment in 2008, McNeil thought he had a shot at making steady payments. He had worked as a machinist for fifteen years and reached journeyman status, meaning that his pay would nearly double, to $25 an hour. “This opened the door to me finally being able to get my defaulted student loans under control,” he says. But soon afterward, with the economy in Michigan tanking, he was laid off again. With his health failing, he knew his career was over.

Not so long ago, the kind of troubles McNeil has known were generally limited to poor and working-class people who attended shady for-profit trade schools. But these days, more and more middle-class Americans who attended mainstream public and private colleges are having trouble with the loans they took out to finance their educations, and they too are getting caught in the often brutal gears of the system that manages those loans. In the absence of serious reform, the feelings of rage and helplessness that accompany such experiences are likely to become much more common.

One reason is the ever-rising cost of higher education. In the early 1990s, fewer than half of bachelor’s degree recipients graduated with student debt. Today, two-thirds do. The average amount of debt amassed has risen by 50 percent since 1993, to about $25,000. According to the Project on Student Debt, the proportion of students who graduated from four-year colleges owing at least $40,000 has grown, from 3 percent in 1996 to 10 percent in 2008. Four out of five of these recent borrowers took out high-cost private student loans on top of their federal loans.

Undergraduates leaving college today are also entering the worst labor market in decades. More than half are either unemployed or working in jobs that don’t require a college degree. For the 42 percent of college students who drop out before graduation, the burden of financing a degree they never received is often even more crushing. Just 26 percent of former students who took out loans and left school without a degree are keeping up with their payments.

Yet those numbers don’t come close to capturing the full extent of the crisis. According to a report released last year by the Institute for Higher Education Policy, more than half of all borrowers who started paying back their student loans in 2005 became delinquent, defaulted, or put their loans into forbearance to delay payments within five years. It is unacceptable, of course, that some students take out loans without having any intention of paying them back. But our current fearsomely complex student debt management and collection system, as it has evolved over the last generation, makes no distinction between deadbeats who don’t plan on paying back their loans and the much greater numbers of people who just don’t have the money to do it. Few policymakers understand what happens to such people once they fall into the clutches of collection agencies, or even who they are.

And for many borrowers, there is no way out. Unlike mortgages and credit card debt, student loans these days cannot be erased through bankruptcy except in rare cases of extreme hardship. And there is no longer any statute of limitation for prosecuting those who fall behind on their loans. As Deanne Loonin, director of the National Consumer Law Center’s Student Loan Borrower Assistance Project, has written, “Even rapists are not in this category since there is a statute of limitations for rape prosecutions, at least in federal law and in most state laws.”

Over the years, politicians, even liberal ones, have paid too little attention to what happens on the back end of the student loan system to those who can’t afford to make their payments. Instead, Democrats have focused on trying to broaden access to higher education by making student loans more available and less costly on the front end. In 2010, the Obama administration achieved a major victory in this access agenda when he signed legislation ending the wasteful practice of subsidizing banks to make student loans. Since the summer of 2010, all federal student loans are now made directly by the government, saving the Treasury $68 billion over eleven years (half of which is going to expanded Pell Grants for needy students). But this monumental reform of the front end of the student loan system leaves the back end untouched, meaning that more and more Americans— people like Gregory McNeil—are left at the mercy of predatory debt-collecting contractors. Having kicked the banks out of the student loan business, it’s high time to get rid of the repo men, too.

The federal government first started underwriting student loans in 1965. At the time, the Johnson administration and Congress made clear that federal loans would be available to all eligible students, regardless of their credit history. Students would also not have to post any collateral to obtain loans.

The risks proved to be quite manageable. A 1977 GAO report found that less than 1 percent of student loans were discharged in bankruptcy. Nonetheless, stories of deadbeat doctors and lawyers escaping their federal loans in bankruptcy took hold in the public imagination, much like those about welfare queens.

In response to these anecdotes, Congress barred federal student loan borrowers from being able to discharge their debt in bankruptcy during the first five years of repayment unless they could prove “undue hardship.” Lawmakers took this action over the objections of Michigan Democrat James O’Hara, then chairman of the House Subcommittee on Postsecondary Education, who argued that Congress was trying to remedy “a ‘scandal’ which exists primarily in the imagination.”

In 1981, Ronald Reagan’s Department of Education began contracting with private companies to collect on defaulted federal student loans. In 1982, a new law allowed the government to withhold federal benefits (not including Social Security) from those in arrears. But the real crackdown came in the early 1990s, after student loan default rates skyrocketed as a result of widespread abuses by unscrupulous trade schools. Worried that these scandals would jeopardize popular support for the federal student aid programs as a whole, Democrats joined with President H. W. Bush’s administration to rein in the trade schools and strengthen the tools the government uses to collect on defaulted loans. Congress extended the waiting period before which federal student loans could be dischargeable in bankruptcy to seven years. And, much more significantly, it changed federal law to put default on student loans into the same criminal category as murder and treason by eliminating the statute of limitations under which student loan borrowers could be prosecuted.

Liberals went along with many of these crackdowns, and even proposed some of their own. President Clinton, for example, signed a law that made it even harder to discharge federal student loans through bankruptcy and allowed the Education Department to tap into a federal database—originally designed to enforce child support payments—to track down and garnishee the wages of those who defaulted on student loans.

George W. Bush’s administration proved even more zealous. It aggressively collected on long-overdue debt, by, for the first time, seizing Social Security payments from elderly and disabled defaulters and signing legislation ending bankruptcy protection for borrowers who take out risky private student loans. Nor has the Obama administration been shy; last year, President Obama called on Congress, as part of a larger deficit reduction proposal, to allow collection agencies to use automated dialing to contact defaulted borrowers’ cell phones.

Why have even liberal politicians been willing to make the student loan repayment system ever more draconian? Partly it’s because, in an age of federal deficits, they’ve been desperate to find ways to boost government revenue without raising taxes. Partly it’s been a general political eagerness to signal that they are not about to coddle deadbeats.

But it’s also because, for years, a number of Democrats have had a vision about how to crack down on freeloaders while at the same time easing the burden on borrowers who through no fault of their own simply cannot repay their loans. The idea is the income-contingent loan, or ICL (see “Answering the Critics of ‘Pay as You Earn’ Plans“), whereby people who take out student loans can repay them based on a fraction of their annual income, rather than fixed payments. The free-market economist Milton Friedman came up with the basic concept in the 1950s as an alternative to state funding of higher education, and it was tested in pilot form by the Reagan administration. But by 1988 Democratic presidential candidate Michael Dukakis was advocating a version of the idea as a way to make student loans more affordable.

Bill Clinton made ICL a central plank in his 1992 presidential campaign. He argued that such loans would not only offer relief to borrowers who never managed to graduate or became unemployed, but would also make it easier for students to embark on socially vital but low-paying public service careers, such as teaching or social work. He also championed the idea that the federal government could save money by making loans directly to students rather than paying banks to do so. In 1993 he signed legislation creating both a direct lending program (the one Obama would expand in 2010) and an ICL option. The hope was that the two initiatives together would provide a cheaper, simpler, and safer alternative to the traditional student loan system. But lobbyists for the banks, whose subsidies were threatened, convinced Congress and Department of Education regulators to limit the reach of the two programs, and for years relatively few borrowers were made aware of them.

Even borrowers who do learn of the income-contingent option often face a bureaucratic nightmare when they try to exercise it. Consider the case of Kayleen Hartman. When she first entered Georgetown University Law Center in 2008, she knew she wanted to become a human rights lawyer, and that such a career would likely give her only a modest income. The only reason she thought she would nonetheless be able to carry the cost of her law degree was that she planned to repay her federal student loans through an updated and more generous version of the Clinton initiative called the income-based repayment, or IBR, program.

So after she graduated in May 2011 and passed her bar exam later that summer, she put in the paperwork for consolidating all her federal loans and using the IBR option for repaying them. But she didn’t hear back from the Department of Education for months—and became alarmed when she started getting letters from her original lenders warning her that she was overdue on her payments. By February, completely panicked, she started trying to reach the loan “servicer.” Servicers are the organizations (some for-profit, some nonprofit) that the government or lenders hire to handle the paperwork on student loans. The servicing representative she talked to dismissed her concerns, saying that the consolidation would be completed any day now. It wasn’t until April that she learned that the department was having trouble consolidating one of her loans—a Perkins loan she had received through her alma mater, Davidson College. The department had been alerted to the problem months earlier, but for some reason the servicer was unaware of it. Meanwhile, her original loans had become delinquent and were in danger of defaulting.

The consolidation was finally completed in May, and she thought her problems were behind her. In her application for consolidation, she had checked a box indicating that she wanted to repay through IBR, and assumed that she would now hear from the department about how to enroll in the program. Instead, she received her first monthly bill from the department for $1,600, a figure that represented half of her take-home pay. She called the servicer again, and learned for the first time that she had to fill out a separate application and submit a copy of her income tax return.

A servicing representative mailed her the form, and she promptly returned it with all of the required documentation. She once again thought she was in the clear, until she received another bill for $1,600. Irate, she called the servicer again, only to be told that the servicing company had never received her application. The representative first questioned whether she had really sent the form, and then accused her of sending it to the wrong address.

Now she is waiting for the servicer to mail her a new application form to fill out. Nearly a year has passed since she began the process, and even with a law degree, she has still not figured out how to make the bureaucracy and its various contract agents deliver a benefit to which she is clearly entitled by law. Meanwhile, because her loans have become delinquent while she’s waited for the department to refinance her loan, her credit is shot. The experience, she says, has been “maddening.” She no longer trusts that the department’s servicing representatives have her best interest in mind. And get this: assuming she ever gets approved for IBR, she’ll have to repeat the application process every year, according to current law, or be automatically kicked out of the program.

Why do the servicers provide such lousy service? One
reason is basic institutional incompetence, says the National Consumer Law Center’s Loonin. But just as important, she says, is the complexity of the regulations that govern the terms and procedures of the various student loans. Even servicing representatives who are sincerely trying to help “really don’t understand the programs,” says Loonin. And, of course, if the loan professionals have trouble grasping the nuances of all the loan programs, what chance do average borrowers have? (For an as-simple-as-we-can-make-it explanation of federal student loan repayment options, see “Got Student Debt?“)

If loan servicers can be exasperating to deal with, the debt-collecting companies can be downright scary. The federal government contracts with twenty-three such firms to collect on loans in default, paying the industry hundreds of millions of dollars annually in fees and commissions. Well-documented horror stories abound about how these collection agencies routinely fail to inform borrowers about repayment options to which they are entitled, demand excessive payments, refuse to provide documentation to back up their claims, call at all hours, harass borrowers’ friends, family members, and neighbors, and generally lash out in abusive and threatening ways.

One of the most aggressive loan-collection firms is Pioneer Credit Recovery, a subsidiary of student loan giant Sallie Mae. Consumer Web sites are full of complaints about the company’s practices. Meanwhile, former Pioneer collectors recently told Bloomberg Businessweek that the company has a “boiler room” culture, where low-paid workers are richly rewarded for squeezing the most money they possibly can out of defaulted borrowers. Those who miss their targets are under constant threat of losing their jobs. “When you’re making eight bucks an hour, it’s all about the bonuses,” said a former Pioneer employee who worked at the collection agency from 2004 to 2007.

Despite such complaints and accusations, Pioneer regularly scores at or near the top of the rankings the Education Department uses each quarter to reward the best performing of its debt-collection contractors with new accounts and generous bonuses. Why? Because the rankings are based almost entirely on the amount of dollars collected, with little regard for how borrowers are treated.

In theory, the department could discipline collection agencies that are known to abuse borrowers by cutting the companies’ fees or ending their contracts. But in 2003, the Department of Education’s inspector general released a disturbing report that took the department to task for its complete and utter failure “to track and monitor complaints” that were made against the collection agencies. By neglecting to follow its own detailed policies for reviewing complaints, the Education Department, the report concluded, didn’t have any idea whether its contractors “were appropriately servicing borrower accounts and adhering to applicable laws and regulations.”

The National Consumer Law Center’s Student Loan Borrower Assistance Project recently found that little has changed in the intervening years. In a report it released in May, the group revealed that the Department of Education and most of the collection companies it hires make it unnecessarily difficult for defaulted borrowers to even lodge complaints. “As long as the Department and its contractors can deploy extraordinary collections tactics to recover federal loans, borrowers must have an accessible way to register their dissatisfaction,” said the report.

In recent months, the Obama administration has taken some steps to address the mess on the back end of the student loan system. The Department of Education has proposed new rules that would require all collection agencies to determine how much income and expenses defaulted borrowers have—something the department hasn’t required them to do until now—and to then craft repayment plans based on the borrower’s ability to pay rather than demand minimum payments based on the original loan amounts. The president has also ordered the department to set up a system to allow borrowers to apply for income-based repayment online without having to go through servicers.

But while these reforms might provide easier paths for many struggling borrowers, they largely leave the current system and its many dysfunctions in place. Borrowers will still be reliant on the servicers to tell them about their repayment options, including IBR. Collection agencies will still be paid based on how much revenue they can extract from defaulted borrowers, which means they will have strong incentive to find ways not to comply with the new requirements. The Department of Education’s lax system of oversight of servicers and collection agencies shows no real signs of improving.

Even if these incremental measures could bring some improvement, it’s worth asking some bigger questions: Is this even the system we want? Do student loan repayment options need to be so impossibly complex? Is it really necessary to subject borrowers to the caprice, incompetence, and abuse of loan servicers and collectors? Should our system take no account of the reality that some students embark on careers that are vitally needed by society but that only pay modest or uneven income, from being a primary care doctor to starting a new business?

As it happens, there is a better way. We could follow the lead of countries like Australia, New Zealand, and the United Kingdom and create a single student loan repayment system that is entirely based on a borrower’s future income. Under such a program, employees with federal student loans would see a portion of their income withheld by their employers and used to pay down their debt, much as they see payroll taxes withheld today. Self-employed borrowers would use a simple schedule on their federal income tax forms that would tell them how much they owed on their federal student loans. When a borrower’s adjustable gross income went up or down, so would their monthly payments, with the only enforcement mechanism needed being the Internal Revenue Service. Defaults would be virtually eliminated, along with the need for the government to spend tax dollars on collection agencies. Borrowers with high incomes would simply pay off the loans more quickly than those with low incomes. (For answers to questions critics of ICL raise, see “Answering the Critics of ‘Pay as You Earn’ Plans“)

The proposal is a win-win. Efforts would still be needed to crack down on college dropout factories and shady trade schools, and to promote improved efficiency and accountability throughout higher education. But borrowers would no longer be left on their own to navigate among a dizzying array of repayment options as their debts spiraled. Nor would anyone need to forsake such callings as family medicine or social work, or even being an entrepreneur, just because of the crushing burden of fixed student debt payments. And above all, the millions of today’s younger Americans who are earnestly trying to repay their debts would not need to endure the hell faced by struggling former students like Gregory McNeil. If this proposal seems political impossible, consider that the Obama administration has already gotten the banks out of the student loan business. Having done that, surely it will be easier to throw over the repo men.

Stephen Burd

Stephen Burd is a senior policy analyst in the Education Policy Program at the New America Foundation.